§ 8. The use of credit. The general use of credit is, as we have observed, an essential condition to the occurrence of a financial crisis, so that, indeed, a crisis might be called a disease of the credit system. The use of credit greatly en hances the rhythm of price. If the value of a thing that is fully paid for falls, the owner alone loses; but if the value of a thing only partly paid for falls so much that the owner is forced to default in his payment, the loss may be transmitted along the line of credit to every one in a long series of trans actions. A credit system, highly developed, is a house of cards at a time of financial stress. Demand liabilities are at such a time the greatest danger, so that the banks, ordi narily the pillars of financial strength, become at such a time the points of greatest weakness in the financial structure. If many of the customers were not restrained by their sense of personal obligation to the banks, by the strong pressure that the banks can bring to bear upon them, or by the force of public opinion among business men, from withdrawing the balances to their credit in a time of crisis, all commercial banks would become insolvent at once in a crisis by the very nature of their business; for all their ordinary deposits are nominally payable on demand.
§ 9. Interest rates in a crisis. In normal times there is always outstanding a great mass of short-time commercial The motive of the borrower, in most cases, has been to hire more labor and to buy more materials for use in his business. Ordinarily these loans can and are renewed with out difficulty, or are replaced by others, based on the security of new business transactions in unbroken succession. Now, at the time of a crisis a general contraction of credit occurs, and borrowers with maturing obligations would face bank ruptcy if they could not renew their loans. The effort of the business man at such a time is not to make a positive profit, but to save what he can from the threatened wreck. The demand for short-time loans, therefore, in such times of stress, fluctuates rapidly, and exceedingly high interest rates may prevail in these loan markets for a few days or a few weeks, rates that have only a remote relationship with the usual capitalization of most agents.
The distress of the business man is magnified by the fact that it is at just such times that both the equipment he has bought and the products he has made become temporarily almost unsalable at prices as high as he paid for them when he bought them with the borrowed money. He may know that prices will soon be higher, but he cannot wait. Various courses are open to him in this emergency: he may borrow the money at a very high rate of interest, holding the goods for better prices; or he may sell the goods under the unfavor able conditions; or he may sell other capital such as stocks and bonds. The end sought is the same—to get ready money ;
and the methods are not essentially unlike—the exchange of greater future values for smaller present values. The sacri fice sale thus reveals the merchant's high estimate of present goods in the form of money. The purchaser of some kinds of 8 See Vol. I, p. 304.
property in times of depression is securing them at a lower capitalization than they will later have. The rise in value may be foreseen as well by seller as by buyer, but the low capitalization reflects the high interest rate temporarily ob taining. A. T. Stewart, once the most famous New York merchant, is said to have laid the foundation of his fortune when, being out of debt himself, he bought up the bankrupt stocks of his competitors in a great financial panic. The high .interest at such times is but the reflection of the high premium on present purchasing power.
The worst of the evils of crises are confined to the markets where the greatest numbers of short-time loans are made. Most of the long-time loans do not fall due in such seasons of stress, and the great mass of slowly exchanging wealth alters little and slowly in price. Such long-term loans as fall due can generally be renewed at rates little higher than usual, the market for long-Thlie and slOrt-time loans be ing in large measure independent of each other. But they are not quite independent, and some lenders take whatever sums they can collect on maturing long-time obligations and lend them on short terms at high rates of interest, or buy goods, whole enterprises, bonds, and stocks, at the unusually low prices temporarily prevailing. The effect of this is to raise somewhat the interest rate on long-time paper to accord with the new conditions.
§ 10. Dynamic conditions and price readjustments. A condition favorable to large and rapid shifts in prices and credits is a dynamic economic society. The past century has opened up new fields for investment on an unexampled scale. Investment has advanced both intensively and extensively in a series of great waves. New machinery and processes have given undreamed of opportunities for enterprise in the older countries, and the physical frontier of investment has moved outward with the march of millions of immigrants to people the fertile wilderness. Such factors disturb the equilibrium of prices both in time and space, give a powerful impulse toward higher values in the older lands, and stimulate the hopes of all investors. When the balance between the prices and profits in various industries and between the incomes of the various periods proves to be false, the inevitable read justment causes suffering and loss to many, but particularly in the inflated industries. But, because of the mutual re lations of men in business, few even of those who have kept freest from speculation can quite escape the evils.