CHAPTER III

CREDIT AND CAPITAL

THE NATURE AND FUNCTION OF CREDIT1

THE fundamental notion that the essence of economic development consists in a different employment of existing services of labor and land leads us to the statement that the carrying out of new combinations takes place through the withdrawal of services of labor and land from their previous employments. For every form of economy in which the leader has no direct power of disposal over these services, this again leads us to two heresies: first to the heresy that money, and then to the second heresy that also other means of payment, perform an essential function, hence that processes in terms of means of payment are not merely reflexes of processes in terms of goods. In every possible strain, with rare unanimity, even with impatience and moral and intellectual indignation, a very long line of theorists have assured us of the opposite.

Economics, almost since it became a science, has continually resisted the popular errors which cling to the phenomenon of money — quite rightly. This has been one of its fundamental services. And whoever thinks through what has been said so far will easily be convinced that none of these errors is maintained in it. Of course if one were to say that money is only a medium for facilitating the circulation of goods and that no important phenomena can be connected with it, this would be false. If one would forge out of this an objection against our argument, then it would be at once refuted by our proof that in our case a different employment of the system's productive powers cannot be achieved otherwise than by a disturbance in the relative purchasing power of individuals. We saw that, in principle, a loan of the services of labor and land by workers and landlords is not possible. Nor can the entrepreneur himself borrow produced means of production. For in the circular flow there would be no idle stocks for the needs of the entrepreneur. If somewhere or other exactly such produced means of production as the entrepreneur needs happen to exist, then of course he can buy them; for this, however, he again needs purchasing power. But he cannot simply borrow them, for they are needed for the purposes for which they were produced, and the possessor cannot and will not wait for his return — which the entrepreneur could indeed reimburse him for, but only later — and also can and will bear no risk. If someone nevertheless does this, then two transactions occur, a purchase and an extension of credit. Both are not only two legally distinct parts of one and the same economic process, but two very different economic processes, to each of which very different economic phenomena adhere, as will be seen later. Finally the entrepreneur also cannot “advance” 2 consumption goods to workers and landlords, simply because he has none. If he buys them, then he needs purchasing power for that purpose. We cannot get over this point, since it is always a question of drawing goods out of the circular flow. With respect to the loan of consumption goods, the same holds true as for the loan of produced means of production. Thus we are asserting nothing mysterious or strange.

It is clear that there would be no sense in objecting that nothing essential “can” depend upon money. Actually purchasing power is the vehicle of an essential process; of this there can be no doubt. Moreover the objection cannot really be made at all, because everyone acknowledges the analogous phenomenon that changes in the quantity or distribution of money can have very far-reaching effects. But this observation has stood on a side-track so far. Yet the comparison is quite instructive. Here too there is not necessarily a change in the sphere of goods, a preceding cause on the commodity side, which could be resorted to for explanation. Goods behave quite passively in any case. Nevertheless their kind and quantity are, as everybody knows, very much influenced by such changes.

Our second heresy is also far from being as dangerous as it seems. It also rests, in the ultimate analysis, on a fact that is not merely demonstrable and even obvious but also generally acknowledged. Means of payment are created in the economic system which are, in their external form, it is true, represented as mere claims to money, but which differ essentially from claims to other goods in that they perform exactly the same service — at least temporarily — as the good in question itself, so that they may under certain circumstances take its place.3 Not only is this recognised in the literature on money and banking, but also in theory in the narrower sense. This can be seen in any textbook. We have nothing to add to the observation, but only to the analysis. The problems the discussion of which had most to do with the recognition of the fact were the questions of the concept and value of money. When the quantity theory set up its formula for the value of money, the critics first seized upon the fact of other means of payment. It is well known too that the old question whether these means of payment, more especially bank credits, are money has been answered affirmatively by many of the best writers. But it is sufficient that it was put. In any case the fact with which we are concerned has been recognised without exception so far as I know, even by those writers who answered the question negatively. It was also always explained, in more or less detail, how and in what forms the matter is technically possible.

This implies recognising that the circulating media so created do not merely represent an equal quantity of metal money, but that they exist in such quantities that they could not possibly all be redeemed at once; and further, that they not only replace, for the sake of convenience, sums of money which previously circulated, but also appear newly created side by side with the existing sums. Likewise the point, by no means essential for us, but which we maintain for purposes of exposition, that this creation of means of payment centres in the banks and constitutes their fundamental function, we find agrees with the prevailing conception. The creation of money by the banks establishing claims against themselves, which is described by Adam Smith, and indeed by still earlier authors in a way quite free from popular errors, has become a commonplace to-day; whereupon I hasten to add that for our purposes it is all the same whether or not one regards the expression “creation of money” as theoretically correct. Our deductions are completely independent of the particulars of any monetary theory.

Finally, there can be no doubt that these circulating media come into being in the process of granting credit and are created especially — neglecting the cases in which it is only a question of avoiding the transport of metal money — for the purpose of granting credit. A bank is, according to Fetter (Principles of Economics, p. 462), “a business whose income is derived chiefly from lending its promises to pay.” So far I have said nothing controversial and so far I do not even see the possibility of a difference of opinion. No one can reproach me with offending against, say, Ricardo's statement that “banking operations” cannot increase a country's wealth, or with making myself guilty of, say, a “vapory speculation”4 in Law's sense. Furthermore, who would deny the fact that, in some countries, perhaps three-quarters of bank deposits are simply credits,5 and that the businessman as a rule first becomes the bank's debtor in order to become its creditor, that he first “borrows” what he uno actu “deposits,” to say nothing of the fact that only a negligible fraction of all transactions are and can be effected by money in the strict sense? Therefore I shall not consider these things more closely. There is really no purpose in advancing explanations here which anyone to whom they offer anything new can find in every elementary book. That all forms of credit, from the bank-note to book-credits, are essentially the same thing, and that in all these forms credit increases the means of payment, is also held to be uncontroversial.6 So far only one point can be controversial. Most of these circulating media obviously cannot be created without a basis consisting of legal tender or commodities. I believe I do not err when I say that to the businessman as well as to the theorist the producer's bill of exchange appears as the typical example of such circulating media. The producer, after completing his production and selling the product, draws on his customers, in order to turn his claim into “money” immediately. Then these products serve as the “basis” — in concreto say bills of lading — and even if the bill is not backed by existing money, it is based instead upon existing goods and so still in a certain sense upon existing “purchasing power.” The deposits mentioned above obviously also arise to a great extent from the discounting of commercial paper of this kind. This could well be considered as the normal case of granting credit or putting credit instruments into the channels of commerce, and every other case might be called abnormal.7 But even in those cases where there is no question of settling a normal commodity transaction, collateral is usually demanded, and therefore what we call “creation” would only be a question of the mobilisation of existing assets. At this point we should therefore come back again to the traditional conception. In fact the latter seems to triumph, because then there would not only be no circulating media without a basis, but even money could be abstracted from and hence everything would be traced back to the exchange of commodities for commodities, that is, purely to processes in the sphere of goods. This interpretation also explains why it is generally believed that the “creation of money” is merely a technical matter, with no deeper significance for the general theory of economic life, which can safely be relegated to a chapter on banking methods.

We do not wholly agree with this. For the time being it need only be emphasised that what practice designates as “abnormal” is only the creation of circulating media which pretend to be the result of regular commodity transactions, without such being the case. Apart from this, finance bills are not simply something “abnormal.” They are, it is true, not creations of credit for financing new combinations, but they frequently come to much the same thing. As regards the collateral, which in such cases cannot be existing products but only other things, its significance, in principle, is not that the assets constituting the collateral are “mobilised” by the granting of credit. This is not a good characterisation of the nature of the thing. On the contrary we must distinguish two cases. First, the entrepreneur may have some kind of security which he can mortgage at the bank.8 This circumstance certainly makes it much easier for him in practice to obtain credit. But it does not belong to the nature of the thing in its purest form. The entrepreneurial function is not, in principle, connected with the possession of wealth, as analysis and experience equally teach, even though the accidental fact of the possession of wealth constitutes a practical advantage. In view of the cases in which the latter circumstance is absent, this interpretation can hardly be challenged, and it follows then that the statement that credit as it were “coins property” is not a sufficient formulation of the matter. Or secondly, the entrepreneur may mortgage goods, which he acquires with the borrowed purchasing power. The granting of credit comes first and collateral must be dispensed with, at least in principle, for however short an interval. From this case the conception of putting existing assets into circulation receives still less support than from the first. On the contrary it is perfectly clear that purchasing power is created to which in the first case no new goods correspond.

From this it follows, therefore, that in real life total credit must be greater than it could be if there were only fully covered credit. The credit structure projects not only beyond the existing gold basis, but also beyond the existing commodity basis. Again, this fact as such cannot very well be denied. Only its theoretical significance can be in doubt. The distinction between normal and abnormal credit is, however, important for us. Normal credit creates claims to the social dividend, which represent and may be thought of as certifying services rendered and previous delivery of existing goods. That kind of credit, which is designated by traditional opinion as abnormal, also creates claims to the social product, which, however, in the absence of past productive services could only be described as certificates of future services or of goods yet to be produced. Thus there is a fundamental difference between the two categories, in their nature as well as in their effects. Both serve the same purpose as means of payment and are externally indistinguishable. But the one embraces means of payment to which there is a corresponding contribution to the social product, the other means of payment to which so far nothing corresponds — at least no contribution to the social product, even though this deficiency is often made up by other things.

After these introductory remarks, the shortness of which it is hoped will cause no misunderstanding, I proceed to the theme of this chapter. First we must prove the statement, so strange at first sight, that in principle no one other than the entrepreneur needs credit — or the corollary but at once much less strange statement that credit serves industrial development. It has already been established that the entrepreneur—in principle and as a rule — does need credit, in the sense of a temporary transfer to him of purchasing power, in order to produce at all, to be able to carry out his new combinations, to become an entrepreneur. And this purchasing power does not flow towards him automatically, as to the producer in the circular flow, by the sale of what he produced in preceding periods. If he does not happen to possess it — and if he did then it would simply be the consequence of former development — he must borrow it. If he does not succeed, then obviously he cannot become an entrepreneur. In this there is nothing fictitious; it is merely the formulation of generally known facts. He can only become an entrepreneur by previously becoming a debtor. He becomes a debtor in consequence of the logic of the process of development, or, to put it in still another way, his becoming a debtor arises from the necessity of the case and is not something abnormal, an accidental event to be explained by particular circumstances. What he first wants is credit. Before he requires any goods whatever, he requires purchasing power. He is the typical debtor in capitalist society.9

The argument must now be completed by the negative proof that the same cannot be said of any other type and that no one else is a debtor by the nature of his economic function. Of course there are in reality many other motives for borrowing or lending. But the point is that the granting of credit does not then appear as an essential element of the economic process. This holds good first of all for consumptive credit. Neglecting the fact that its significance can only be a limited one, it is not an element in the fundamental forms and necessities of industrial life. It is not part of the economic nature of any individual that he should contract consumptive loans or of the nature of any productive process that the participators should incur debts for the purposes of their consumption. Therefore the phenomenon of consumptive credit is of no further interest for us here, and in spite of all its practical importance we exclude it from our consideration. This involves no abstraction — we recognise it as a fact, only we have nothing particular to say about it. Exactly the same holds good for those cases in which a credit requirement arises solely for the maintenance of a business which has been disturbed, perhaps by misfortunes. These cases, which I embrace under the concept of “consumptive-productive credits,” are also no part of the nature of an economic process in the sense that their treatment appertains to the understanding of the life of the economic organism. They too are of no further interest to us here.

Since every kind of extension of credit for purposes of “innovations” is by definition the granting of credit to the entrepreneur, and forms an element of economic development, then the only kind of granting of credit left for consideration here is credit for running a business in the circular flow (Betriebskredit). Our proof is achieved if we can explain it as “unessential” in our sense. What of it then?

We saw in the first chapter that it is not part of the nature of the circular flow that credit (Betriebskredit) is currently taken and given:10 when the producer has finished his products, then according to our conception he sells them immediately and begins his production anew with the proceeds. To be sure, things do not always happen thus. It may be that he wishes to begin producing before he has delivered the products to his customer. But the decisive point is that we can, without overlooking anything essential, represent the process within the circular flow as if production were currently financed by receipts. Credit in the ordinary routine of established business owes its practical importance solely to the fact that there is development and that this development carries with it the possibility of employing sums of money which are temporarily idle. Hence every businessman will turn these receipts to account as promptly as possible and will then borrow what purchasing power he may require. If there were no development, then the sums of money necessary to carry out transactions would normally have to be actually kept in every firm and household, and during the time when they were not needed would have to lie idle. It is development that alters this. It soon sweeps away those types whose pride it was that they never took any credit. And when in the end all businesses — old as well as new ones — are drawn into the circle of the credit phenomenon, bankers will even prefer this kind of credit on account of the smaller risk it involves. Many banks, particularly of the “deposit” type and also almost all old-established houses, actually do this and restrict themselves more or less to such “current” credit. But this is only a consequence of development already in full swing.

This interpretation does not place us in opposition to the prevailing one as much as might be thought.11 On the contrary, we assert by it, in complete agreement with the usual view, that we can dispense with credit if we want to grasp the economic process of the circular flow. Only because the prevailing theory takes the same view, and like us sees in the financing by credit of current commodity transactions nothing essential to the understanding of the matter, can it eliminate this proceeding from its treatment of the main features of the economic process. Only on this account can it restrict its view to the sphere of goods. Within the world of goods something like credit transactions may of course be found, but we have already come to an understanding on this. At all events the prevailing theory recognises the necessity of creating new purchasing power at this point just as little as we do, and the fact that it also does not see such a necessity at any other point shows again that it is merely static.

This current credit can therefore be eliminated from our treatment with the same justification as consumptive credit. From the knowledge that it involves only a question of a technical expedient of exchange — in the circular flow, of course, because with development it would be something different for the reason mentioned — an expedient which has no further effect upon the economic process, we come to the following conclusion. In order to contrast current credit sharply with that credit which does play a fundamental rôle and without which complete understanding of the economic process is impossible, we shall assume in the case of the circular flow that all exchanges are effected by metal money which exists once for all in given quantities and with a given rapidity of circulation. Obviously the whole circulation of an economy without development may also consist of credit means of payment. Since these means of payment, however, would function just like metal money in that they are “certificates” for existing goods and past services, and since there is therefore no essential difference between them and metallic money, by using this expository device we merely indicate that what we regard as the essential element in the credit phenomenon is not to be found in current credit within the circular flow.

By this we have both proved our thesis and precisely formulated the sense in which it is meant. Only the entrepreneur then, in principle, needs credit; only for industrial development does it play a fundamental part, that is a part the consideration of which is essential to an understanding of the whole process. Furthermore, it is seen at once from the arguments of the second chapter that the correlative of the thesis also holds good, namely the statement that where there is no direct power of disposal by leaders over means of production, development is in principle impossible without credit.

The essential function of credit in our sense consists in enabling the entrepreneur to withdraw the producers' goods which he needs from their previous employments, by exercising a demand for them, and thereby to force the economic system into new channels. Our second thesis now runs: in so far as credit cannot be given out of the results of past enterprise or in general out of reservoirs of purchasing power created by past development, it can only consist of credit means of payment created ad hoc, which can be backed neither by money in the strict sense nor by products already in existence. It can indeed be covered by other assets than products, that is by any kind of property which the entrepreneur may happen to own. But this is in the first place not necessary and in the second place does not alter the nature of the process, which consists in creating a new demand for, without simultaneously creating, a new supply of goods. This thesis needs no further proof here, but follows from the arguments of the second chapter. It provides us with the connection between lending and credit means of payment, and leads us to what I regard as the nature of the credit phenomenon.

Since credit in the one case in which it is essential to the economic process can only be granted from such newly created means of payment (provided there are no results of previous development); and since, conversely, only in this one case does the creation of such credit means of payment play more than a merely technical rôle, then to this extent giving credit involves creating purchasing power, and newly created purchasing power is of use only in giving credit to the entrepreneur, is necessary for this purpose alone. This is the only case in which we cannot, without impairing the truth of our theoretical picture, substitute metal money for credit means of payment. For we can assume that a certain quantity of metal money exists at any time, since nothing depends upon its absolute magnitude; but we cannot assume an increase of it to appear just at the right time and place. Therefore if we exclude from lending as well as from the creation of credit instruments those cases in which credit transactions and credit instruments play no essential part, then the two must coincide, if we neglect the results of previous development.

In this sense, therefore, we define the kernel of the credit phenomenon in the following manner: credit is essentially the creation of purchasing power for the purpose of transferring it to the entrepreneur, but not simply the transfer of existing purchasing power. The creation of purchasing power characterises, in principle, the method by which development is carried out in a system with private property and division of labor. By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it. It temporarily substitutes, as it were, a fiction of this claim for the claim itself. Granting credit in this sense operates as an order on the economic system to accommodate itself to the purposes of the entrepreneur, as an order on the goods which he needs: it means entrusting him with productive forces. It is only thus that economic development could arise from the mere circular flow in perfect equilibrium. And this function constitutes the keystone of the modern credit structure.

Hence, while granting credit is not essential in the normal circular flow, because in it no necessary gap exists between products and means of production, and because it can be assumed there that all purchases of production goods by producers are cash transactions or that in general whoever is a buyer previously sold goods of the same money value, it is certain that there is such a gap to bridge in the carrying out of new combinations. To bridge it is the function of the lender, and he fulfils it by placing purchasing power created ad hoc at the disposal of the entrepreneur. Then those who supply production goods need not “wait” and yet the entrepreneur need advance them neither goods nor existing money. Thus the gap is closed which would otherwise make development extraordinarily difficult, if not impossible in an exchange economy where private property prevails. That the function of lenders lies in this is denied by no one. Differences of opinion exist only about the nature of the “bridge.” I believe that our conception, far from being more audacious and foreign to reality than others, is nearest to reality and makes a whole network of fictions superfluous.

In the circular flow, from which we always start, the same products are produced every year in the same way. For every supply there waits somewhere in the economic system a corresponding demand, for every demand the corresponding supply. All goods are dealt in at determined prices with only insignificant oscillations, so that every unit of money may be considered as going the same way in every period. A given quantity of purchasing power is available at any moment to purchase the existing quantity of original productive services, in order then to pass into the hands of their owners and then again to be spent on consumption goods. There is no market for the bearers of the original productive services themselves, especially for land, and there is also no price for them within the normal circular flow.12

If we neglect, as unessential, the value of the material of the monetary units, the purchasing power then really represents nothing but existing goods. Its total tells us nothing, but the shares of households and firms in this total do. If now credit means of payment, new purchasing power in our sense, are created and placed at the entrepreneur's disposal, then he takes his place beside the previous producers and his purchasing power its place beside the total previously existing. Obviously this does not increase the quantity of productive services existing in the economic system. Yet “new demand” becomes possible in a very obvious sense. It causes a rise in the prices of productive services. From this ensues the “withdrawal of goods” from their previous use, to which we have referred.13 The process amounts to compressing 14 the existing purchasing power. In one sense no goods and certainly no new goods correspond to the newly created purchasing power. But room for it is squeezed out at the cost of previously existing purchasing power.

This explains the manner in which the creation of purchasing power works. The reader can see that there is nothing illogical or mystical in it.15 The external form of the credit instruments is quite irrelevant. To be sure, the matter is seen most plainly in the case of the uncovered bank-note. But also a bill, which does not replace existing money, and which is not based upon goods already produced, is of the same character, if it actually circulates. Of course this is not true if it merely records the entrepreneur's obligation to his creditor or if it is merely discounted, but only when it is used in paying for goods. And all other forms of credit instruments, even simple credits in the books of a bank, may be considered from the same point of view. Just as when additional gas streams into a vessel the share of the space occupied by each molecule of the previously existing gas is diminished by compression, so the inflow of new purchasing power into the economic system will compress the old purchasing power. When the price changes which thus become necessary are completed, any given commodities exchange for the new units of purchasing power on the same terms as for the old, only the units of purchasing power now existing are all smaller than those existing before and their distribution among individuals has been shifted.

This may be called credit inflation. But it is distinguished from credit inflation for consumptive purposes by a very essential element. In these cases also new purchasing power takes its place beside the old, prices rise, a withdrawal of goods results in favor of the credit receiver or of those to whom the latter pays out the borrowed sums. There the process breaks off: the goods withdrawn are consumed, the means of payment created remain in circulation, the credit must be continually renewed, and prices have risen permanently. It may be then that the loan is paid off out of the normal income stream — for example by an increase in taxation. But this is a new, special operation (deflation), which, proceeding in the well known way, again restores the health of the monetary system, which but for it would not return to its previous state.

In our case, however, the process goes vi impressa further. The entrepreneur must not only legally repay money to his banker, but he must also economically repay commodities to the reservoir of goods — the equivalent of borrowed productive means; or, as we have expressed it, he must ultimately fulfil the condition upon which goods may normally be taken out of the social stream. The result of the borrowing enables him to fulfil this condition. After completing his business — in our conception, therefore, after a period at the end of which his products are on the market and his productive goods used up — he has, if everything has gone according to expectations, enriched the social stream with goods whose total price is greater than the credit received and than the total price of the goods directly and indirectly used up by him. Hence the equivalence between the money and commodity streams is more than restored, the credit inflation more than eliminated, the effect upon prices more than compensated for,16 so that it may be said that there is no credit inflation at all in this case — rather deflation — but only a non-synchronous appearance of purchasing power and of the commodities corresponding to it, which temporarily produces the semblance of inflation.

Furthermore, the entrepreneur can now repay his debt (amount credited plus interest) at his bank, and normally still retain a credit balance ( = entrepreneurial profit) that is withdrawn from the purchasing-power fund of the circular flow. Only this profit and interest necessarily remain in circulation; the original bank credit has disappeared, so that the deflationary effect in itself — and especially if new and bigger enterprises are not continually being financed — would be much more severe than that just indicated. It is true that in practice two reasons prevent the prompt disappearance of the newly created purchasing power: first the fact that most enterprises are not terminated in one period but in most cases only after a series of years. The essence of the matter is not altered by this, but the newly created purchasing power remains longer in circulation and the “redemption” at the legal date then often takes the form of a “prolongation.” In this case it is economically no redemption at all but a method of periodically testing the soundness of the enterprise. Economically this should really be called “presentation for audit” instead of “presentation for payment” — whether the thing to be redeemed is a bill or a personal loan. Moreover, if it is true that long-term enterprises are financed by short-term credit, every entrepreneur and every bank will try for obvious reasons to exchange this basis as soon as possible for a more permanent one, indeed will regard it as an achievement if the first stage can be completely jumped in an individual case. In practice this approximately coincides with replacing purchasing power created ad hoc by that existing already. And this generally happens in the case of development in full swing which has already accumulated reserves of purchasing power — thus for reasons which our theory itself explains and which do not argue against it — and indeed in two steps. In the first place, shares or bonds are created and their amounts are credited to the enterprise, which means that banking resources still finance the enterprise. Then these shares and bonds are disposed of and gradually are paid for — not always at once, on the contrary the accounts of the subscribing customers are often only debited — by the subscribers out of existing supplies of purchasing power or reserves or savings. Thus, as it may be expressed, they are resorbed by the community's savings. The redemption of the credit instruments is thus accomplished and they are replaced by existing money. But this is not yet the final redemption of the entrepreneur's debt, the redemption in goods. The latter only comes later, even in this case.

Secondly, still another fact prevents the prompt disappearance of the new purchasing power. Credit instruments may disappear in the case of final success, they have so to say the tendency to do so automatically. But even if they do not disappear, no disturbance occurs either in the individual or in the social economy — for now the commodities are there which constitute a counterbalance to and the only really significant kind of “cover” for the new purchasing power, which is precisely what is always absent in the case of consumptive credit. And so the process of production can always be repeated anew with the help of renewal of credit, although this is no longer “new enterprise” within our meaning. The credit instruments thus not only have no further influence upon prices, but they even lose that which they originally exercised. Indeed, this is the most important of the ways in which bank credit forces its way into the circular flow, until it has so established itself there that analytical effort is necessary in order to recognise that its source is not there. If this were not so the received theory would not only be false — which it is in any case — but inexcusable and incomprehensible.

If the possibility of giving credit is therefore not limited by the quantity of liquid resources existing independently of creation for the very purpose of granting credit, nor by the existing — idle or total — quantity of goods, by what is it limited?

First as regards practice: let us assume that we have a free gold standard, that is redemption of bank-notes in gold upon demand, the obligation to purchase gold at a legal price, and free export of gold. Assume also that we have a banking system grouped around a central note-issuing bank, but that there are no other legal barriers and rules for the gestation of banking business — for example no note-reserve regulations and so on for the central bank or deposit-reserve regulations and so on for the other banks. This represents the leading case, the treatment of which is easily applicable to other cases. Then every new creation of purchasing power which precedes the appearance of the corresponding quantities of goods and hence raises prices will have the tendency to raise the value of the gold contained in gold coin above the value of the monetary unit. This will lead to a diminution of the quantity of gold in circulation, but above all to the presentation of bank means of payment for redemption, first bank-notes, then directly and indirectly all others, in another sense, for another purpose and for another reason than that which we have just described. And if the solvency of the banking system in this sense is not to be endangered, the banks can only give credit in such a way that the resulting inflation is really temporary and moreover remains moderate. But it can only remain temporary if the commodity complement of the newly created purchasing power comes on the market at the right time, and if, in cases of failure where it does not appear on the market at all and in cases of lengthy production where it appears only after long years, the banker intervenes with purchasing power drawn from the circular flow, for example with money saved by other people. Hence the necessity of maintaining a reserve, which acts as a brake on the central bank as well as on the other banks. Competing with this nexus is the circumstance that all credits given are finally resolved into small sums in daily trade, and in order to serve in the latter must be changed into coin or small state notes — at least in most countries — which cannot be created by the banks. Finally, the credit inflation must start an outflow of gold abroad — hence a further danger of insolvency. It may happen, however, and is indeed sometimes approximately realised, that the banks of all countries extend their credits almost simultaneously. Therefore, even if we cannot, in the nature of things, state the limit to the creation of purchasing power under the assumptions made as accurately as, say, the limit to the production of a commodity, and even if the limit must vary according to the mentality of the people, legislation, and so on, yet we can state that there is such a limit at any time and what circumstances normally guarantee its maintenance. Its existence neither excludes the creation of purchasing power in our sense nor alters its significance. But it makes its volume at any time an elastic, though nevertheless a definite, magnitude.

The fundamental question under consideration here is of course only very superficially answered by the above; just as the question regarding the reasons for a rate of exchange is answered superficially by saying it must lie between the gold points in the case of a universal free gold standard. However, just as we look at essentials in the latter case if we omit the gold mechanism and look at the “commodity points” underneath, so in our case, by the same principle, we arrive at a more fundamental explanation of the fact that the creation of purchasing power has definite, even though elastic, limits if we consider a country with a paper standard or let us say outright with nothing but bank means of payment. Since the case of countries trading with one another offers nothing fundamentally new we leave the analysis of it to the reader. Here, then, the limit is given by the condition that credit inflation in favor of new enterprises should be only temporary, or that there should be no inflation at all in the sense of permanently raising the price level. And the brake which guarantees the maintenance of this limit is the fact that any other conduct in the face of the rush of entrepreneurs seeking credit would mean a loss for the bank concerned. This loss always occurs if the entrepreneur does not succeed in producing commodities at least equal in value to the credit plus interest. Only when he succeeds in so doing has the bank done good business — then and only then, however, is there also no inflation, as we have shown, that is no infraction of the limit. From this the rules may be derived which determine in individual cases the magnitude of the possible creation of purchasing power.

Only in one other case could the banking world, if it were released from the obligation of redeeming its means of payment in gold and if the regard for international exchange were suspended, start inflation and arbitrarily determine the price level, not only without loss but even with profit: namely, if it pumped credit means of payment into the circular flow either by making bad commitments good by a further creation of new circulating media or by giving credits which really serve consumptive ends. In general no single bank could do this. For while its issue of means of payment would not appreciably affect the price level, the bad commitment would remain bad and the consumptive credit become bad if it did not lie within the limits in which it could be repaid by the debtor out of his income. But all banks together could do it. They could, under our assumptions, continually give additional credit and precisely through its effect upon prices make good that given previously. And that this is possible to a certain extent even outside these assumptions is the chief reason why special legal restrictions and special safety-valves are actually necessary in practice.

This last statement is really self-evident. Just as the state, under certain circumstances, can print notes without any assignable limit, so the banks could do likewise if the state — for it comes to this — were to transfer the right to them in their interest and for their purposes, and common sense did not prevent them from exercising it. But this has nothing to do with our case, viz. the case of granting credit and creating purchasing power for carrying out new combinations which are remunerative at the existing level of prices17 — hence nothing to do with the meaning, nature, and origin of the creation of entrepreneurial purchasing power in general. I emphasise this expressly because the thesis concerning the unlimited power of the banks to create circulating media, after being repeatedly quoted, not only without the necessary qualifications, but also without the context in which it stands,18 has become a point of attack and a ground for rejecting the new theory of credit.

CAPITAL

It is now time to give expression to a thought which has long been awaiting formulation and which is familiar to every businessman. That form of economic organisation in which the goods necessary for new production are withdrawn from their settled place in the circular flow by the intervention of purchasing power created ad hoc is the capitalist economy, while those forms of economy in which this happens through any kind of power of command or through agreement of all concerned represent non-capitalistic production. Capital is nothing but the lever by which the entrepreneur subjects to his control the concrete goods which he needs, nothing but a means of diverting the factors of production to new uses, or of dictating a new direction to production. This is the only function of capital, and by it the place of capital in the economic organism is completely characterised.

Now what is this lever, this means of control? It certainly does not consist of any definite category of goods, of any definable part of the existing supply of goods. It is generally recognised that we meet with capital in production and that it is useful in some way or other in the productive process. Hence we must also see it somewhere in operation in our case of carrying out new combinations. Now all the goods which the entrepreneur needs are on the same level from his standpoint. He wants the services of natural agents, of labor, of machinery, of raw material, all of them equally and in just the same sense, and nothing distinguishes one of these wants from the others. Of course this is not to say that there is no relevant difference at all between these categories of goods. On the contrary there are certainly differences, even though their significance was and still is overestimated by many theorists. But it is clear that the entrepreneur's behavior is the same towards all these categories: he buys all of them for money, for which he calculates or pays interest, without distinction, whether they are tools or land or labor. They all play the same part, are equally necessary for him. In particular it is quite immaterial whether he begins his production as it were ab ovo, that is merely buys land and labor, or whether he also acquires already existing intermediate products instead of producing them himself. Finally, if he should acquire consumption goods this would make no fundamental difference either. Nevertheless, it would look as if consumption goods had the first claim to be emphasised, especially if one accepted the theory that the entrepreneur “advances” consumption goods to the possessors of productive means, in the narrower sense of the word. In this case these goods would be characteristically different from other goods; they would play a special rôle, and indeed precisely the one which we assign to capital. From this it would follow that the entrepreneur would exchange productive services for consumption goods. Then we should have to say that capital consists of consumption goods. However, this possibility is already settled.

Setting aside this last interpretation, then, there is no reason for making any kind of distinction between all the goods which the entrepreneur buys, consequently no reason for including any group of them under the name capital. That capital defined so as to consist of goods belongs to every economic organisation and hence is not suitable for characterising the capitalistic one, requires no argument. Furthermore, it is not true that if the businessman were asked wherein consists his capital, he would point to any of these categories of goods. If he mentions his factory he includes the ground on which it stands, and if he wishes to be complete he will not forget his working capital in which directly or indirectly purchases of labor services are included.

The capital of an enterprise, however, is also not the aggregate of all the goods serving its purposes. For capital confronts the world of goods. Goods are bought for capital — “capital is invested in goods” — but this very fact implies the recognition that its function is different from that of the goods acquired. The function of the goods consists in serving a productive purpose corresponding to their technical nature. The function of capital consists in procuring for the entrepreneur the means with which to produce. It stands as a third agent necessary to production in an exchange economy between the entrepreneur and the world of goods. It constitutes the bridge between them. It does not take part directly in production, it is not itself “worked up”; on the contrary it performs a task which must be done before technical production can begin.

The entrepreneur must have capital before he can think of providing himself with concrete goods. There is a time when he already has the necessary capital but not yet the production goods, and at this moment one can see more clearly than ever that capital is not something identical with concrete goods but is an independent agent. And its only purpose, the only reason why the entrepreneur needs capital — I appeal to obvious facts — is simply to serve as a fund out of which productive goods can be paid for. Furthermore, so long as this purchase is not completed, the capital has absolutely no relation to any definite goods at all. It exists of course — who could deny it? — but its characteristic quality is precisely that it does not come into consideration as a concrete category of goods, that it is not employed technically as a good, but as a means of providing those goods which are to be employed in production in the technical sense. But when this purchase is completed, does the entrepreneur's capital then consist of concrete goods—of all kinds of land bought as well as of tools bought, but still of goods? If one exclaims with Quesnay: “Parcourez les fermes et les ateliers, et … vous trouverez des bâtiments, des bestiaux, des semences, des matières premières, des meubles et des instruments de toute espèce” — from our point of view one must add further: services of land and labor and also consumption goods as well — is not this justified after the purchase? The capital has now fulfilled the function ascribed to it by us. If the necessary productive means, and, as we shall assume, also the necessary labor services, are bought, then the entrepreneur no longer has the capital which was placed at his disposal. He has surrendered it for productive means. It has been dissolved into incomes. The traditional conception at present is that his capital now consists of the goods acquired. Indeed it is a presupposition of this interpretation that the function of capital in procuring goods is completely ignored, and replaced by the unreal hypothesis that the very goods which he needs are lent to the entrepreneur. If one does not do this and if, following reality, one distinguishes the fund out of which production goods are paid for from these productive means themselves, there cannot in my opinion be the slightest doubt that it is to this fund that everything that one is accustomed to say of capital and all that we designate as capitalistic phenomena refer. If this is correct then it is furthermore clear that the entrepreneur no longer possesses this fund, because he has just paid it out, and that the parts of it in the hands of the sellers of productive means can be no different in character from the sums received from the sale of bread in the hands of the baker. The everyday method of expression frequently met with, which describes the productive means when purchased as “capital,” proves nothing, all the more when the other expression goes with it, namely that capital is “embodied in these goods.” The latter method of expression can only be correct in the sense in which it can also be said that coal is “embodied” in a steel rail, that is in the sense that the use of coal has led to the creation of the steel rail. But for all that, does not the entrepreneur still have his capital? And can he not at least “draw out” his capital from this “investment” again, while the same coal cannot be obtained again? I believe that these questions can be satisfactorily answered. No, the entrepreneur has spent his capital. In return for it, he has acquired goods which he will not employ as capital, that is as a fund in paying for other goods, but in technical production. However, if he changes his mind and wishes to part with these goods, there will usually be other people ready to buy them — and then he can again obtain possession of a greater or smaller amount of capital. From this point of view, since his productive means can serve not only as productive means but also indirectly as capital — in so far as he can use them to obtain first purchasing power and then other productive means — he is right if he calls them elliptically his capital. Really they are the only source of purchasing power at his command if he should be in need of it before his production is completed. We shall come to still another reason for this interpretation. The second question is now also answered: the entrepreneur can obtain capital again by selling his production goods. He cannot of course get the identical capital again, in most cases not even the same amount. But since this does not matter, the plastic expression “to draw out his capital” has though only a figurative yet quite a sound meaning. It does not conflict with our interpretation.

What is capital then if it consists neither of a definite kind of goods nor of goods in general? By this time the answer is obvious enough: it is a fund of purchasing power. Only as such can it fulfil its essential function, the sole function for which capital is necessary in practice and for which alone the capital concept has a use in theory, which cannot be just as well replaced by enumerating categories of goods.

The question now arises as to what exactly constitutes this fund of purchasing power. This question seems to be very simple. Of what does my fund of purchasing power consist? Why, of money and of my other assets calculated in money. This answer would bring us practically to Menger's capital concept. Certainly I call this “my capital” innumerable times. Further, there are also no difficulties in distinguishing it as a “fund” from the “stream” of returns, so that here we take a step again in Irving Fisher's direction. Again, it might be said that I can embark upon an enterprise with this very sum or lend it to an entrepreneur.

However, this view, apparently so satisfactory at first sight, is unfortunately not completely adequate. It is not true that I can enter the ranks of entrepreneurs only with this sum. If I can draw a bill that will be taken in payment, then I can also buy production goods for its amount. One might now say that I simply contract a debt thereby, which is far from increasing my capital. One might say further that the goods “bought” with the bill are just lent to me. Yet let us look more closely. If I am successful I shall be able to redeem the bill with money or counter-claims, which do not come out of my capital but out of the proceeds of my product. Thus I have increased my capital, or if there is any reluctance in granting this, I have done something that renders me just the same service as an increase of my capital, without incurring debts which would later decrease my capital again. It might be objected that my capital would have grown if I had not had to repay debts. However, these debts were paid out of a gain, which we cannot even be certain would have been added to my capital if it had accrued to me unimpaired. For I might use it to acquire consumption goods, in which case it would be contrary to every kind of usage to describe it as a part of capital. If it is correct that the function of capital only consists in assuring the entrepreneur control over production goods, then we cannot evade the conclusion that my capital would be increased by creating the bill. If the reader keeps in mind what was said earlier in combination with what follows, our result will lose much of its paradoxical appearance. It is true, I have not become richer by creating the bill. But the term “wealth” (Vermögen) makes it possible to take account of this other aspect of the matter.

But it is also not true that expression in terms of money suffices to lend a capital character in our sense to property which is not itself held in the form of money. If one possesses some sort of goods it will not in general be possible to obtain by direct exchange the production goods which one needs. On the contrary one will always have to sell the goods one has and then employ the proceeds of the sale as capital, that is in obtaining the production goods required. Actually the conception under consideration recognises this also in that it stresses the money value of the goods which anyone possesses. It is easy to see that it is only an elliptical or figurative method of expression when one describes these goods themselves as capital. The same is also true of purchased means of production, as already mentioned, which this conception also treats as capital.

So far our definition is on the one hand wider and on the other hand narrower than Menger's and others related to it. Only means of payment are capital, not merely “money” but circulating media in general, of whatever kind they may be; not all means of payment, however, but only those which actually fulfil the characteristic function with which we are concerned.

This limitation lies in the nature of the thing. If means of payment do not serve to provide an entrepreneur with production goods and to withdraw the latter from their previous employment for this purpose, then they are not capital. In an economic system without development there is therefore no “capital”; or, otherwise expressed, capital does not fulfil its characteristic function, it is not an independent agent. Or, still differently expressed, the various forms of general purchasing power do not constitute capital there; they are simply exchange media, technical means for carrying out the customary exchanges. With this, their rôle in the circular flow is complete — they have none except this technical rôle, so that they can be neglected without overlooking anything very essential. In the carrying out of new combinations, however, money and its substitutes become an essential factor, and we express this by describing them as capital. Thus, according to our point of view, capital is a concept of development to which nothing in the circular flow corresponds. This concept embodies an aspect of the economic process which only the facts of development suggest to us. I should like to draw the reader's attention to this statement. It contributes much to the understanding of the point of view here developed. If one speaks of capital with the connotation which the word has in practical life, then one always thinks not so much of things as of processes or of a certain aspect of things, namely of the possibility of entrepreneurial activity, of the possibility of control over productive means in general. This aspect is something common to many concepts of capital, and the efforts to bring it out explain, in my opinion, the “protean” qualities of the concrete definition. According to it nothing is really in itself capital, absolutely and by virtue of immanent qualities, but that which is designated as capital is so only to the extent that it satisfies certain conditions, or only from a certain point of view.

We shall define capital, then, as that sum of means of payment which is available at any moment for transference to entrepreneurs. At the moment when development starts from a circular flow in equilibrium, only a very small part of that sum of capital could, according to our interpretation, consist of money; on the contrary, it would have to consist of other means of payment newly created for the purpose. If development is once in motion or if capitalist development joins a non-capitalist or a transitional form, it will start with a supply of accumulated liquid resources. But in strict theory it could not do this. And even in reality it is always impossible when something really significant is to be done for the first time.

Capital, then, is an agent in the exchange economy. A process of the exchange economy is given expression to in the capital aspect, namely the transfer of productive means to the entrepreneur. There is therefore in our sense really only private and no “social” capital. Means of payment can only perform their capital rôle in the hands of private individuals. Hence there would be little purpose in speaking of social capital with this meaning. Nevertheless, the sum of private capitals tells us something: it gives the magnitude of the fund that can be put at the disposal of entrepreneurs, the magnitude of the power of withdrawing means of production from their previous channels. Therefore the concept of social capital is not meaningless,19 even though there would be no such capital in a communist economy. Yet one thinks for the most part of a nation's stock of goods when one speaks of social capital, and only the real capital concepts have led to that of social capital.

THE MONEY MARKET

One more step remains to be taken. Capital is neither the whole nor a part of the means of production — original or produced. Nor is capital a stock of consumption goods. It is a special agent. As such it must have a market in that theoretical sense in which there is a market for consumption goods and for production goods. And to this theoretical market something similar must correspond in reality as in the case of these other two. We saw in the first chapter that there are markets for the services of labor and land and for consumption goods in which everything essential to the circular flow is settled, while the produced means of production, transitory items, have no such independent market. In development, which introduces the new agent capital into the economic process, there must be still a third market in which something interesting happens, the capital market.

This does exist: reality shows it to us directly, much more directly than it shows us the markets for services and for consumption goods. It is much more concentrated, much better organised, much easier to observe than the other two. It is what the businessman calls the money market, that about which every newspaper reports daily under this title. From our standpoint the name is not wholly satisfactory: it is not simply money that is dealt in, and we might in part join the protest of economists against this conception of it. But we accept the name. In any case the capital market is the same as the phenomenon that practice describes as the money market. There is no other capital market.20 It would be an attractive and a profitable task to outline a theory of the money market. As yet we have none.21 It would be especially interesting and profitable to collect and test the theoretical meaning of the practical rules of experience which determine the practical man's decisions and his judgment of particular situations. They are indeed for the most part strictly formulated, and guide every writer of money-market articles. These practical rules for economic forecasting are at present quite detached from theory, although the study of them leads deep into the understanding of modern economic life. We cannot go into this here. We shall only say what is necessary for our purposes. This can be done in a few words.

In an economy without development there would be no such money market. If it were highly organised and its transactions were settled with credit means of payment it would have a central settlement bureau, a kind of clearing house or bookkeeping centre for the economic system. In the transactions of this institution everything that happens in the economic system would be mirrored, for example the periodical payments of wages and taxes, the requirements for moving the harvest and for holidays. But these would only be matters of accounting. Now these functions must also be performed if there is development. With development, moreover, there is always employment for purchasing power which is momentarily idle. And finally, with development, as already emphasised, bank-credit penetrates into the transactions of the circular flow. Thus it is, then, that these things become, in practice, elements of the function of the money market.

They become a part of the organism of the money market. And so the requirements of the circular flow are added to the entrepreneur's demand in the money market on the one hand, and money from the circular flow increases the supply of money in the money market on the other. Hence we feel in every money-market article the pulse of the circular flow, hence we see that the demand for purchasing power increases at harvest-time, when taxes are due and so forth, while after these times the supply increases. But this must not prevent us from distinguishing the transactions in the money market which belong to the circular flow from others. Only the latter are fundamental; the former are added onto them, and the fact that they appear in the money market at all is merely a consequence of development. All the reciprocal effects which obviously bind the two together do not alter the fact that, even practically, they may be distinguished in every case and that in the money market it is always possible to say what belongs to the circular flow and what belongs to development.

The kernel of the matter lies in the credit requirements of new enterprises. Of course we must remember that the influence of the international relations in which every economic system finds itself, and of non-economic intervention, to which every economic system is exposed, are neglected here, in order to shorten and simplify the exposition. Hence the phenomena of the national balance of payments, of the bullion trade, and so on drop out of sight. With this proviso, only one fundamental thing happens on the money market, to which everything else is accessory: on the demand side appear entrepreneurs and on the supply side producers of and dealers in purchasing power, viz. bankers, both with their staffs of agents and middlemen. What takes place is simply the exchange of present against future purchasing power. In the daily price struggle between the two parties the fate of new combinations is decided. In this price struggle the system of future values first appears in a practical, tangible form and in relation to the given conditions of the economic system. It would be wholly wrong to believe that the price of short-term credits is a matter of indifference for new undertakings since it is long-term credit that they want. On the contrary, the whole economic situation at every moment is nowhere so clearly expressed as in the price of short loans. The entrepreneur does not necessarily borrow for the whole period over which he needs credit, but as necessity arises and often almost from day to day. Moreover, speculators often hold shares, especially of new enterprises, with such short-term credit, which may be granted to-day and denied tomorrow. We may observe from day to day how the credit requirements of industry manifest themselves and how the banking world sometimes supports and encourages, sometimes curbs, the demand. While in other markets the demand as well as the supply exhibits a certain constancy, even in development, here surprisingly large fluctuations appear from day to day. We shall explain this by the special function of the money market. All plans and outlooks for the future in the economic system affect it, all conditions of the national life, all political, economic, and natural events. There is scarcely a piece of news that does not necessarily influence the decisions relative to the carrying out of new combinations or the money-market position and the opinions and intentions of entrepreneurs. The system of future values must be adapted to every new situation. This is of course not merely effected by variations in the price of purchasing power. Frequently, personal influence acts in addition to or in the place of the latter. But there is no need to go into these well known details.

The money market is always, as it were, the headquarters of the capitalist system, from which orders go out to its individual divisions, and that which is debated and decided there is always in essence the settlement of plans for further development. All kinds of credit requirements come to this market; all kinds of economic projects are first brought into relation with one another, and contend for their realisation in it; all kinds of purchasing power, balances of every sort, flow to it to be sold. This gives rise to a number of arbitrage operations and intermediate manoeuvres which may easily veil the fundamental thing. Nevertheless, I believe that at bottom our conception need hardly fear contradiction.

Thus the main function of the money or capital market is trading in credit for the purpose of financing development. Development creates and nourishes this market. In the course of development it is assigned still another, that is a third, function: it becomes the market for sources of incomes themselves. We shall consider later the relation between the price of credit and the price of sources of permanent or temporary returns. Here so much is clear, that the sale of such sources of returns represents a method of acquiring capital, and their purchase a method of employing capital, consequently the dealing in sources of returns cannot be far removed from the money market. Traffic in land also belongs here, and only technical circumstances prevent it from appearing in practice as a part of money-market transactions; but there is no lack of causal connection between the two.


Notes

1 The line of thought that is expounded fundamentally unchanged in the following has in the meantime received valuable substantiation and improvement from the investigations of A. Hahn in his Volkswirtschaftliche Theorie des Bankkredits (1 ed. 1920, 2 ed. 1926). The reader is expressly referred to this original and meritorious book, which has essentially advanced our knowledge of the problem. Also in many respects parallel is W. G. Langworthy Taylor in The Credit System. Perhaps the post-war phenomena and the discussions of the rôle of bank credit in boom and depression have removed from what I have to say much of the appearance of a paradox. To-day every theory of the business cycle considers the fact of “additional credit” in prosperity and takes account of the question, raised by Keynes, whether the cycle may be mitigated by being influenced from the money side. This does not yet mean the acceptance of my point of view. But it must lead to it. Cf. also my article “Kreditkontrolle” in the Archiv für Sozialwissenschaft und Sozialpolitik (1925). Recently Robertson, in Banking Policy and the Price Level, has arrived at similar results (cf. on this Pigou, Economic Journal, June, 1926).

2 The theoretical construction which this unreal conception has enforced since Quesnay's day thus refutes itself. And it is so important that one may speak of “advances-economics” (Vorschussökonomie).

3 Although one may not in general add up claims to goods and the goods themselves — any more than the ear and the grains of corn — yet the matter is clearly somewhat different here. While I cannot ride on a claim to a horse, I can, under certain conditions, do exactly the same with claims to money as with money itself, namely buy.

4 Cf. J. S. Mill. Moreover, every economist will admit that Ricardo's statement is not quite correct, even if he is ever so conservative on this point. Cf. for example J. L. Laughlin, who says in his Principles of Money: “Credit does not increase capital (that is means of production) but mobilises it and makes it more efficient and thereby leads to an increase in product.” We shall have something similar to say.

5 Only a few banks show in their periodical statements what part of their deposits consists of real deposits. The above estimate is based upon English statements, which show it at least indirectly, and probably amounts to a communis opinio. This does not hold good for Germany, for example, because there it is not the practice simply to credit a customer with the amount of the loan. However, the essence of the theory is not on this account different. Strictly speaking, moreover, all bank deposits are based upon mere credits, as Hahn rightly emphasised — only that credits which arise out of “sums paid in” are covered in a special manner and do not increase the purchasing power of the depositors.

6 Of course there are always theorists who take the layman's standpoint, who regard with astonishment “the gigantic sums in the banks.” It is more surprising that financial writers sometimes take a similar line too. As an example, see the otherwise very serviceable book of Clare, A Money Market Primer, which indeed does not accept this standpoint outright, but yet defines the sums available for granting credit as “other peoples' money,” which is of course only true for a part, and even then only in a figurative sense.

7 In this I am neglecting from the outset the case in which the regular business of an economic system is dispatched with credit means of payment and the producer receives a bill or other credit instrument from his customers and buys producers' goods with it immediately. Here there is no granting of credit at all in any relevant sense, and the case is not fundamentally different from cash transactions by means of metal currency. This case, of which we shall say no more here, was mentioned in the first chapter.

8 Moreover, if it is a question of things like land or shares, which do not circulate — or are not in the market for goods — then the creation of money has just the same effect in the sphere of commodities and upon prices as an uncovered issue. This is often overlooked. Cf. the analogous error in the case of government fiat money when this money is “based” upon land. The frequent foundation of this category of means of payment upon some kind of collateral only eliminates the insecurity which would otherwise exist, but does not alter the fact that there is no new supply of products corresponding to the new demand for products proceeding from it. Cf. Chapter II.

9 The entrepreneur is also a debtor in a deeper sense, as may be emphasised here; he receives goods from the social stream — again in principle — before he has contributed anything to it. In this sense he is so to speak a debtor of society. Goods are transferred to him, to which he has not that claim which alone gives access to the national dividend in other cases. Cf. Chapter II.

10 It is to be hoped that the reader will not confuse this “current credit” (in the circular flow) with the sum which must also be supplied to the entrepreneur for “running” in contrast to founding the business, that is especially for the purpose of current wage payments.

11 Moreover, it is directly verified by the facts. For many centuries there was practically only consumptive credit. Then there was no more than credit for founding a business. And the circular flow went on without it. Current credit only attained its present importance in modern times. And since a modern factory differs economically from a medieval workshop in no other fundamental respect, the conclusion is reached that the former needs no credit in principle.

12 Cf. the construction in Chapter I, from which it is clear why I do not mention produced means of production with the services of labor and land, although purchasing power is obviously applied to them too and not only to the services of labor and land.

13 On this point I differ from Spiethoff. His three articles: “Die äussere Ordnung des Kapital- und Geldmarktes,” “Das Verhältnis von Kapital, Geld, und Güterwelt,” and “Der Kapitalmangel in seinem Verhältnisse zur Güterwelt” in Schmoller's Jahrbuch (1909) (also independently under the title Kapital Geld und Güterwelt) have above all the merit of having attacked the problem. At a number of points they anticipated what is said in this chapter. The possibility of “ creating new money substitutes” was also expressly emphasised (for example, in the second article, p. 85). But to this there is an “insurmountable economic limit, in the existing supply of goods. Only in so far as these artificial measures can put hitherto idle goods in circulation are they able to work.” If this limit is exceeded prices rise. The latter is certainly correct — but the salient point for us is precisely here. Of course we agree that tightness of money cannot be eliminated by creating purchasing power — or at any rate can only be when it is a matter of a momentary panic.

14 In the first place, the purchasing power of previous producers in the market for producers' goods will be compressed, then the purchasing power in the market for consumption goods of those people who receive no share or no adequate share in the increased money incomes resulting from the entrepreneur's demand. This explains rising prices in periods of boom. If I am not mistaken it was von Mises who coined the extremely happy expression “forced saving” (erzwungenes Sparen) for this process.

15 Cf. also A. Hahn, the article “Kredit” in the Handwörterbuch der Staatswissenschaften.

16 This alone would explain falling prices in periods of depression and actually explains the secular fall in the price level in times when no other causes, for example gold discoveries, prevent it, as we shall see in Chapter VI.

17 Our theory has been interpreted to mean that credit creation facilitates the carrying out of new things by raising prices and thereby making remunerative what would not otherwise be so. This is not what it means.

18 Cf. the otherwise excellent article by Hahn in the Handwörterbuch der Staatswissenschaften on “Kredit.” Against his formulation it appears to me correct to say: although not by existing goods, the quantity of new purchasing power that it is possible to create is supported and limited by future goods, and, to repeat, by future goods at present prices.

19 This is especially true if one measures every unit of capital by the amounts of production goods obtainable for it at any time. If one does this then one may also speak of “real” capital — but only in a figurative sense.

20 At the most one may with Spiethoff (loc. cit.) distinguish the capital market as the market for long-term purchasing power from the money market as the market for short loans. But purchasing power is the commodity in each.

21 Cf., however, A. Hahn, “Zur Theorie des Geldmarkts,” Archiv für Sozialwissenschaft und Sozialpolitik (1923).