Capital, Volume III
Chapter 24. Externalization of the Relations of Capital in the Form of Interest-Bearing Capital
The relations of capital assume their most externalised and most fetish-like form in interest-bearing capital. We have here M — M', money creating more money, self-expanding value, without the process that effectuates these two extremes. In merchant's capital, M — C — M', there is at least the general form of the capitalistic movement, although it confines itself solely to the sphere of circulation, so that profit appears merely as profit derived from alienation; but it is at least seen to be the product of a social relation, not the product of a mere thing. The form of merchant's capital at least presents a process, a unity of opposing phases, a movement that breaks up into two opposite actions — the purchase and the sale of commodities. This is obliterated in M — M', the form of interest-bearing capital. For instance, if £1,000 are loaned out by a capitalist at a rate of interest of 5%, the value of £1,000 as a capital for one year = C + Ci', where C is the capital and i' the rate of interest. Hence, 5% = 5/100 = 1/20, and 1,000 + 1,000 × 1/20 = £1,050. The value of £1,000 as capital = £1,050, i.e., capital is not a simple magnitude. It is a relationship of magnitudes, a relationship of the principal sum as a given value to itself as a self-expanding value, as a principal sum which has produced a surplus-value. And capital as such, as we have seen, assumes this form of a directly self-expanding value for all active capitalists, whether they operate on their own or borrowed capital.
M — M'. We have here the original starting-point of capital, money in the formula M — C — M' reduced to its two extremes M — M', in which M' = M + DM, money creating more money. It is the primary and general formula of capital reduced to a meaningless condensation. It is ready capital, a unity of the process of production and the process of circulation, and hence capital yielding a definite surplus-value in a particular period of time. In the form of interest-bearing capital this appears directly, unassisted by the processes of production and circulation. Capital appears as a mysterious and self-creating source of interest — the source of its own increase. The thing (money, commodity, value) is now capital even as a mere thing, and capital appears as a mere thing. The result of the entire process of reproduction appears as a property inherent in the thing itself. It depends on the owner of the money, i.e., of the commodity in its continually exchangeable form, whether he wants to spend it as money or loan it out as capital. In interest-bearing capital, therefore, this automatic fetish, self-expanding value, money generating money, are brought out in their pure state and in this form it no longer bears the birth-marks of its origin. The social relation is consummated in the relation of a thing, of money, to itself. Instead of the actual transformation of money into capital, we see here only form without content. As in the case of labour-power, the use-value of money here is its capacity of creating value — a value greater than it contains. Money as money is potentially self-expanding value and is loaned out as such — which is the form of sale for this singular commodity. It becomes a property of money to generate value and yield interest, much as it is an attribute of pear-trees to bear pears. And the money-lender sells his money as just such an interest-bearing thing. But that is not all. The actually functioning capital, as we have seen, presents itself in such a light, that it seems to yield interest not as a functioning capital, but as capital in itself, as money-capital.
This, too, becomes distorted. While interest is only a portion of the profit, i.e., of the surplus-value, which the functioning capitalist squeezes out of the labourer, it appears now, on the contrary, as though interest were the typical product of capital, the primary matter, and profit, in the shape of profit of enterprise, were a mere accessory and by-product of the process of reproduction. Thus we get the fetish form of capital and the conception of fetish capital. In M — M' we have the meaningless form of capital, the perversion and objectification of production relations in their highest degree, the interest-bearing form, the simple form of capital, in which it antecedes its own process of reproduction. It is the capacity of money, or of a commodity, to expand its own value independently of reproduction — which is a mystification of capital in its most flagrant form.
For vulgar political economy, which seeks to represent capital as an independent source of value, of value creation, this form is naturally a veritable find, a form in which the source of profit is no longer discernible, and in which the result of the capitalist process of production — divorced from the process — acquires an independent existence.
It is not until capital is money-capital that it becomes a commodity, whose capacity for self-expansion has a definite price quoted every time in every prevailing rate of interest.
As interest-bearing capital, and particularly in its direct form of interest-bearing money-capital (the other forms of interest-bearing capital, which do not concern us here, are derivatives of this form and presuppose its existence), capital assumes its pure fetish form, M — M' being the subject, the saleable thing. Firstly, through its continual existence as money, a form, in which all its specific attributes are obliterated and its real elements invisible. For money is precisely that form in which the distinctive features of commodities as use-values are obscured, and hence also the distinctive features of the industrial capitals which consist of these commodities and conditions of their production. It is that form, in which value — in this case capital — exists as an independent exchange-value. In the reproduction process of capital, the money-form is but transient — a mere point of transit. But in the money-market capital always exists in this form. Secondly, the surplus-value produced by it, here again in the form of money, appears as an inherent part of it. As the growing process is to trees, so generating money (tocoz) appears innate in capital in its form of money-capital.
In interest-bearing capital the movement of capital is contracted. The intervening process is omitted. In this way, a capital = 1,000 is fixed as a thing, which in itself = 1,400, and which is transformed after a certain period into 1,100 just as wine stored in a cellar improves its use-value after a certain period. Capital is now a thing, but as a thing it is capital. Money is now pregnant. [Goethe, Faust, Part I, Scene 5. — Ed] As soon as it is loaned out, or invested in the reproduction process (inasmuch as it yields interest to the functioning capitalist as its owner, separate from profit of enterprise), interest on it grows, no matter whether it is awake or asleep, is at home or abroad, by day or by night. Thus interest-bearing money-capital (and all capital is money-capital in terms of its value, or is considered as the expression of money-capital) fulfils the most fervent wish of the hoarder.
It is this ingrown existence of interest in money-capital as in a thing (this is how the production of surplus-value through capital appears here), which occupies Luther's attention so thoroughly in his naive onslaught against usury. After demonstrating that interest may be demanded if the failure to repay a loan on a definite date to a lender who himself required it to make some payment, caused a loss to him, or resulted in his missing an opportunity to make a profit on a bargain, for instance, in buying a garden, Luther continues:
"Now that I have loaned you them (100 gulden), you cause me a double loss due to my not being able to pay on the one hand nor buy on the other, so that I have to lose on both sides, and this is called duplex interesse, damni emergentis et lucri cessantis.... On hearing that John sustained losses on his loan of 100 gulden and demands just damages, they rush in and charge double on every 100 gulden, such double reimbursement, namely, for the loss due to non-payment and to inability to make a profit on a bargain, just as though these 100 gulden had the double loss grown on to them, so that whenever they have 100 gulden, they loan them out and charge for two losses, which they have not at all sustained... Therefore you are a usurer, who takes damages out of his neighbour's money for an imaginary loss that you did not sustain at all, and which you can neither prove nor calculate. This sort of loss is called by the jurists non verum, sed phantasticum interesse. It is a loss which each conjures up for himself... It will not do to say, therefore, that there could have been losses because I could not have been able to pay or buy. Else it would mean ex contingente necessarium, which is making something out of a thing that is not, and a thing that is uncertain into a thing that is absolutely sure. Would not such usury devour the world in a few years? ... If an unhappy accident befalls him against his will, and he must recover from it, he may demand damages for it, but it is different in trade and just the reverse. There they scheme to profit at the expense of their needy neighbours, how to amass wealth and get rich, to be lazy and idle and live in luxury on the labour of others, without any care, danger, and loss. To sit by the stove and let my 100 gulden gather wealth for me in the country and yet keep them in my pocket, because they are only loaned, without any danger or risk; my friend, who would not like that?" (Martin Luther, An die Pfarherrn wider den Wucher zu predigen, etc., Wittenberg, 1540.)
The conception of capital as a self-reproducing and self-expanding value, lasting and growing eternally by virtue of its innate properties — hence by virtue of the hidden quality of scholasticists — has led to the fabulous fancies of Dr. Price, which outdo by far the fantasies of the alchemists; fancies, in which Pitt believed in all earnest, and which he used as pillars of his financial administration in his laws concerning the sinking fund.
"Money bearing compound interest increases at first slowly. But, the rate of increase being continually accelerated, it becomes in some time so rapid, as to mock all the powers of the imagination. One penny, put out at our Saviour's birth to 5 per cent compound interest, would, before this time, have increased to a greater sum, than would be contained in a hundred and fifty millions of earths, all solid gold. But if put out to simple interest, it would, in the same time, have amounted to no more than seven shillings and four pence half-penny. Our government has hitherto chosen to improve money in the last, rather than the first of these ways."[1]
His fancy flies still higher in his Observations on Reversionary Payments, etc., London, 1772. There we read:
"A shilling put out to 6% compound interest at our Saviour's birth" (presumably in the Temple of Jerusalem) "would ... have increased to a greater sum than the whole solar system could hold, supposing it a sphere equal in diameter to the diameter of Saturn's orbit." "A state need never therefore be under any difficulties; for with the smallest savings it may in as little time as its interest can require pay off the largest debts" (pp. XIII, XIV).
What a pretty theoretical introduction to the national debt of England!
Price was simply dazzled by the gargantuan dimensions obtained in a geometrical progression. Since he took no note of the conditions of reproduction and labour, and regarded capital as a self-regulating automaton, as a mere number that increases itself just as Malthus [An Essay on the Principle of Population, London, 1798, pp. 25-26. — Ed] did with respect to population in his geometrical progression, he was struck by the thought that he had found the law of its growth in the formula s = c(1 + i)n, in which s = the sum of capital + compound interest, c = advanced capital, i = rate of interest (expressed in aliquot parts of 100) and n stands for the number of years in which this process takes place.
Pitt takes Dr. Price's mystification quite seriously. In 1786 the House of Commons had resolved to raise £1 million for the public weal. According to Price, in whom Pitt believed, there was, of course, no better way than to tax the people, so as to "accumulate" this sum after raising it, and thus to spirit away the national debt through the mystery of compound interest. The above resolution of the House of Commons was soon followed up by Pitt with a law which ordered the accumulation of £250,000,
"until, with the expired annuities, the fund should have grown to £4,000,000 annually." (Act 26, George III, Chap. 3l.) ["An Act for vesting certain sums in Commissioners, at the End of every Quarter of a Year, to be by them applied to the Reduction of the National Debt" (Anno 26 Georgii III, Regis, cap. 31). — Ed.]
In his speech of 1792, in which Pitt proposed that the amount devoted to the sinking fund be increased, he mentioned machines, credit, etc., among the causes of England's commercial supremacy, but as
"the most wide-spread and enduring cause, that of accumulation. This principle, he said, was completely developed in the work of Smith, that genius ... and this accumulation, he continued, was accomplished by laying aside at least a portion of the annual profit for the purpose of increasing the principal, which was to be employed in the same manner the following year, and which thus yielded a continual profit."
With Dr. Price's aid Pitt thus converts Smith's theory of accumulation into enrichment of a nation by means of accumulating debts, and thus arrives at the pleasant progression of an infinity of loans — loans to pay loans.
It had already been noted by Josiah Child, the father of modern banking, that £100 at 10% would produce in 70 years by compound interest £102,400. (Traité sur le commerce, etc., par J. Child, traduit, etc., Amsterdam et Berlin, 1754, p. 115. Written in 1669.)
How thoughtlessly Dr. Price's conception is applied by modern economists, is shown in the following passage from the Economist:
"Capital, with compound interest on every portion of capital saved, is so all-engrossing that all the wealth in the world from which income is derived, has long ago become the interest of capital... All rent is now the payment of interest on capital previously invested in the land." (Economist, July 49, 1851.)
In its capacity of interest-bearing capital, capital claims the ownership of all wealth which can ever be produced, and everything it has received so far is but an instalment for its all-engrossing appetite. By its innate laws, all surplus-labour which the human race can ever perform belongs to it. Moloch.
In conclusion, the following hodge-podge by the romantic Müller:
"Dr. Price's immense increase of compound interest, or of the self-accelerating forces of man, presupposes an undivided, or uninterrupted, uniform application for several centuries, if they are to produce such enormous effects. As soon as capital is divided, cut up into several independently growing shoots, the total process of accumulating forces begins anew. Nature has distributed over a span of about 20 to 25 years the progression of energy which falls on an average to the share of every labourer (!). After the lapse of this time the labourer leaves his career and must transfer the capital accumulated by the compound interest of labour to a new labourer, mostly distributing it among several labourers or children. These must first learn to activate and apply their share of capital, before they can draw any actual compound interest on it. Furthermore, an enormous quantity of capital gained by civil society even in the most restless communities, is gradually accumulated over many years and not employed for any immediate expansion of labour. Instead, as soon as an appreciable sum is gathered together, it is transferred to another individual, a labourer, bank or state, under the head of a loan. And the receiver then sets the capital into actual motion and draws compound interest on it, so that he can easily pledge to pay simple interest to the lender. Finally, the law of consumption, greed, and waste opposes those huge progressions, in which man's powers and their products would multiply if the law of production, or thrift, were alone effective." (A. Müller, Elemente der Staatskunst, III, pp. 147-49.)
It is impossible to concoct a more hair-raising absurdity in so few lines. Leaving aside the droll confusion of labourer and capitalist, value of labour-power and interest on capital, etc., the charging of compound interest is supposed to be explained by the fact that capital is loaned out to bring in compound interest. The method employed by our Müller is thoroughly characteristic of the romanticism in all walks of life. It is made up of current prejudices, skimmed from the most superficial semblance of things. This incorrect and trite content should then be "exalted" and rendered sublime through a mystifying mode of expression.
The process of accumulation of capital may be conceived as an accumulation of compound interest in the sense that the portion of profit (surplus-value) which is reconverted into capital, i.e., serves to absorb more surplus-labour, may be called interest. But:
1) Aside from all incidental interference, a large part of available capital is constantly more or less depreciated in the course of the reproduction process, because the value of commodities is not determined by the labour-time originally expended in their production, but by the labour-time expended in their reproduction, and this decreases continually owing to the development of the social productivity of labour. On a higher level of social productivity, all available capital appears, for this reason, to be the result of a relatively short period of reproduction, instead of a long process of accumulation of capital.[2]
2) As demonstrated in Part III of this book, the rate of profit decreases in proportion to the mounting accumulation of capital and the correspondingly increasing productivity of social labour, which is expressed precisely in the relative and progressive decrease of the variable as compared to the constant portion of capital. To produce the same rate of profit after the constant capital set in motion by one labourer increases ten-fold, the surplus labour-time would have to increase ten-fold, and soon the total labour-time, and finally the entire 24 hours of a day, would not suffice, even if wholly appropriated by capital. The idea that the rate of profit does not shrink is, however, the basis of Price's progression and in general the basis of "all-engrossing capital with compound interest."[3]
The identity of surplus-value and surplus-labour imposes a qualitative limit upon the accumulation of capital. This consists of the total working-day, and the prevailing development of the productive forces and of the population, which limits the number of simultaneously exploitable working-days. But if one conceives of surplus-value in the meaningless form of interest, the limit is merely quantitative and defies all fantasy.
Now, the concept of capital as a fetish reaches its height in interest-bearing capital, being a conception which attributes to the accumulated product of labour, and at that in the fixed form of money, the inherent secret power, as an automaton, of creating surplus-value in geometrical progression, so that the accumulated product of labour, as the Economist thinks, has long discounted all the wealth of the world for all time as belonging to it and rightfully coming to it. The product of past labour, the past labour itself, is here pregnant in itself with a portion of present or future living surplus-labour. We know, however, that in reality the preservation, and to that extent also the reproduction of the value of products of past labour is only the result of their contact with living labour; and secondly, that the domination of the products of past labour over living surplus-labour lasts only as long as the relations of capital, which rest on those particular social relations in which past labour independently and overwhelmingly dominates over living labour.
Chapter 25. Credit and Fictitious Capital
An exhaustive analysis of the credit system and of the instruments which it creates for its own use (credit-money, etc.) lies beyond our plan. We merely wish to dwell here upon a few particular points, which are required to characterise the capitalist mode of production in general. We shall deal only with commercial and bank credit. The connection between the development of this form of credit and that of public credit will not be considered here.
I have shown earlier (Buch I, Kap. III, 3, b [English edition: Ch. III, 3, b. — Ed.]) how the function of money as a means of payment, and therewith a relation of creditor and debtor between the producer and trader of commodities, develop from the simple circulation of commodities. With the development of commerce and of the capitalist mode of production, which produces solely with an eye to circulation, this natural basis of the credit system is extended, generalised, and worked out. Money serves here, by and large, merely as a means of payment, i.e., commodities are not sold for money, but for a written promise to pay for them at a certain date. For brevity's sake, we may put all these promissory notes under the general head of bills of exchange. Such bills of exchange, in their turn, circulate as means of payment until the day on which they fall due; and they form the actual commercial money. Inasmuch as they ultimately neutralise one another through the balancing of claims and debts, they act absolutely as money, although there is no eventual transformation into actual money. Just as these mutual advances of producers and merchants make up the real foundation of credit, so does the instrument of their circulation, the bill of exchange, form the basis of credit-money proper, of bank-notes, etc. These do not rest upon the circulation of money, be it metallic or government-issued paper money, but rather upon the circulation of bills of exchange.
W. Leatham (banker of Yorkshire) writes in his Letters on the Currency, 2nd ed., London, 1840:
"I find, then, the amount for the whole of the year of 1839 ... to be £528,493,842" (he assumed that the foreign bills of exchange made up about one-fifth of the total) "and the amount of bills out at one time in the above year, to be £132,123,460" (p. 56). The bills of exchange make up "one component part greater in amount than all the rest put together" (p. 3). "This enormous superstructure of bills of exchange rests (!) upon the base formed by the amount of bank-notes and gold, and when, by events, this base becomes too much narrowed, its solidity and very existence is endangered" (p. 8). "If I estimate the whole currency"
(he means of the bank-notes)
"and the amount of the liabilities of the Bank and country bankers, payable on demand, I find a sum of 153 million, which, by law, can be converted into gold ... and the amount of gold to meet this demand" only 14 million (p.11). "The bills of exchange are not ... placed under any control, except by preventing the abundance of money, excessive and low rates of interest or discount, which create a part of them, and encourage their great and dangerous expansion. It is impossible to decide what part arises out of real bonâ fide transactions, such as actual bargain and sale, or what part is fictitious and mere accommodation paper, that is, where one bill of exchange is drawn to take up another running, in order to raise a fictitious capital, by creating so much currency. In times of abundance and cheap money this I know reaches an enormous amount"
(pp. 43-44). J.W. Bosanquet, Metallic, Paper and Credit Currency, London, 1842:
"An average amount of payments to the extent of upwards of £3,000,000 is settled through the Clearing House
(where the London bankers exchange due bills and filed cheques)
every day of business in the year, and the daily amount of money required for the purpose is little more than £200,000" (p. 86).
(In 1889, the total turnover of the Clearing House amounted to £7,618.75 million, which, in roughly 300 business days, averages £25½ million daily. — F. E.]
"Bills of exchange act undoubtedly as currency, independent of money, inasmuch as they transfer property from hand to hand by endorsement" (p. 92). "It may be assumed that upon an average there are two endorsements upon every bill in circulation, and ... each bill performs two payments before it becomes due. Upon this assumption it would appear, that by endorsement alone property changed hands, by means of bills of exchange, to the value of twice five hundred and twenty-eight million, or £1,056,000,000, being at the rate of more than £3,000,000 per day, in the course of the year 1839. We may safely therefore conclude, that deposits and bills of exchange together, perform the functions of money, by transferring property from hand and to hand without the aid of money, to an extent daily of not less than £18,000,000" (p. 93).
Tooke says the following about credit in general:
"Credit, in its most simple expression, is the confidence which, well, or ill-founded, leads a person to entrust another with a certain amount of capital, in money, or in goods computed at a value in money agreed upon, and in each case payable at the expiration of a fixed term. In the case where the capital is lent in money, that is whether in bank-notes, or in a cash credit, or in an order upon a correspondent, an addition for the use of the capital of so much upon every £100 is made to the amount to be repaid. In the case of goods the value of which is agreed in terms of money, constituting a sale, the sum stipulated to be repaid includes a consideration for the use of the capital and for the risk, till the expiration of the period fixed for payment. Written obligations of payment at fixed dates mostly accompany these credits, and the obligations or promissory notes after date being transferable, form the means by which the lenders, if they have occasion for the use of their capital, in the shape whether of money or goods, before the expiration of the term of the bills they hold, are mostly enabled to borrow Or to buy on lower terms, by having their own credit strengthened by the names on the bills in addition to their own." (Inquiry into the Currency Principle, p. 87.)
Ch. Coquelin, Du Crédit et des Banques dans L'Industrie, Revue des Deux Mondes, 1842, Tome 31:
"In every country the majority of credit transactions takes place within the circle of industrial relations... The producer of the raw material advances it to the processing manufacturer, and receives from the latter a promise to pay on a certain day. The manufacturer, having completed his share of the work, in his turn advances his product on similar terms to another manufacturer, who has to process it further, and in this way credit stretches on and on, from one to the other, right up to the consumer. The wholesale dealer gives the retailer commodities on credit, while receiving credit from a manufacturer or commission agent. All borrow with one hand and lend with the other, sometimes money, but more frequently products. In this manner an incessant exchange of advances, which combine and intersect in all directions, takes place in industrial relations. The development of credit consists precisely in this multiplication and growth of mutual advances, and therein is the real seat of its power."
The other side of the credit system is connected with the development of money-dealing, which, of course, keeps step under capitalist production with the development of dealing in commodity. We have seen in the preceding part (Chap. XIX) how the care of the reserve funds of businessmen, the technical operations of receiving and disbursing money, of international payments, and thus of the bullion trade, are concentrated in the hands of the money-dealers. The other side of the credit system — the management of interest-bearing capital, or money-capital, develops alongside this money-dealing as a special function of the money-dealers. Borrowing and lending money becomes their particular business. They act as middlemen between the actual lender and the borrower of money-capital. Generally speaking, this aspect of the banking business consists of concentrating large amounts of the loanable money-capital in the bankers' hands, so that, in place of the individual money-lender, the bankers confront the industrial capitalists and commercial capitalists as representatives of all moneylenders. They become the general managers of money-capital. On the other hand by borrowing for the entire world of commerce, they concentrate all the borrowers vis-à-vis all the lenders. A bank represents a centralisation of money-capital, of the lenders, on the one hand, and on the other a centralisation of the borrowers. Its profit is generally made by borrowing at a lower rate of interest than it receives in loaning.
The loanable capital which the banks have at their disposal streams to them in various ways. In the first place, being the cashiers of the industrial capitalists, all the money-capital which every producer and merchant must have as a reserve fund, or receives in payment, is concentrated in their hands. These funds are thus converted into loanable money-capital. In this way, the reserve fund of the commercial world, because it is concentrated in a common treasury, is reduced to its necessary minimum, and a portion of the money-capital which would otherwise have to lie slumbering as a reserve fund, is loaned out and serves as interest-bearing capital. In the second place, the loanable capital of the banks is formed by the deposits of money-capitalists who entrust them with the business of loaning them out. Furthermore, with the development of the banking system, and particularly as soon as banks came to pay interest on deposits, money savings and the temporarily idle money of all classes were deposited with them. Small amounts, each in itself incapable of acting in the capacity of money-capital, merge together into large masses and thus form a money power. This aggregation of small amounts must be distinguished as a specific function of the banking system from its go-between activities between the money-capitalists proper and the borrowers. In the final analysis, the revenues, which are usually but gradually consumed, are also deposited with the banks.
The loan is made (we refer here strictly to commercial credit) by discounting bills of exchange — by converting bills of exchange into money before they come due — and by advances of various kinds: direct advances on personal credit, loans against securities, such as interest-bearing paper, government paper, stocks of all sorts, and, notably, overdrafts against bills of lading, dock warrants, and other certified titles of ownership of commodities and overdrawing deposits, etc.
The credit given by a banker may assume various forms, such as bills of exchange on other banks, cheques on them, credit accounts of the same kind, and finally, if the bank is entitled to issue notes — bank-notes of the bank itself. A bank-note is nothing but a draft upon a banker, payable at any time to the bearer, and given by the banker in place of private drafts. This last form of credit appears particularly important and striking to the layman, first, because this form of credit-money breaks out of the confines of mere commercial circulation into general circulation, and serves there as money; and because in most countries the principal banks issuing notes, being a peculiar mixture of national and private banks, actually have the national credit to back them, and their notes are more or less legal tender; because it is apparent here that the banker deals in credit itself, a bank-note being merely a circulating token of credit. But the banker also has to do with credit in all its other forms, even when he advances the cash money deposited with him. In fact, a bank-note simply represents the coin of wholesale trade, and it is always the deposit which carries the most weight with banks. The best proof of this is furnished by the Scottish banks.
Special credit institutions, like special forms of banks, need no further consideration for our purpose.
"The business of bankers ... may be divided into two branches... One branch of the banker's business is to collect capital from those who have not immediate employment for it, and to distribute or transfer it to those who have. The other branch is to receive deposits of the incomes of their customers, and to pay out the amount, as it is wanted for expenditure by the latter in the objects of their consumption... The former being a circulation of capital, the latter of currency... " — "One relates to the concentration of capital on the one hand and the distribution of it on the other, the other is employed in administering the circulation for local purposes of the district." Tooke, Inquiry into the Currency Principle, pp. 36, 37.
We shall revert to this passage later, in Chapter XXVIII.
Reports of Committees, Vol. VIII. Commercial Distress, Vol. 11, Part I, 1847-48, Minutes of Evidence. (Further quoted as Commercial Distress, 1847-48.) In the forties, when discounting bills of exchange in London, 21-day drafts of one bank on another were often accepted in lieu of banknotes. (Testimony of J. Pease, country banker, Nos. 4638 and 4645.) According to the same report, bankers were in the habit of giving such bills of exchange regularly in payment to their customers whenever money was tight. If the receiver wanted bank-notes, he had to rediscount this bill. For the banks this amounted to a privilege of coining money. Messrs. Jones, Lloyd and Co. made payments in this way "from time immemorial," as soon as money was scarce and the rate of interest rose above 5%. The customer was glad to get such banker's bills because bills from Jones, Loyd and Co. were easier discounted than his own; besides, they often passed through twenty to thirty hands. (Ibid., Nos. 901 to 904, 905, 992.)
All these forms serve to make the payments claim transferable.
"There is scarcely any shape into which credit can be cast, in which it will not at times be called to perform the functions of money; and whether that shape be a bank-note, or a bill of exchange, or a banker's cheque, the process is in every essential particular the same, and the result is the same." Fullarton, On the Regulation of Currencies, 2nd ed., London, 1845, p. 38. — "Bank-notes are the small change of credit" (p. 51).
The following from J. W. Gilbart's The History and Principle of Banking, London, 1834:
"The trading capital of a bank may be divided into two parts: the invested capital, and the borrowed banking capital" (p. 117). "There are three ways of raising a banking or borrowed capital. First, by receiving; secondly, by the issuing of notes; thirdly, by the drawing of bills. If a person will lend me £100 for nothing, and I lend that £100 to another person at four per cent interest, then, in the course of a year, I shall gain £4 by the transaction. Again, if a person will take my 'promise to pay'" ("I promise to pay" is the usual formula for English bank-notes) "and bring it back to me at the end of the year, and pay me four per cent for it, just the same as though I had lent him 100 sovereigns, then I shall gain £4 by that transaction; and again, if a person in a country town brings me £100 on condition that, twenty-one days afterwards, I shall pay the same amount to a person in London, then whatever interest I can make of the money during the twenty-one days, will be my profit. This is a fair representation of the operations of banking, and of the way in which a banking capital is created by means of deposits, notes, and bills" (p. 117). "The profits of a banker are generally in proportion to the amount of his banking or borrowed capital... To ascertain the real profit of a bank, the interest upon the invested capital should be deducted from the gross profit, and what remains is the banking profit" (p. 118). "The advances of bankers to their customers are made with other people's money" (p. 146). "Precisely those bankers who do not issue notes, create a banking capital by the discounting of bills. They render their discounts subservient to the increase of their deposits. The London bankers will not discount except for those houses who have deposit accounts with them" (p. 119). "A party who has had bills discounted, and has paid interest on the whole amount, must leave some portion of that amount in the hands of the banker without interest. By this means the banker obtains more than the current rate of interest on the money actually advanced, and raises a banking capital to the amount of the balance left in his hands" (pp. 119- 20).
Economising on reserve funds, deposits, cheques:
"Banks of deposit serve to economise the use of the circulating medium. This is done upon the principle of transfer of titles.... Thus it is that banks of deposit ... are enabled to settle a large amount of transactions with a small amount of money. The money thus liberated, is employed by the banker in making advances, by discount or otherwise, to his customers. Hence the principle of transfer gives additional efficiency to the deposit system..." (p. 123). "It matters not whether the two parties, who have dealings with each other, keep their accounts with the same banker or with different bankers; for, as the bankers exchange their cheques with each other at the clearing house.... The deposit system might thus, by means of transfers, be carried to such an extent as wholly to supersede the use of a metallic currency. Were every man to keep a deposit account at a bank, and make all his payments by cheques, money might be superseded, and cheques become the sole circulating medium. In this case, however, it must be supposed that the banker has the money in his hands, or the cheques would have no value" (p. 124).
Centralisation of local transactions in the hands of the banks is effected 1) through branch banks. Country banks have branch establishments in the smaller towns of their district, and London banks in different districts of the city. 2) Through agencies.
"Each country banker employs a London agent to pay his notes or bills ... and to receive sums that may be lodged by parties residing in London for the use of parties residing in the country" (p.127). "Each banker accepts the notes of others, but does not reissue them. In all larger cities they come together once or twice a week and exchange their notes. The balance is paid by a draft on London" (p.134). "It is the object of banking to give facilities to trade, and whatever gives facilities to trade gives facilities to speculation. Trade and speculation are in some cases so nearly allied, that it is impossible to say at what precise point trade ends and speculation begins.... Wherever there are banks, capital is more readily obtained, and at a cheaper rate. The cheapness of capital gives facilities to speculation, just in the same way as the cheapness of beef and of beer gives facilities to gluttony and drunkenness" (pp. 137, 438). "As banks of circulation always issue their own notes, it would seem that their discounting business was carried on exclusively with this last description of capital, but it is not so. It is very possible for a banker to issue his own notes for all the bills he discounts, and yet nine-tenths of the bills in his possession shall represent real capital. For, although in the first instance, the banker's notes are given for the bill, yet these notes may not stay in circulation until the bill becomes due — the bill may have three months to run, the notes may return in three days" (p. 172). "The overdrawing of a cash credit account is a regular matter of business; it is, in fact, the purpose for which the cash credit has been granted.... Cash credits are granted not only upon personal security, but also upon the security of the Public Funds" (pp. 174, 175). "Capital advanced, by way of loan, on the securities of merchandise, would produce the same effects as if advanced in the discounting of bills. If a party borrows £400 on the security of his merchandise, it is the same as though he had sold his merchandise for a £100 bill, and got it discounted with the banker. By obtaining this advance he is enabled to hold over this merchandise for a better market, and avoids a sacrifice which, otherwise, he might be induced to make, in order to raise the money for urgent purposes" (pp. 180-81).
The Currency Theory Reviewed, etc., pp. 62-63:
"It is unquestionably true that the £1,000 which you deposit at A today may be reissued tomorrow, and form a deposit at B. The day after that, reissued from B, it may form a deposit at C ... and so on to infinitude; and that the same £1,000 in money may thus, by a succession of transfers, multiply itself into a sum of deposits absolutely indefinite. It is possible, therefore, that nine-tenths of all the deposits in the United Kingdom may have no existence beyond their record in the books of the bankers who are respectively accountable for them ... Thus in Scotland, for instance, currency (mostly paper money at that) has never exceeded £3 million, the deposits in the banks are estimated at £27 million.... Unless a run on the banks be made, the same £1,000 would, if sent back upon its travels, cancel with the same facility a sum equally indefinite. As the same £1,000 with which you cancel your debt to a tradesman today, may cancel his debt to the merchant tomorrow, the merchant's debt to the bank the day following, and so on without end; so the same £1,000 may pass from hand to hand, and bank to bank, and cancel any conceivable sum of deposits."
[We have seen that Gilbart knew even in 1834 that
"whatever gives facilities to trade gives facilities to speculation. Trade and speculation are in some cases so nearly allied, that it is impossible to say at what precise point trade ends and speculation begins."
The easier it is to obtain advances on unsold commodities, the more such advances are taken, and the greater the temptation to manufacture commodities, or dump already manufactured commodities in distant markets, just to obtain advances of money on them. To what extent the entire business world of a country may be seized by such swindling, and what it finally comes to, is amply illustrated by the history of English business during 1845-47. It shows us what credit can accomplish. Before passing on to the following examples, a few preliminary remarks.
At the close of 1842 the pressure which English industry suffered almost uninterruptedly since 1837, began to lift. During the following two years foreign demand for English manufactured goods increased still more; 1845 and 1846 marked a period of greatest prosperity. In 1843 the Opium War had opened China to English commerce. The new market gave a new impetus to the further expansion of an expanding industry, particularly the cotton industry. "How can we ever produce too much? We have to clothe 300 million people," a Manchester manufacturer said to this writer at the time. But all the newly erected factory buildings, steam-engines, and spinning and weaving machines did not suffice to absorb the surplus-value pouring in from Lancashire. With the same zeal as was shown in expanding production, people engaged in building railways. The thirst for speculation of manufacturers and merchants at first found gratification in this field, and as early as in the summer of 1844. Stock was fully underwritten, i.e., so far as there was money to cover the initial payments. As for the rest, time would show! But when further payments were due — Question 1059, C. D. 1848/57, indicates that the capital invested in railways in 1846-47 amounted to £75 million — recourse had to be taken to credit, and in most cases the basic enterprises of the firm had also to bleed.
And in most cases these basic enterprises were already over-burdened. The enticingly high profits had led to far more extensive operations than justified by the available liquid resources. Yet there was credit-easy to obtain and cheap. The bank discount rate stood low: 1¾ to 2¾% in 1844, less than 3% until October 1845, rising to 5% for a while (February 1846), then dropping again to 3¼% in December 1846. The Bank of England had an unheard-of supply of gold in its vaults. All inland quotations were higher than ever before. Why then allow this splendid opportunity to escape? Why not go in for all one was worth? Why not send all one could manufacture to foreign markets which pined for English goods? And why should not the manufacturer himself pocket the double gain arising from selling yarn and fabrics in the Far East, and the return cargo in England?
Thus arose the system of mass consignments to India and China against advance payments, and this soon developed into a system of consignments purely for the sake of getting advances, as described in greater detail in the following notes, which led inevitably to over-flooding the markets and a crash.
The crash was precipitated by the crop failure of 1846. England, and particularly Ireland, required enormous imports of foodstuffs, notably corn and potatoes. But the countries which supplied them could be paid with the products of English industry only to a very limited extent. Precious metals had to be given out. Gold worth at least nine million was sent abroad. Of this amount no less than seven and a half million came from the treasury of the Bank of England, whose freedom of action on the money-market was thereby considerably impaired. Other banks, whose reserves were deposited with the Bank of England and were practically identical with those of that Bank, were thus also compelled to curtail accommodation of money. The rapid and easy flow of payments was obstructed, first here and there, then generally. The banking discount rate, still 3 to 3½% in January 1847, rose to 7% in April, when the first panic broke out. The situation eased somewhat in the summer (6½%, 6%), but when the new crop failed as well panic broke out afresh and even more violently. The official minimum bank discount rose in October to 7 and in November to 10%; i.e., the overwhelming mass of bills of exchange was discountable only at outrageous rates of interest, or no longer discountable at all. The general cessation of payments caused the failure of several leading and very many medium-sized and small firms. The Bank itself was in danger due to the limitations imposed by the artful Bank Act of 1844. The government yielded to the general clamour and suspended the Bank Act on October 25, thereby eliminating the absurd legal fetters imposed on the Bank. Now it could throw its supply of bank-notes into circulation without hindrance. The credit of these bank-notes being in practice guaranteed by the credit of the nation, and thus unimpaired, the money stringency was thus instantly and decisively relieved. Naturally, quite a number of hopelessly enmeshed large and small firms failed nevertheless, but the peak of the crisis was overcome, the banking discount dropped to 5% in December, and in the course of 1848 a new wave of business activity began which took the edge off the revolutionary movements on the continent in 1849, and which inaugurated in the fifties an unprecedented industrial prosperity, but then ended again — in the crash of 1857. — F. E.]
I. A document issued by the House of Lords in 1848 deals with the colossal depreciation of government paper and bonds during the 1847 crisis. According to it the depreciation of October 23, 1847, compared with the level in February of the same year, amounted to:
II. With reference to the swindle in East Indian trade, in which drafts were no longer drawn because commodities were being bought, but rather commodities were bought to be able to make out discountable drafts convertible into money, the Manchester Guardian of November 24, 1847, remarks:
Mr. A in London instructs a Mr. B to buy from the manufacturer C in Manchester commodities for shipment to a Mr. D in East India. B pays C in six months' drafts to be made out by C on B. B secures himself by six months' drafts on A. As soon as the goods are shipped A makes out six months' drafts on D against the mailed bill of lading.
"The shipper and the co-signee were thus both put in possession of funds — months before they actually paid for the goods; and, very commonly, these bills were renewed at maturity, on pretence of affording time for the returns in a 'long trade'. Unfortunately, losses by such a trade, instead of leading to its contraction, led directly to its increase. The poorer men became, the greater need they had to purchase, in order to make up, by new advances, the capital they had lost on the past adventures. Purchases thus became, not a question of supply and demand, but the most important part of the finance operations of a firm labouring under difficulties. But this is only one side of the picture. What took place in reference to the export of goods at home, was taking place in the purchase and shipment of produce abroad. Houses in India, who had credit to pass their bills, were purchasers of sugar, indigo, silk, or cotton — not because the prices advised from London by the last overland mail promised a profit on the prices current in India, but because former drafts upon the London house would soon fall due, and must be provided for. What was so simple as to purchase a cargo of sugar, pay for it in bills upon the London house at ten months' date, transmit the shipping documents by the overland mail; and, in less than two months, the goods on the high seas, or perhaps not yet passed the mouth of the Hoogly, were pawned in Lombard Street — putting the London house in funds eight months before the drafts against those goods fell due. And all this went on without interruption or difficulty, as long as bill-brokers had abundance of money 'at call,'; to advance on bills of lading and dock warrants, and to discount, without limit, the bills of India houses drawn upon the eminent firms in Mincing Lane."
[This fraudulent procedure remained in vogue so long as goods to and from India had to round the Cape in sailing vessels. But ever since they are being shipped in steamboats via the Suez Canal this method of fabricating fictitious capital has been deprived of its basis — the long freight voyage. And ever since the telegraph informs the English businessman about the Indian market and the Indian merchant about the English market, on the same day this method has become totally impracticable. — F.E.]
III. The following is taken from the quoted Report on Commercial Distress, 1847-48:
"In the last week of April 1847, the Bank of England advised the Royal Bank of Liverpool that it would thereafter reduce its discount business with the latter bank by one-half. The announcement operated with peculiar hardship on this account, that the payments into Liverpool had latterly been much more in bills than in cash; and the merchants who generally brought to the Bank a large proportion of cash with which to pay their acceptances, had latterly been able to bring only bills which they had received for their cotton and other produce, and that Increased very rapidly as the difficulties increased.... The acceptances ... which the Bank had to pay for the merchants, were acceptances drawn chiefly upon them from abroad, and they have been accustomed to meet those acceptances by whatever payment they received for their produce.... The bills that the merchants brought... in lieu of cash, which they usually brought ... were of various dates, and of various descriptions; a considerable number of them were bankers' bills, of three months' date, the large bulk being cotton bills. These bills of exchange, when bankers' bills, were accepted by London bankers, and by merchants in every trade that we could mention — the Brazilian, the American, the Canadian, the West Indian.... The merchants did not draw upon each other; but the parties in the interior, who had purchased produce from the merchants, remitted to the merchants bills on London bankers, or bills on various parties in London, or bills upon anybody. The announcement of the Bank of England caused a reduction of the maturity terms of bills drawn against sales of foreign products, frequently extending to over three months" (pp. 26, 27).
The period of prosperity in England from 1844 to 1847, was, as described above, connected with the first great railway swindle. The above-named report makes the following reference to the effect of this swindle on business in general:
In April 1847 "almost all mercantile houses had begun to starve their business more or less ... by taking part of their commercial capital for railways" (p.42). "Loans were made on railway shares at a high rate of interest, say, 8%, by private individuals, by bankers and by fire-offices" (p. 66). "Loans to so great an extent by commercial houses to railways induced them to lean too much upon banks by the discount of paper, whereby to carry on their commercial operations" (p. 67). (Question:) "Should you say that the railway calls had had a great effect in producing the pressure which there was" (on the money-market) "in April and October" (1847)? — (Answer:) "I should say that they had had hardly any effect at all in producing the pressure in April; I should imagine that up to April, and up, perhaps, to the summer, they had increased the power of bankers in some respects rather than diminished it; for the expenditure had not been nearly so rapid as the calls; the consequence was, that most of the banks had rather a large amount of railway money in their hands in the beginning of the year."
(This is corroborated in numerous statements made by bankers in C. D. 1848-57.)
"In the summer that melted gradually away, and on the 31st of December it was materially less. One cause ... of the pressure in October was the gradual diminution of the railway money in the bankers' hands; between the 22nd of April and the 31st of December the railway balances in our hands were reduced one- third; and the railway calls have also had this effect throughout the Kingdom; they have been gradually draining the deposits of bankers" (pp. 43, 44).
Samuel Gurney (head of the ill-famed firm of Overend, Gurney and Co.) similarly says:
"During the year 1846 ... there had been a considerable demand for capital, for the establishment of rail-ways ... but it did not increase the value of money.... There was a condensation of small sums into large masses, and those large masses were used in our market; so that, upon the whole, the effect was to throw more money into the money-market of the City than to take it out" [p. 159].
A. Hodgson, Director of the Liverpool Joint-Stock Bank, shows how much bills of exchange may constitute a reserve for bankers:
"It has been our habit to keep at least nine-tenths of all our deposits, and all money we have of other persons, in our bill case, in bills that are falling due from day to day ... so much so, that during the time of the run, the bills falling due were almost equal to the amount of the run upon us day by day" (p. 53).
Speculative bills.
"5092. Who were those bills (against sold cotton) generally accepted by?" — (R. Gardner, the cotton manufacturer repeatedly mentioned in this work:) "Produce brokers: a person buys cotton, and places it in the hands of a broker, and draws upon that broker, and gets the bills discounted." — "5094. And they are taken to the banks at Liverpool, and discounted? — Yes, and in other parts besides.... I believe if it had not been for the accommodation thus granted, and principally by the Liverpool banks, cotton would never have been so high last year as it was by 1½ d. or 2d. a pound." — "600. You have stated that a vast amount of bills were put in circulation, drawn by speculators upon cotton brokers in Liverpool; does that system extend to your advance on acceptances upon colonial and foreign produce as well as on cotton?" (A. Hodgson, a Liverpool banker:) "It refers to all kinds of colonial produce, but to cotton most especially." — "601. Do you, as a banker, disencourage as far as you can that description of paper? — We do not; we consider it a very legitimate description of paper, when kept in moderation. This description of paper is frequently renewed."
Swindling in the East Indian and Chinese Market, 1847. — Charles Turner (head of one of the leading East Indian houses in Liverpool):
"We are all aware of the events which have taken place as regards the Mauritius trade, and other trades of that kind. The brokers have been in the habit ... not only of advancing upon goods after their arrival to meet the bills drawn against those goods, which is perfectly legitimate, and upon the bills of lading ... but ... they have advanced upon produce before it was shipped, and in some cases before it was manufactured. Now, to speak of my own individual instance: I have bought bills in Calcutta to the extent of six or seven thousand pounds in one particular instance; the proceeds of the bills went down to the Mauritius, to help in the growth of sugar; those bills came to England, and above half of them were protested; for when the shipments of sugar came forward, instead of being held to pay those bills, it had been mortgaged to third parties ... before it was shipped, in fact almost before it was boiled" (p.78). "Now manufacturers are insisting upon cash but it does not amount to much, because if a buyer has any credit in London, he can draw upon the house, and get the bill discounted; he goes to London, where discounts now are cheap; he gets the bill discounted, and pays cash to the manufacturer.... It takes twelve months, at least, for the shipper of goods to get his return from India ... a man with ten or fifteen thousand pounds would go into the Indian trade; he would open a credit with a house in London, to a considerable extent, giving that house one per cent; he, drawing upon the house in London, on the understanding that the proceeds of the goods that go out are to be returned to the house in London, but it being perfectly understood by both parties that the man in London is to be kept out of a cash advance; that is to say, in other words, the bills are to be renewed till the proceeds come home. The bills were discounted at Liverpool, Manchester ... or in London ... many of them lie in the Scotch banks" (p. 79). — "786. There is one house which failed in London the other day, and in examining their affairs, a transaction of this sort was proved to have taken place; there is a house of business at Manchester, and another at Calcutta; they opened a credit account with a house in London to the extent of £200,000; that is to say, the friends of this house in Manchester, who consigned goods to the East India House from Glasgow and from Manchester, had the power of drawing upon the house in London to the extent of £200,000; at the same time, there was an understanding that the corresponding house in Calcutta were to draw upon the London house to the extent of £200,000; with the proceeds of those bills sold in Calcutta, they were to buy other bills, and remit them to the house in London, to take up the first bills drawn from Glasgow... There would have been £600,000 of bills created upon that transaction." — "971. At present, if a house in Calcutta purchase a cargo" (for England), "and give their own bills upon their correspondent in London in payment, and they send the bills of lading home to this country, those bills of lading ... immediately become available to them in Lombard Street for advances, and they have eight months' use of the money before their correspondents are called upon to pay."
IV. In 1848 a secret committee of the House of Lords investigated the causes of the 1847 crisis. The evidence given to the committee was not published, however, until 1857 (Minutes of Evidence, taken before the Secret Committee of the H. of L. appointed to inquire into the Causes of Distress, etc., 1857; quoted as C.D. 1848/57). Here Mr. Lister, Director of the Union Bank of Liverpool, testified, among other things, to the following:
"2444. In the spring of 1844 there was an undue extension of credit... because a man transferred property from business into railways and was still anxious to carry on the same extent of business. He probably first thought that he could sell the railway shares at a profit and replace the money in his business. Perhaps he found that could not be done, and he then got credit in his business where formerly he paid in cash. There was an extension of credit from that circumstance."
"2500. Were those bills ... upon which the banks had sustained a loss by holding them, principally bills upon corn or bills upon cotton?" — "They were bills upon all kinds of produce, corn and cotton and sugar, all foreign produce of all descriptions. There was scarcely any thing perhaps with the exception of oil, that did not go down." — "2506. A broker who accepts a bill will not accept it without a good margin as to the value."
"2512. There are two kinds of bills drawn against produce; the first is the original bill drawn abroad upon the merchant, who imports it.... The bills which are drawn against produce frequently fall due before the produce arrives. The merchant, therefore, when it arrives, if he has not sufficient capital, has to pledge that produce with the broker till he has time to sell that produce. Then a new species of bill is immediately drawn by the merchant in Liverpool upon the broker, on the security of that produce.... Then it is the business of the banker to ascertain from the broker whether he has the produce, and to what extent he has advanced upon it. It is his business to see that the broker has property to protect himself if he makes a loss."
"2516. We also receive bills from abroad.... A man buys a bill abroad on England, and sends it to a house in England; we cannot tell whether that bill is drawn prudently or imprudently, whether it is drawn for produce or for wind."
"2533. You said that almost every kind of foreign produce was sold at a great loss. Do you think that that was in consequence of undue speculation in that produce? — It arose from a very large import, and there not being an equal consumption to take it off. It appears that consumption fell off a great deal." — "2534. In October produce was almost unsaleable."
How a general sauve qui peut develops at the height of a crisis is revealed in the same report by a first-rate expert, the esteemed crafty Quaker, Samuel Gurney, of Overend, Gurney and Co.:
"1262 ... When a panic exists a man does not ask himself what he can get for his bank-notes, or whether he shall lose one or two per cent by selling his exchequer bills, or three per cent. If he is under the influence of alarm he does not care for the profit or loss, but makes himself safe and allows the rest of the world to do as they please."
V. Concerning the mutual satiation of the two markets Mr. Alexander, a merchant in the East India trade, testifies before the Committee of the Lower House on the Bank Act of 1857 (quoted as B.C. 1857):
"4330. At the present moment, if I lay out 6s. in Manchester, I get 5s. back in India; if I lay out 6s. in India, I get 5s. back in London."
So that the Indian market is, therefore, drugged by England, and the English by India. This was, indeed, the case in the summer of 1857, barely ten years after the bitter experience of 1847!
Next: Chapter 26