Money

It should be pointed out that traders are constantly buying from one another. Retailers buy from wholesale dealers, and wholesale dealers from producers. Producers buy their materials from wholesale dealers, and dealers buy from one another. But all these transactions are in anticipation of the ultimate sale to the consumer (or to the investor), and their effect is to distribute the price received from the consumer among all the different traders, and the other people engaged in economic activity. To these latter the money payments, in the form of wages, salaries, inter est and rent, are pure income. When a trader sells, money is substituted for goods in his working capital ; when he spends money on buying or producing, goods are substituted for money. If there were no such thing as credit, a trader's transactions would involve very large fluctuations in the amount of money held by him. In that case, when consumers spend more than they receive and their balances are diminished, the traders' balances would he increased by an equal amount.

Temporary Borrowing.

The use of banking, however, makes the course of events quite different. The holding of a balance of idle money is a source of loss. Instead of keeping a large balance of money in hand to meet any big expenditure that the course of business may make desirable, traders rely on borrowing tem porarily from their bankers. They pay interest so long as they need the loan, and then when they receive money they pay it back. Thus goods may pass from trader to trader, and each will become indebted so long as he holds the goods, and will pay off the debt as soon as he sells them. The result is that when the traders' sales are accelerated, they do not hold the extra proceeds in money; they pay off bank advances. And when their sales fall off or their output outstrips sales, they do not meet the situation by reducing their balances of money; they borrow more from the banks. Traders' balances do of course vary. Apart from casual variations, they tend to rise and fall in proportion to turn over. They are also materially affected as we shall see presently, by the prospects of business and the state of credit. But the primary response of the traders to an increase or decrease in cash receipts in comparison with disbursements is to be found not in their balances but in their indebtedness to the banks.

If we imagine a community without banks (as in the middle ages) and suppose an addition made to the supply of money, the people who in the first instance receive the money will find their cash balances disproportionately increased. They will forthwith increase their expenditure. The money then passes into the hands of the traders who supply them, and they in turn will proceed to spend it (e.g., on replenishing their stock in trade, or extending their fixed capital) and pass it on to others who will be placed in turn in the same position. Demand is increased, production stimulated, and the incomes of people engaged in trading and production swollen. Production cannot be stimulated beyond capacity, and as that limit is approached the increased demand takes effect in a rise of prices instead of additional output. In

creased output and increased prices alike mean increased con sumers' income and consumers' outlay. And as people's incomes increase, they hold increased cash balances. A new state of equi librium is reached when the requirements of the community in regard to balances have so far increased as to absorb all the addi tional money.

Expansion of Credit.

In a community with a highly de veloped banking system what requires to be considered is, not so much an addition to the supply of money, as an addition to the supply of bank credit. In fact an addition to the supply of money, raising people's balances of money above requirements, would probably be immediately paid into the banks and so transformed into bank credit. The unspent margin is composed of bank credit, plus the money outside the banks. Apart from changes in the supply of money, it can be increased or decreased by an increase or decrease in the earning assets of the banks. Suppose, now, that the banks proceed to lend more, that there is what is called an expansion of credit. The borrowers are probably traders. They do not borrow money to hold it idle, but disburse it forthwith on the purchase of goods. The goods purchased have to be supplied or replaced by producers, whose incomes from profits and wages are thereby increased. The money lent by the banks quickly re appears in the form of an addition to the consumers' income. It is almost true to say that, if the banks begin to lend LI o,000 a day more than before, the consumers' income is increased by L o,000 a day, though of course no such numerical statement could be exact.

Close on the increase in the consumers' income follows an in crease in the consumers' outlay, but not in general an exactly equal increase, for the recipients of the increased incomes will probably retain a little in balances. The increased consumers' outlay is felt by the dealers in commodities as increased demand. They sell more and will apply superfluous receipts to repaying bank advances, but may retain a little in balances in virtue of their increased business. The dealers in commodities, finding themselves with increased sales, reduced stocks and less indebted ness, will be led to give further orders to the producers. The activity of the producers is intensified, they borrow more, the consumers' income is still further swollen, and demand is again increased. Whereas in the first instance the lending by the banks and the consumers' income are made greater by approximately equal amounts, the increase in lending is soon offset by an in crease in repayments. The actual increase in the outstanding amount of bank loans (and therefore in the amount of the un spent margin) is limited to the excess of lending over repayments. This excess is equal to the increase in consumers' balances, plus the increase in traders' balances (in fact that is another way of saying that it is equal to the increase in the unspent margin).