Professional Documents
Culture Documents
FRITZ MACHLUP
PROFESSOR OF ECONOMICS AT THE UNIVERSITY OF
BUFFALO
vni
COMPARISON BETWEEN THE PRESENT AND THE F I R S T
EDITION
20
CHAPTER I I I
40
CHAPTER IV
acknowledged
°
that the rise of securityJ prices
r
per
r
se can Hence,
security
higher
never be proof or a symptom of the tying-up of money prices are no
capital. " ' "X
X
a tie-up of
27. Granted that security speculation need not tie up
capital, we still have to consider whether it may not
do so. We are not here discussing the case of bear
sellers who let the proceeds of their sales lie idle. The
discussion is for the time being limited to the case
which Reisch and most other authors regard as the
critical one: the case of continually repeated bull
transactions.9 We may then ask what are the condi-
tions requisite for a tying-up of money capital?
One of the necessary conditions appears to be Three
connected with the mechanism of payment. The very °°£ iecessary
highly developed settlement technique of stockfc>ratie-up of
exchanges introduces conditions that are quite different
from those created by the methods of payment used in security
other markets. If all security transactions came actions:—
within the clearing arrangements of the stock
exchange, and there were no transactions other than
those between people who take part in the clearing
procedure (brokers and jobbers), then the possibility
of the tying-up of money capital would be excluded
on purely technical grounds which we shall examine in
Chapter VI. For the time being, however, we shall
assume that transactions are carried on with cash (coin —first, that
-i , N i . rm . . transactions
and notes) or cheque payments. The appropriateness a r e completed
of this assumption becomes clear when it is remembered with cash or
that the settlement procedure of the stock exchange is ments; —
restricted to the narrower circle of operators and that
transactions between the public and the brokers are
completed with the ordinary methods of payment.
9
Continually repeated bull transactions take place when the
holders of any particular securities estimate the prospects of a
price rise in other securities more highly and so sell theirs in
order to buy other securities.
47
STOCKMARKET, CREDIT AND CAPITAL FORMATION
H<avy losses unable to repay their debts to the banks. In short, the
s oc
of borrowers ^ ^ exchange losses in this case prevent the "defla-
may reduce tionary" effects which the repayment of credits may
deilation— possibly have; if they are not repaid, the bank deposits
remain in existence, whereas if they are repaid they
are, temporarily at least, destroyed.
This (slightly frivolous) manner of reasoning serves
to show the danger of carrying arguments to extremes
and the need for exercising very great caution in
analysing economic problems. If we make the
argument even more extreme, we obtain quite different
—if the banks results: if the failure of the speculators to repay
thtm. their loans caused the banks to get into such diffi-
culties that they had to close down, then the immediate
result would be the destruction of all their deposits.
In this case the failure to repay bank credits would
be more deflationary than their repayment.7
35. In other cases also it can be shown that,
theoretically at least, the exact opposite of the
Usually the expected and feared results is conceivable. Let us
cor sumption
of stock take the case of a reduced capital supp]y due to the
exc aange consumption of gains made on the stock exchange
gains is held
to reduce the (No. 3 in the list of interpretations given above). We
net supply of have already referred to this case in Section 18. The
mo: ley
capital;— money capital employed to buy shares comes into the
hands of the seller, and if he chooses to look upon
part of this money capital as profit and uses it for
consumption purposes, then the funds available as
money capital are reduced in favour of the funds used
for consumption.
At first sight it may seem paradoxical to argue that
7
Incidentally, "the losses to banks on brokers' loans have been
extremely slight. It might even be true that of all banks' assets,
brokers' loans have been the soundest in this depression from the
banks' point of view." Rufus S. Tucker, "Government Control
of Investment and Speculation," American Economic Review
Supplement, 1935, Vol. XXV, p. 146.
64
LOSS OF CAPITAL IN STOCK EXCHANGE SPECULATION
66
CHAPTEE VI
on its way and for the time being can neither be spent
nor lent in the economic process proper/' 3
—ami that The idea, then, is that the demand for other
the demand . , . i i • « „ -, -, -i «
for goods falls economic goods is reduced in favour of the demand for
as the demand securities. I t is a fairly generally held opinion that
for securities . , „ . .
rises— by exerting a demand for circulating media, the
securities market comes into competition with other
markets. Balogh, for instance, says that ''circulating
media move from one market to another but are 'held
u p ' on each of them for some short or long interval of
time."4
He speaks of a "circulationary tie-up" 5 to indicate
that circulating media are held up for a particularly
long time on a rising stock market. Palyi, famous
for his sharp wit and tongue, also finds, in an analysis
of American conditions, that " t h e remainder of the
circulating media . . . were used to purchase securities
and real estate and were until recently tied up in these
uses" 6 ; he thinks it necessary to add somewhat scorn-
fully in parentheses: "There is a new-found theory
which holds that the stock exchange never ties up
capital even in the short run, but that the money
paid in the morning flows out into the 'economic
system' in the evening in order to return to the stock
exchange the following morning: no account will be
taken of this ingenious theory h e r e . " Nor will any
account be taken here of this ingenious method of
criticizing the caricature of a theory.
I n so far as the argument concerns not the provision
3 Herbert von Beckerath, Kajntalmarht und Geldmarkt, Jena
1916,
4
p. 162.
Thomas Balogh, "Latente Inflation, Wahrungssystem, Noten-
bankpolitik und Borsenhausse," Schmoller's Jahrbuch fur Gesetzge-
bung, Verwaltung und Volkswirtschaft im Deutschen Eeiche, 53rd
year, 1929, p. 591.
5 Ibid., p. 596.
s Melchior Palyi, "Zinsfuss und Zahlungsbilanz in den Vereinig-
ten Staaten," Magazin der Wirtschaft, 5th year, No. 45, Berlin
1929, p. 1687.
68
DEMAND FOR MONEY BY THE STOCK MARKET
selling orders among the various brokers, the amount Check pay-
of cheque payments would fall relatively, and indeed, Conceivably
might fall absolutely. All these developments are *al1 w i t h
possible; an inspection of clearing-house statistics7 business;—
shows that in the past the amount of payments for—actually
settlement usually rose absolutely but fell relatively Jnev rose
with an increase in turnover. part.
The absolute increase in cheque payments which may
thus accompany rising stock market transactions can
be taken care of out of unchanged totals of brokers'
cash balances. In other words, there is no logical Increased
necessity for a rise in clearing balances requiring balances,
settlement to cause a rise in the bank balances held by however, can
brokers at the close of the day. There is almost no without
statistical evidence available which might show lncreased
° ban k
whether, in point of fact, brokers carried larger balances,
balances when transactions were larger. The reason
why they easily could do more business without higher
hank balances will become obvious from an analysis
of the mechanism of stock exchange loans.8
41. The settlement procedure is open only to actual
members of the stock exchange, i.e., the jobbers
(dealers) and brokers. Securities are traded, however,
not only between members of the stock exchange but
also between brokers and the public. It would be a
serious error to confine our investigation of the pro-
blems connected with the stock exchange to the activi-
ties of the professional dealers, since the activity of
See Appendix C, Table XIV.
8
See Chapter VII and Appendix B. Cf. on this point the lucid
discussion by Charles 0. Hardy, Credit Policies of the Federal
Reserve System, Brookings Institute, Washington, D.C. 1932. On
p. 167 he writes : "There is no theoretical limit to the volume of
business which can be supported by a given volume of reserves, if
substantially everything is liquidated each day before the banks'
statements are made up. As service balances required of brokers
do not vary in proportion to their loans, as is customary with
commercial loans, there is no theoretical necessity for brokers to
increase their average balances as their turnover goes up."
77
STOCKMARKET, CREDIT AND CAPITAL FORMATION
these dealers is directed by the willingness to buy and
sell on the part of the public. There is an old stock
exchange joke which says that no inn can keep going
in the long run if the bar-tenders have nothing else to
do except play billiards with each other. It can exist
only if there are customers to serve. In the same way
the members of the stock exchange live not from "play-
ing with each other," but from the operations which
they undertake on behalf of the public. A rise on the
securities market cannot last any length of time unless
the public is both willing and able to make increased
No special purchases. But all that was said about the clearing
cleaning
exis:s for mechanism dispensing with the use of money does not
pay nents apply to transactions between the public and the stock
betv/een
brolers and exchange, and we must therefore continue our investi-
the public,— gation in this direction.
The fact that "inside business" on the stock
exchange, as I have tried to show, need not have the
—h» nee, effect of tying up more circulating media in times of
money
mig it be boom does not mean that "outside business" carried
tied up on between brokers and the public may not have
for these
payments. this effect.
42. The attempt is sometimes made to dispose of the
argument that the stock exchange or the speculating
public cause a tie-up of circulating media by compar-
ing the process to a "sieve with wide holes." The
The "sieve' securities market is supposed to be analogous to a sieve
analogy because the sellers of securities obtain the money just
explains
little:— as soon as it is invested by the buyers, and the circulat-
ing media to a certain extent merely "run through" ;
they remain at the disposal of the whole market with-
out any "tie-up" or "absorption." But this formula
could be applied just as well to any other market with
—on every the result that money would never be "held u p " or
market the
selle r gets "absorbed" anywhere. The seller of a commodity
what; the
buy< r pays. also obtains the money spent by the buyer, and it
78
DEMAND FOR MONEY BY THE STOCK MARKET
affected. tne rise m its price, lhe prices of such goods may
rise without necessitating any changes in other prices.2
The conclusions of the previous paragraphs might
also be relevant to the case of a rise in security prices.
Payments for The payment of the price of the securities is in the
undoubtedly6 n a t u r e of a transfer payment. The purchase of securi-
of the nature ties is neither more nor less of a transfer payment
of transfer . . ,
payments. tnan every loan; it is a transfer payment acknowledged
by a special kind of certificate or receipt. And if
the seller of the securities uses the purchasing power
he received in order to buy the same goods as those
of which the buyer of the securities relinquished the
purchase, and if the purchase takes place at the same
time as it would have been made by the buyer of the
securities, then the rise in security prices will leave
commodity prices unchanged. But if the seller of the
securities buys producers' goods, as may happen
2
In the German edition of this book I tried to show in a foot-
note that changes in monopoly prices under conditions of inelastic
demand may be interpreted as cases of the same kind. An increase
in monopoly rent might, I thought, be used for the purchase of the
same article as the consumers of the monopoly product had to
relinquish. Koopmans expressed the opinion (op. cit., pp. 337 ff.)
that I had stopped half-way, as in fact every payment might be
indifferent with respect to the economic process. I myself think
now, however, that I went too far since my object was not to
investigate how things would be if money were neutral, but to ask
in what cases this neutrality would be possible or would actually
prevail.
82
DEMAND FOR MONEY BY THE STOCK MARKET
securities from someone who wants to use the proceeds —may help to
T -i. i , •, • , i , avoid delays
in the commodity market, it is not unreal to assume ar i 8 i ng frOm
that theyJ will be used there no later than would have transfers of
# money
been the case if no transfer payment had intervened, capital.
A fairly plausible case can thus be made out for the
hypothesis of neutral transfer payments. But the
strange thing is that very few authors have bothered
their heads about the loss of time caused by transfer
payments when they have been dealing with ordinary
loans, relief payments, tax payments and the like.4
It has been thought necessary to emphasize the lapse
of time only in the case of transfer payments connected
with the securities market. In so far as it is simply
a matter of the flow of purchasing power through the
stock exchange, i.e., the transfer of purchasing power
from the purchaser of the shares to a seller who intends
to use it to purchase goods or services, it is difficult
to see why the lapse of time should have been thought
a greater evil here than in the case of ordinary loan
transactions and other transfer payments. As the
argument usually runs in terms of whether stock
exchange credit has harmful consequences which other Not whether
kinds of credit have not, it is unnecessary to try to throu I^the
prove that stock exchange credit finds its way onto stock
-,. . . exchange in
the commodity market in no time ; the question "no time"
is only whether the purchasing power transferred is l^akes6^61"
likely to take "more time" before it becomes demand "more time"
for goods and services in the case of stock exchange other r ° Ug
credit than in the case of other kinds of credit channels is
4
the question.
Hans Neisser, Der Tauschwert des Geldes, Jena 1928, saw
this problem. (See p. 9 : "It is indeed formally possible for the
process of making loans and granting credit to take a certain
amount of time . . . ; thus if the social product were to remain
the same but a relative extension of lending were to take place
this would require money, increase the volume of transactions and
give rise to a tendency to a fall in prices.") But he did not think
that this was of much practical importance.
85
STOCKMARKET, CREDIT AND CAPITAL FORMATION
6
Here we are making another rather unrealistic simplification.
It appears as though corporation M had conducted the sale of its
new issue directly through this broker, and as though the sale
to Mr. B represented the whole of the issue. A completely realistic
exposition would not, however, alter the results.
110
DEMAND FOR LOANS BY THE STOCK MARKET
—th buyer any money for them because he was in debt for them:
has t
to p?i y andand just as the seller has no money to receive, the
the seller buyer has no money to pay. The volume of loans out-
nothing to
recei ve ;— standing may fall, just as they rose previously, without
there being any "inflow," "outflow," "creation," or
"destruction" of bank credit. The claims against the
—ye figures unlucky speculators disappear when their creditors
J r
of br >kers' . ?*[
loant fall.
buy up their shares from them.
Fifth To complete the exposition, the chain of operations
illusl ra-
tion, - may again be illustrated by an example. (Ledger
balances are shown in Appendix A.)
— which Monday: M r . A receives a d e m a n d from his broker
customers' ^° P u ^ U P m o r e m a r g i n because t h e securities held for
marg.n debts h i m have depreciated in value. M r . A decides to sell
main y G securities w h i c h realize $15,000. T h e shares are
through b o u g h t b y Mr. B ' s broker on M r . B ' s behalf.
forced i
sa l es _ settlement takes place to-morrow.
—or when Case (2) can only be judged if we know how the
banifrdeposits Dan
k deposits of the buyers of the shares would have
fromi* ^ e e n u s e ( * ^ *^ e S ^ a r e purchase had not taken place.
margin I t is possible, though not very probable, that funds
wM^mostly will be withdrawn from the markets for goods in this
mea is the case also. 5 I t is more probable that the funds will
anc^oHdie come out of idle balances. If these now lead, through
balances;— the share purchase, to the eventual wiping out of a
certain amount of bank credit, there is no net defla-
tionary effect. The raising of the excess reserves of
the banks through the cancellation of these inactive
deposits actually increases the potential supply of new
—or when credit in the future. 6 I n case (3) where call loans are
lend, rs buy withdrawn in order to purchase shares, and shares are
shar< s from s o i ^ ^ n o r ( j e r to pay back call loans, there is nothing
r J &
the margin # '
debt >rs, which would have any effect either actual or potential
othei Markets o n * n e effective demand in other markets.
untouched.
58. The conclusions of the last nine sections are
sufficient to shake all confidence in the significance
of the statistics of brokers' loans. As brokers' loans
can rise for so many different reasons, it is quite
The naiysis impossible to diagnose the situation merely on the
valid con- basis of the aggregate figures for these loans. I t
ciusi< >n can be remains impossible, no matter how perfect a correla-
brokers' tion can loans
brokers' be shown
on theto one
existside
between the turnover
and the volume of
stocks, the level of stock prices or the velocity of
circulation of bank deposits on the other. The most
naive interpretation of all was that which said that
brokers' loans represented credit tied up in stock
5
Eiteman, if I do not misunderstand him, seems to be of this
opinion. See op. cit., Journal of Political Economy, p. 690.
6 This is the only point, and a weak one at that, in support of
those who expect a decline in brokers' loans to benefit "legitimate
business." It is somewhat reminiscent of Till Eulenspiegel when
somebody is glad that there has been a shrinkage of bank balances
because then it is possible for them to expand again.
124
DEMAND FOR LOANS BY THE STOCK MARKET
128
CHAPTER Y I I I
T H E L I Q U I D F U N D S OF B E A R I S H S E L L E R S
145
CHAPTER IX
153
CHAPTER X
A DIGRESSION ON INTERNATIONAL
SPECULATION
69. We are all familiar with tlie important role
assigned to national boundaries in the analysis of
International economic matters. Trade in commodities, loan trans-
arentreatedS actions and transfers of property between the citizens
differently of different countries are usually treated separately,
from domestic •* f
ones, - and from quite a different angle, from the same
economic relationships between citizens of one and the
same country. It is natural then that we should
usually think of transfers of securities between
domestic holders and foreign holders as being different
from transfers between co-nationals. Incidentally, it
would be advantageous for purposes of analysing
economic relationships if we were to drop the habit—
much fostered by nationalistic propagandists—of talk-
ing about actions of "this country" and the "foreign
country," when what is meant is the business opera-
tions of citizens of the countries concerned.
The role played by national boundaries in the exist-
ing body of economic doctrine hinges on two different
points: The first is the view that international trade
functions according to certain special laws of its own,
a view which has led to the belief that the laws
governing exchange in general are inapplicable to
international exchange. The second point consists in
a value judgment according to which the welfare or
wealth of communities separated by state boundaries
is to be evaluated in a different manner, and the
exchange between two nationals of different countries
154
DIGRESSION ON INTERNATIONAL SPECULATION
has to be considered in the light of whether it is —partly
"advantageous'' to the country concerned. The second value'judg-
point is not open to dispute on scientific grounds, ments,—
because the purpose of science is to analyse inter-
relationships independently of value judgments and
merely to formulate propositions which apply, no
matter what system of political or ethical values may
be introduced. The first point reduces itself to the
proposition that in international trade certain con-
ditions are present which are not present in the case of
trade between nationals of the same country. The most —partly
important of these conditions are obstacles that are obstacles to
placed in the way of international trade by state inter- international
. . . . . . . trans-
vention, e.g., restrictions on immigration, import actions,—
restrictions, currency and credit manipulation. What
has made problems concerning financial transactions —which are
between countries ofincreasingly
special techniques manipulatingcomplicated is and
the monetary the intervention,
dtuj to state
credit system which have been developed to cope with
various pseudo-problems of international monetary
theory. I am thinking here mainly of the famous
international transfer problem.1
Financial journalists find something to criticize in
every possible aspect of international capital move- International
ments. Every investment abroad—even when it yields movements
profits—is held guilty of robbing industry at home; arouse much
every investment by foreigners—even if it does not comment,
always yield profits—is denounced on the grounds that
foreigners are getting hold of too much financial
control. Objections are raised both against the citizens
of the home country who "gamble their capital away"
1
On the transfer problem see my articles, "Wahrung und Aus-
landsverschuldung," Mitteilungen des Verbandes osterreichischer
Banken und Bankiers, Vol. 10, Vienna 1928, pp. 194 ff.; "Transfer
und Preisbewegung," Zeitschrift filr Nationalokonomie, Vol. I,
Vienna 1930, pp. 555 ff.; and "Theorie der Kapitalflucht," Welt-
wirtschaftliches Archiv, Vol. 36, Kiel 1932, pp. 512 ff.
155
STOCKMARKET, CREDIT AND CAPITAL FORMATION
on foreign stock exchanges and against speculation by
foreigners who carry profits away from the home stock
market.
Here we can only make a few brief remarks on
these views. If there were no questions of income
distribution involved, we should be able to say at
once that the investment of capital in the most profit-
able2 uses, no matter whether at home or abroad, can
never be harmful to the collective well-being of the
''economy'' concerned. But it is practically impossible
to avoid these questions of income distribution in con-
siderations of this kind, and it is then impossible to
find an "index of welfare" which is free of value
judgments or which is unconnected with political aims.
As regards the gains or losses that are made in inter-
national speculation, all that we can say is that the
chances which domestic owners of capital have of
making profits or losses on foreign stock exchanges
are fundamentally neither smaller nor greater than the
chances which foreign owners of capital have of
winning or losing on the stock exchange of "our"
country.
163
CHAPTEE XI
THE SUPPLY OF CAPITAL AND INDUSTEIAL
FLUCTUATIONS
72. It lias been pointed out a number of times in
the previous chapters that too easy conditions in the
capital market produced by an expansion of bank
Why credit credit, cause industrial investments to be undertaken
expansion is
like]y to lead which in the course of time will most likely turn out
to dispropor- to have been misdirected. It is not my purpose
tionalities in
production,— to give a complete description of the way in which
this comes about. The process has been analysed in
the writings of Wicksell,1 Mises,2 Hayek,3 and others.
—ha i been Hayek's writings exerted much influence in stimulat-
expl ined
with refer- ing the discussion of problems of price and interest
ence to theory as they relate to excesses and painful setbacks
relat ive
pric< 8. of investment. It is, however, useful for purposes
A siiiplified of exposition to have in addition a simplified version
version may which omits the complications of price and interest
be at tempted.
analysis, but pictures the way in which the supply of
money capital affects the structure of production.
Cassel attempted to give something of the kind in
his Theory of Social Economy. An "analysis of real
capital . . . brings us back," he says, ". . . to the
1
Knut Wicksell, Interest and Prices, London 1936 (German
edition, Geldzins und Giiterpreise, 1898); Lectures on Political
Economy, Vol. II, London 1934 (German edition, 1922).
2
Ludwig von Mises, The Theory of Money and Credit, London
1934 (first German edition 1912); Geldwertstabilisierung und
Konjunktur'poUtih, Jena 1928.
3 Friedrich A. von Hayek, Monetary Theory and the Trade
Cycle, London 1932 (German edition 1929); Prices and Production,
London 1931. At the time when I completed the German edition
of this book, Prices and Production had not yet been published
and so I was able to refer to it only as a forthcoming publication.
164
CAPITAL AND INDUSTRIAL FLUCTUATIONS
real capital in existence at the beginning of the period
and the capital disposal offered during the period, and,
of course, to the other primary factors of production
available during that same time." 4 This formulation
evidently involves double counting if it counts the
"capital disposal offered'' and "the primary factors
of production." If we reduce the analysis to barter
terms, all that we find are the "real capital in exist-
ence at the beginning of the period" and the "primary
factors of production" which are assigned to the pro-
duction of future output by working with, and adding
to, the real capital previously in existence or by
replacing real capital that has been used up. The
"capital disposal offered" gives the producers com- Money
mand over these primary factors of production so that p
they can be used for carrying on roundabout processes services into
o i .• mi ,, •,! T u, -i. , p1 roundabout
of production. The "capital disposal" directs the prOcesses of
factors of production into the time-consuming processes production,
of production.5
In his total gross receipts for the products sold,
an individual entrepreneur recovers, in liquid form,
the cost of production invested in his output. If he
wants to maintain the volume of output at the same If the volume
level as before, he must reinvest the recovered cost, °s tlbbe^main"
i.e., the liquidated investment of the preceding tained, all
periods. Thus the money proceeds of the sale of his coital must
products represent money capital which the entre- be reinvested,
preneur can use, if he finds it profitable, for the
purpose of continuing production by buying capital
goods (intermediate products) from other entrepreneurs
4
Gustav Cassel, The Theory of Social Economy, London 1932
(translated from the fifth German edition), p. 207.
5
The problem of the time dimension of the production process
has provoked a great deal of heated discussion in recent years.
I have attempted to clear up the most serious misunderstandings
and the confusion which surround the concept of the time structure
of the capitalistic production process, in an essay entitled "Pro-
fessor Knight and the Period of Production," in the Journal of
Political Economy, Vol. 43, 1935.
165
STOCKMARKET, CREDIT AND CAPITAL FORMATION
173
CHAPTER XII
CREDIT CREATION AND THE ATTEMPT TO
DETERMINE ITS PROPER LIMITS
75. The view expressed here that credit expansion
is liable to end with a crisis is not one that is shared
by all economists. It may be emphasized once again
that it is not, of course, the credit itself which is
"dangerous." The bank credit created by the note
issuing banks and the commercial banks may in the
aggregate comprise a very considerable proportion of
the total circulation (i.e., the circulation of money
including checking deposits) and it would be courting
ridicule to claim that this "fiduciary circulation'' is
dangerous. It is not dangerous any longer. It
exerted its effects earlier at the time of its creation,
and by now has long been a part of the circulation
of means of payment which is entirely harmless and
is even necessary in order that the existing price
structure may be maintained.
The reason why there are so many misunderstand-
ings and differences of opinion in this sphere of
banking theory is that it is a sphere where problems
Tht double relating to the supply of money and the price level
rok of converge with problems relating to the demand for
moi Ley: as
circulating capital and the level of interest rates. The double
medium it
affeots prices, role of bank money as a medium of payment and
as money as money capital has paved the way for a great deal
capital it
affeots of confusion which many authors seem unable to
interest rates. escape. The muddle is avoided if it is made perfectly
clear that bank money functions directly as money
174
CREDIT CREATION AND ITS PROPER LIMITS
1
A qualification to this thesis will be treated in §§ 87 to 90.
2
It is to be understood that "lowering" stands also for
"counteracting an increase," and "raising" for "counteracting a
fall."
175
STOCKMARKET, CREDIT AND CAPITAL FORMATION
2
Op. cit., pp. 501 and 502 : "The true interest on capital might,
therefore, be defined as that rate of interest at which the value of
money remains unaltered. At this rate of interest just so much new
^>ank money will be put into circulation as corresponds to the
growing needs of trade, the price level remaining constant. The
competition of bank money with savings on the capital market may
be considered as normal and the rate of interest which keeps the
capital market in equilibrium may be defined as the 'natural rate
of interest.' "
J. M. Keynes in his Treatise on Money, Vol. I, defined the
natural rate of interest without reference to the price level, solely
on the basis of the equilibrium in the capital market : "Thus
the natural rate of interest is the rate at which saving and the
value of investment are exactly balanced" (p. 155). Nevertheless,
the connexion with the stable price level is implicit in Keynes's
fundamental equations.
3 Cassel, op. cit., p. 437.
4 Ibid.
5 Ibid.
181
STOCKMARKET, CREDIT AND CAPITAL FORMATION
Are he limits exchange "ties u p " credit, implies that the proper
wide'•'for ° r li m its of inflation are reached later in the case of loans
stool; ex- to the stock exchange than in the case of loans to
h ^ industry; the other, which argues that stock exchange
othe kinds credit is used "more intensively," 1 or that it is more
likely to be invested in fixed capital, implies that the
limits are reached earlier in the case of stock exchange
credit than in the case of loans to industry.
In reality, however—as will be demonstrated—it
makes no difference, from the point of view of the
"proper limits" of inflation, what kind of credit is
given. Neither the duration of the loan, nor the
purpose for which it is visibly (i.e., apparently) used,
can deprive a credit expansion which goes beyond a
certain point of its inflationary character. (It is, of
p s from course, another thing if strict provisions and condi-
quamitative tions relating to the duration and the purpose for
credi;, control which the credit may be used by the borrower, have
which is
incidtmtal to the incidental effect that they restrict the volume of
qualitative borrowing. Here we are considering whether the
discnmina-
tion, - duration and purpose of a given quantity of credit has.
much to do with its effects.)
There are probably a good many optimists who, on,
the basis of the maxims of practical banking, believe
that loans granted for investment in working capital
are less dangerous than loans granted for investment
in fixed capital, and that a larger dose of the first may
—-our ques- \ye risked than of the second. In the next chapter we
examination shall call attention to certain serious misunderstand-
°f l c r * n £ s a s ^° * n e n a * u r e °^ working capital and fixed
and stTort- capital, and shall later show also that the effect of an
increase in credit is hardly ever dependent on its form..
Anticipating these findings, we may for the moment
repeat that the "proper" limits of credit expansion,
are not affected by the nature and quality of the credit..
1
Felix Somary, Bankpolitik, second edition, Tubingen 1930,,
p. 44.
200
CREDIT CREATION AND ITS PROPER LIMITS
201
CHAPTEE XIII
WORKING CAPITAL AND SHORT-TERM LOANS
84. The thesis that the distinction made by the
individual enterprise between working capital and fixed
capital, and more especially the reasoning on which
the distinction is based, cannot be directly applied
to the sphere of general economic analysis, is not a new
The business discovery. Unfortunately, however, there is a general
concepts
"working tendency for concepts relating to the economic practice
capital" and of individuals and firms to be misapplied to the analysis
"fixe I capi-
tal" c annot of the functioning of the economic system as a whole.
be properly
applied to Almost universally "working capital*' is treated as
genei il being something fundamentally distinct from fixed
econ< mics.
capital. This view has had important practical con-
sequences in connexion with banking policy : the credit
policy which the banks have been urged to follow on
"scientific'' grounds has laid great emphasis on the
difference between lending for investment in working
capital and lending for investment in fixed capital.
The individual entrepreneur regards as working
capital that part of his capital which is released when
he stops producing; fixed capital, in contrast, remains
tied up even after he has stopped producing. This
aspect is highly significant from the point of view of
the individual firm, and a statement of "current"
assets and "current" liabilities, revealing the liquidity
position of the firm, is also of importance to every
individual lender. From the social point of view,
however, the liquidity of working capital takes on a
different aspect when we consider that the first entre-
preneur's money capital can only be released if his
202
WORKING CAPITAL AND SHORT-TERM LOANS
Trada credit (in hand and in the banks) which firms needed to
customers' keep, were reduced and the capital requirements of
advances the firms were more and more reduced to stocks of
reduce cash goods. Fluctuations in these working capital require-
ments
q °f individual firms, which appear to be con-
even without ditioned by periodic rather than continuous movements
facilities;—"^ °^ go°ds in process from one stage to the next, could
then be compensated by lending between entrepreneurs
in the same branch of industry. To return to our
previous example where we supposed that the stocks
of goods were moved forward from entrepreneur A
via B and C to D ; then the money capital necessary
to acquire the intermediate products could simply be
lent to the various entrepreneurs in rotation. And
for this to take place it would not be necessary for
the banks to do the lending; it could be done through
the channels of trade credit and customers' advances
between the firms concerned. For example, B could
make advances to A continually throughout the year
and these credits would be settled by the delivery once
in the year of A's product. Further, B could deliver
goods to C on credit and accept the latter's claims
against D in payment.
Polak gives concrete examples to illustrate the way
in which whole lines of production can be financed
by a single entrepreneur (representing one stage in
the line of production) who makes advances to his
sources of supply and extends trade credit to his
customers.8 Polak does not see the inflationary
character of the transition to such a situation. But
he shows very well how the ups and downs in short-
8
Polak, op. dt., pp. 49 ff. and p. 140. Polak shows how whole-
salers often act to a certain extent as merchant-bankers. If, for
example, the traders hold large stocks of commodities after the
harvest, finance their gradual sale by giving trade credit, and, as
the sales proceeds come in, finance the next year's production by
making advance payments to the farmer, all the "fluctuations in
capital requirements" can be seen to have cancelled out.
214
WORKING CAPITAL AND SHORT-TERM LOANS
! Farmers, - - — hc —
| Wholesalers, - - - £b £b | c fc j ^c
I Factory of first processing, - Jb Jb \ |b
' Factory of second processing. £b ^b £b
a
Retail shops - - - i ib | |b
principle no worse and no better than the other. The The two cases
transition, however, from one situation to another will fjntjbut tiie
have effects of a "dynamic" nature. In particular, transition
the transition from one situation in which firms hold former to the
larger cash balances the lower are their stocks of }
. . . . inflationary.
commodities, to a situation in which they lend out
their cash balances on short term, will have the infla-
tionary effects already described.2
But even in the case of new credits granted out of
surplus balances3 it is necessary to distinguish whether
the liquidity of the firm is merely a function of the
normal sales rhythm or whether it is the result of a
contraction of production. If the firm with the con-
tinuous production and seasonal discontinuities in
sales, and the firm with the seasonal discontinuities in
production and continuous sales, and all firms
which are intermediate between these two types, show
periodical fluctuations in the size of their cash
balances, then the decision to lend out these funds has
an inflationary effect, so long as the firm which owns
the funds intends to maintain production at an
unreduced level. It is not inflationary, however, if If surplus
the funds were released because the firm had decided accumulate
to contract production. In the first case the lender because of
„ , . • i -i . • . T . • contracted
transfers purchasing power without intending to give production,
up its use in his own business; he plans to use it t h e i r lendin g
ou 1S
7 . . t
himself
2 within the same period. In the second case necessary,—
These last two paragraphs are an addition to the original text.
the
I have insertedgives
lender them up purchasing
because power
the exposition which
in the Germanheedition
does
gave rise to several misunderstandings. Valentin F. Wagner, in
his Geschichte der Kredittheorien (p. 139), says, for example :
"Machlup's thesis is that when temporary surpluses of cash are
used to grant credit for financing working capital they represent
always an expansion of the supply of credit which causes more
roundabout production processes to be undertaken."
3 Wagner, who has taken over the term "Kasseniiberschuss-
kredit," which I believe I was the first to use, speaks also of a
"kassenmassige Kreditschopfung," that is a credit expansion out of
existing balances (op. cit., pp. 140 and 156).
223
STOCKMARKET, CREDIT AND CAPITAL FORMATION
230
CHAPTEE XIV
248
CHAPTEE XV
261
CHAPTER XYI
287
CHAPTEE XVII
CONCLUSIONS
Thursday
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399
INDEX OF NAMES.
ID 401
INDEX OF SUBJECTS.
Absorption of capital—
meaning of, 5-7; through increase in stock prices, 7, 120n,
148-153; through real investment, 30, 39, 288; through con-
sumption of profits, 32-34, 54, 63
Absorption of circulating media—
analogous to hoarding, 41; by speculators' transactions, 44,
55, 78, 87, 289; conditions for, 47-48; by chains of transfer
payments, 50, 88, 93, 113, 289; due to lack of new issues, 52,
289; by the stock exchange, 67-78, 86-88, 93-96, 289, 312;
by brokers' transactions, 73-77, 289; as a localization of an
inflation, 94; by bearish sellers, 129-145. 290; in sayings
deposits, 132-137, 143
Agricultural credit, 260n, 282, 294
Amortization (see replacement fund)
Anti-pyramiding zone, 268
Easy money—
policy, 48, 108, 268, 300; to stimulate private investment,
195 (see also creation of credit; interest rates)
Elasticity—
of demand for credit, 49-50, 90, 233-234, 253, 317; of credit
supply, 92, 235, 270
Enterpreneur—
the shareholder as, 22
Equilibrium rate of interest, 176, 180, 247-248 (see also natural
rate of interest; excess reserves)—
of U.S. banks, 101, 124, 132n, 134n, 138, 265, 268, 299, 313
Exchange rates (see foreign exchange rates)
Exchange equalization account—
British, 161
Expectations as to security prices, 130, 133, 142n, 266, 276
Ex-post savings, 185
Lending capacity—
of banking system affected by stock exchange loans, 19,
283-284; increased through cancellation of deposits, 124^
309, 310; of English banks, 132n, 134n; increased through
shifting to time deposits, 138
Lengthening of the production period—
(see period of production; structure of production)
Liquid funds—
(see cash balances; liquidity preference; money capital;
surplus cash balances)
Liquidation—
of fixed capital, 13, 16, 29; of working capital, 14, 16, 28-29,
37, 203-207, 253, 291; of security holdings, 23-24, 33-34, 121-
124, 140, 144; of stock exchange loans, 115-116, 121-124, 144,
290; and re-investment, 165-167, 208; of temporary savings,
33-34, 225; of a crisis, 246, 292
Liquidity—
of securities, 23-24, 36, 250; of call loans, 140-141; rules of
banking, 191, 206; of commercial loans, 191-193, 206-207;
of working capital, 192, 202-207, 253, 291; of a business firm,
202; of short-term capital, 230, 251-254; tests on critical
days, 243; of bank assets, 257
Liquidity -preference—
and stable security prices, 24n; and hoarding, 50, 132, 135,
140-144; and interest theory, 91n, 176n; and rising stock
prices, 130-133, 140; satisfied by holding call loans, 140-141,
144; bear position and, 141; satisfied by debt payments,
144; reduced—supports stock boom, 260
409
INDEX OF SUBJECTS
Loan value of securities, 266-272
Loanable funds—
and interest rates, 18, 176n (see also creation of credit;
interest rates; money capital; surplus cash balance)
London Stock Exchange, 98n, 329-330
Long-term credit—
made out of short-term funds, 23, 250-251, 258; from tem-
porary savings, 24, 33, 65, 225; may move inversely with
short-term credit, 280-287, 293 (see also interest ratea;
investment; saving)
Loss of capital—
potential—through hoarding, 41-42; causes of—listed, 57-59;
m security speculation, 57-66, 289, 294; of banks, 64; leading
to make-up saving, 65-66; invested in fixed equipment, 256
Partnerships—
obtaining loans, 271; getting new partners, 282
Passive inflationism, 248
Period of production—
controversy about, 165n; lengthening of the, 166n, 209-213
(see also structure of production; roundaboutness of pro-
duction)
Price level—
affected by credit creation, 174-177, 239n; stabilizing the
177, 179-182, 193, 291, 295; and increased productivity, 177,
190, 298; lowered through security speculation, 70-72, 82;
and transfer payments, 80-83, 85n; as guide to monetary
policy, 193, 297-298; of securities (see security prices)
Price payments, 80-82
Producers' goods (see fixed capital; working capital; investment;
structure of production)
Production, volume of—
reduced through hoarding, 26-27, 41-42; impaired by reduced
capital supply, 33, 159, 165-168; and monetary circulation,
189-190; increased through credit creation, 194-198, 254-255;
and liquidity of short-term capital, 208, 291; and surplus
cash balances, 227, 292
411
INDEX OF SUBJECTS
Productivity—
controversy on, 2-4; and price level, 177, 190, 298 (see also
marginal productivity; technical progress)
Professional speculators, 8, 23-25, 34-36, 55, 77, 92-93, 234 (see
also jobber)
Profits-
consumption of, 32-33, 53-54, 64, 288; business—and share
prices, 57-58, 90, 317; saving out of, 16, 170, 186, 208;
withdrawn from stock market, 107; stock exchange—counted
as income, 31n, 149-153; loan margins increased through, 267;
loans repaid from, 208 (see also capital gains)
Profit inflation, 186
Propensity to consume, 197
Public works—
financed by created credit, 194; to replace private invest-
ment, 195-197, 251; to offset private hoarding, 197
Pyramiding of margins, 267-268
Savings deposits—
and liquidity preference, 130-145; competing with securities,
131; funds switched from demand deposits to, 132-139;
reserve ratios for, 134n, 138n; in U.S., 1926-1929, 137;
replaced by call loans, 140-145; time deposits as, 237-239
Seasonal fluctuations—
in production period, 209; of capital requirements, 209-221,
291; of inventories, 211-212, 215-222; in surplus cash hold-
ings, 211-213; 219-230, 241-243, 291; of volume and velocity
of circulation, 222-223, 228; in turnover of goods, 230; of
money market rates, 232-235, 241-243, 292; in security prices,
234
Secondary saving, 186
Securities and Exchange Act, U.S., 268
Security capitalism, 24
Security issues (see issues of securities)
Security loans, 259, 311-312, 315 (see also brokers' loans; margin
loans; margin requirements)
Security method of raising capital—
function and advantages of, 21, 23, 33; causing duplication
of credit, 270-272; competing with other methods, 282.
Security prices—
absorption of funds seen in rise of, 46, 120n, 148; high—
attract new issues, 48-50, 52, 90, 107-108, 266, 289, 316-317;
high—mean cheap money for industry, 49, 140, 278-282, 293;
rise in—leads to profit taking and consumption, 54, 107;
reasons for fall of, 57-59; losses due to fall of, 57-66; rise
not at expense of commodity prices, 70-72; clearing balances
independent of, 75; payments of—are like transfer payments,
82; boom in—needs support by abundant credit, 90-92, 279,
290; and interest rates, 90, 91n, 108, 234, 274-277; brokers'
loans and rise of, 102, 106-107; and bear position, 131-133,
413
INDEX OF SUBJECTS
Security prices—continued.
135, 139, 141; rise in—regarded as income, 152n, 153; no
seasonal fluctuations in, 234; and loan margins, 266-269;
among the guides to monetary policy, 296, 298-299; index of,
316-317, 321, 329-330, 365-370, 375-376, 394-399
Self-liquidating loans, 191, 204, 206
Self-finance of industry, 170 (see also corporate saving)
Service balances with banks, 77n, 325n
Settlement (see clearing)
Settlement days, 98n, 99n, lOOn
Short-term capital—
international movements of, 155, 159-163, 317-318, 371; work-
ing capital versus, 202-230; no suitable investment for, 207,
233, 249; liquidity of, 230n, 254n; shortage of, 244 (see also
working capital; investment)
Short-term credit—
no short-term investment for, 202-230; inelastic demand for,
233, 253; leads to fixed investment, 249-257, 292; trans-
formed into long-term credit, 23, 250-251, 258; affected by
movement in long-term credit, 280-287, 293 (see also money
market; call loan rates; temporary saving; liquidity)
Sieve analogy, 78
Specificity of equipment, 203, 256
Stability—
of foreign exchange rates, 161-162; of capital supply, 165-
173, 185; of price level, 177, 179-182, 193, 291, 295; of
employment, 193, 195-198, 297; versus progress, 294
Stages of production, 13, 166-168, 173, 198, 204, 205-207 (see also
structure of production)
Standard Statistics Co., 321, 370
Statistics—
for United States, 311-328, 331-387; for United Kingdom,
329-330, 388-395
Statistical proofs—value of, 139
Stock exchange clearing (see clearing)
Stock exchange credit (see broker's loans; margin loans; margin
requirements)
Stock exchange speculation (see security prices; expectations; bear
position; bull sentiment; loss of capital; margin requirements)
Stock prices (see security prices)
Structure of production—
affected by supply of money capital, 164, 166-169, 210;
affected by increase in consumption, 170; affected by credit
414
INDEX OF SUBJECTS
Structure of production—continued.
creation, 175-177, 194-195, 198, 291, 295; and liquidity of
short-term capital, 205; affected by use of surplus cash
balances, 212-213, 241-242 (see also period of production;
roundaboutness of production)
Supply of money capital (see money capital; saving; creation of
credit; dishoarding)
Surplus cash balances, 15-17, 212-230, 233-248, 291-292, 296 (see also
cash balances; dishoarding)
Velocity of circulation—
assumed as constant, 71-72; compensating for change in
money work, 84; of funds on stock market, 129-130, 324-325,
327, 383-385; showing hoarding or dishoarding, 132n, 138-
139; increased during 1927-1929, 138-139, 280; inflated
through use of surplus balances, 213, 226n, 245; seasonal
fluctuations of, 222; cyclical fluctuations of, 228n, 246, 247n;
and 100 per cent, plan, 240n; of brokerage deposits, 307, 308
Vertical integration of industry, 187, 229, 245
Voluntary saving (see saving)
Wage rates—
rigidity of, 26, 42, 183, 190n; and capital supply, 166; and
interest rates, 176n, 198; credit expansion, employment and,
194, 197-198;
Widening of the market, 24
Working capital—
currently liquidated, 13-15; contrasted with other funds,
16-17; liquidation of, 28-29^ 37, 203-207, 253, 291; reinvest-
ment of liquidated, 166, 208; financed by created credit,
192, 200; definition of, 202; contrasted with fixed capital,
202-203; and short-term loans, 202-230; elasticity of demand
for, 252-256; financed by long-term capital, 281
416