From this system of banking, of which the advantages are confined chiefly to those who have entered into a special business relation, there naturally springs a more general use of the forms of credit to which the system has given rise. The written orders or bills drawn against the bank, when duly certified, are ac cepted as representative credit. They supple ment the money in circulation in the manner described in the chapter on the distribution of products. Banks find that their own credit enables them to meet all demands upon them . from their depositors without actually retain ing in their vaults all the monies deposited. Such amounts as are not needed may be lent out at a profit. Among the most frequent loans in the early days of banking were those to the government. Sometimes the king would have urgent need for money, for which taxes had been voted, but which had not yet been collected. Those who possessed hoards of money were in position to advance it on a pledge that it would be repaid with interest at a specified time. In some instances the original loan, was never repaid, the bankers receiving instead an annual interest. The famous Bank of England was founded to re lieve the necessities of the government. The bank consisted of subscribers who had lent 1,200,000 to the government on the security that out of the payments of tonnage 1 they should annually receive eight per cent, or, in all, The bank thus organized was also to have the privilege of carrying on an ordinary banking business, i.e., to receive money on deposit and to lend it at interest. Until this time in England the banking business had been chiefly in the hands of the gold smiths. It was the practice for merchants to keep their available funds in the chests of the goldsmith, drawing it out when neces sary, but usually by means of orders or bills which were used in the payment of debts and which generally passed through many hands, just as modern bank-notes do, before they were presented for payment.
Experience showed that fully one-half — or, in favorable circumstances, even two-thirds — of the funds thus collected in a large and stable bank might safely be used in outside loans. If one-third or one-half of the deposits were 1 A tax on ships.
2 Cunningham, Growth of English History and Commerce, II., 395.
kept on hand in the form of ready cash, it would be sufficient to meet all ordinary de mands. The reason for this is that a depositor seldom draws on the bank immediately for the full amount of his deposit, and since there are every day new deposits there will always be some money not in danger of withdrawal ; secondly, one who receives an order for money will not take the trouble to present it if he can satisfy his own obligations, or make new pur chases with the order just as well as with the cash that he would obtain by presenting it. Only careful experiment and wise judgment will enable the bankers to estimate correctly the extent to which they may rely upon these two facts in the management of their business. Depositors are easily alarmed, and if there is a rumor that the bank is in the least danger of failing to meet their demands upon it, there is certain to be a rush of withdrawals far in excess of the ordinary demand. Such emer gencies severely test the ability of the bank to render available its outstanding loans and in vestments. In times of crisis, banks have frequently failed, notwithstanding an abundance of assets, merely because they are not in a form available for immediate use and could not be exchanged for ready cash except at a great sacrifice, if at all.
The proper basis for representative credit is not therefore wealth, in general, but those forms of wealth that can be readily realized upon when the necessity For a sound basis it is further essential that the available funds should be accurately proportioned to the existing stage of commercial development. Where people are accustomed to the banking system, and where banks are in the habit of coming together for mutual assistance in periods of danger and public distrust, the whole field of credit is vastly extended without corresponding increase of the reserve funds in the vaults of the banks. Where people are accustomed to barter, or to use coins in all purchase and sale, the field of credit is closely circumscribed.
The most primitive and widely diffused form of credit, antedating the rise of banks, is that of book accounts. The merchant grants a 1 There, in part, lay the difficulty with the assignats of the French Revolution.
period of time to his customer for the payment of goods bought, himself receiving in turn similar grace from the wholesale dealer. This system springs from the greater convenience to buyers from the permission to postpone pay ment for irregular purchases until a future date, usually fixed with some reference to the ordinary time for customers to receive their own income ; and upon the well-known trait of human nature, that goods will be purchased more freely if there is no demand for immediate payment.
The system causes a great saving in the use of small change, and it secures a somewhat more intimate relation between merchant and cus tomer. Where pass-books or some other per manent memorandum of sales is kept in the hands of the customer, it affords an opportu nity for a survey of the general expenditure which may result in judicious readjustment. But the system is subject to grave abuses. Mer chants have difficulty in determining whether their various customers should be given credit, and, if so, to what extent. Dishonest debtors and others whose ventures prove unfortunate, so that they are unable k) pay their accounts at the time stipulated, bring heavy losses. As an insurance against such losses, merchants are obliged to charge higher prices for their goods. Their irregularity in collecting such debts makes it difficult for merchants to meet their own obli gations. Even when there are no errors of judgment from the merchant's standpoint, in the giving of credit much harm is often done by the practice. Customers gradually find them selves limited to the particular stores at which their credit is good, and so lose the advan tage from an inspection of the entire market. Higher prices are paid because of the risks and expenses of collection. Unexpectedly large accounts face the customer when the time for their presentation appears, and if they are paid promptly, the result is often an unbalanced and irregular distribution of income. The experi ence of cooperative stores indicates that a sav ing of from ten per cent upwards is possible by the introduction of a strictly cash system accom panied by economies of retail trade which it permits. This form of credit, though it has assumed vast proportions, is therefore of doubt ful utility.