CHAPTER III

CREDIT FUNDS

CREDIT is a contract made between two parties whereby the one promises to deliver a certain amount of money to the other at a specified time. This contract, or promise, may be written or oral, formal or informal, express or implied, but in each case the essential fact is the same-a contract for the future delivery of money. A "credit transaction is one in which a promise to pay (i. e., a contract for future delivery of money) is exchanged for something Definition of else of value. One deals "on credit"-he deals on his own promises to pay, or contracts for future delivery, instead of money; one buys for (or on) credit-he purchases goods and gives his obligation to pay in exchange; one sells for (or on) credit-he transfers his goods to another in exchange for the promises of that other to deliver a definite sum of money at a definite future time.

credit.

ILLUSTRATIONS OF CREDIT USES

Morgan is a young man of sober, industrious habits, is well trained, has a good reputation in the community where he lives. He decides to begin business for himself. He goes among the farmers with whom he is acquainted, and asks them if he may become their agent for the sale of grain in Chicago. A list of clients is scheduled which seems to warrant the opening of an office. But he has no capital, and it will require at least $1,000 in "funds" to equip and manage an office where he can display his sam

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ples, meet prospective buyers, manage consignments, etc. He lays his plan before his friend Drexel, who has an abundance of means and who makes it his business to supply funds to those who have need for them in business. Morgan explains his plan, shows his assured list of clients and his business prospects, and proposes to Mr. Drexel that if he will give to him $1,000, then he (Morgan) will execute to Drexel a contract in writing for the delivery of $1,100 one year hence. Mr. Drexel has confidence in the integrity of young Morgan, and after studying his plan of undertaking and his prospects of success, he decides to exchange $1,000 for Morgan's contract to deliver $1,100 one year hence. No money passes, however. Morgan hands to Drexel his "note" for $1,100, and Drexel gives to Morgan his "check" for $1,000. Morgan takes the check to the bank and presents it, and the cashier transfers $1,000 from the credit account of Drexel to the account of Morgan. That is his capital. This credit account is the "fund" with which his business is begun.

Morgan now goes to Chicago, where he has the credit account transferred to a bank. He rents and equips an office. He forms business relations with an old and reliable produce broker who has a seat on the Board of Trade, and agrees to divide commissions with him until, finally, he is able to purchase a seat of his own. He devotes himself to building up and enlarging his clientage. By adverCredit as cur- tisement and constant effort he gains prestige; rent funds. he arranges with the bank to carry the margins. of speculating clients; he finds constantly increasing profits in his commissions. A business which at first netted him only enough to meet office and personal expenses, after years of effort came to net him $10,000 per month. During this time he has paid the original loan from Drexel, bought a seat on the produce brokers' board (the Board of Trade), and at a mature age becomes possessed of many valuable properties and securities. All of this has come to

him from the use of credit, from untiring energy, from thrifty habits, and an unimpeached integrity. He now wishes to retire from the business of broking and to lead a more quiet life, devoting only such time as may be necessary to the care of his investments.

Gates, a young man of wealth, and a friend of Morgan, desires to engage in the business of broking. He would not spend a life of hard competitive effort in building up a new business; he prefers to buy a business already established. He goes to Morgan for advice, and each recognizing an opportunity, a trade is made, whereby Gates agrees to pay $50,000 for Morgan's seat on the Board, and $250,000 for the business name of his firm. That is, Morgan retains all

A credit purchase.

the securities, accounts, and investments acquired by him in course of business; he sells his seat (his opportunity to trade on the Board) and his "good-will" (or business reputation) for the sum of $300,000. But how is this to be paid for? Does Gates count out standard gold coins to that amount? No. He does not even pass to Morgan his check. Finding that it will be advantageous to retain his present available "funds" for use in the business, it is arranged that the purchase shall be made "on credit"; that is to say, Gates offers to Morgan three promissory notes for $100,000 each, due in one, two, and three years respectively. This ($300,000) is agreed on as the purchase price of the business, but in consideration for the time that payment is deferred, Gates further promises to pay 5 per cent interest on the respective amounts until paid. By these several contracts (agreements for the purpose of exchange) Gates promises to deliver $115,000 at the end of the first year, $110,000 at the end of the second year, and $105,000 at the end of the third year-$330,000 in all, principal and interest—instead of $300,000, the price agreed on, if payment had been made in money at the time the business was delivered. Now notice just what has taken place. Morgan has sold what? Nothing tangi

ble; nothing that may be seen; nothing that may be passed from hand to hand. He has disposed of his business opportunity and his business reputation as a broker-nothing else. Morgan may still do business in any other way so long as he does not attempt to use his seat on the Board, or the name and reputation of his old firm for the business of broking. And what has he received? Something tangible? Something that may be seen? Something that may be passed from hand to hand? Yes, but what is it? Is it gold? Is it money? No. What is it? "Paper." One slip reads as follows:

$100,000.00.

NEW YORK, January 1, 1901.

One year after date, for value received, I promise to pay to Morgan or order One Hundred Thousand Dollars in gold coin of the United States, of present weight and fineness. With interest at the rate of 5 per cent per annum from date until paid.

[Signed]

GATES.

The other two slips read exactly the same, except as to date of payment. But suppose that Morgan loses these slips of paper, or that they are destroyed by fire, is the credit destroyed? Not at all. The obligation to pay remains as before; if Morgan can prove the loss and likewise the amount due, he can enforce the payment. These slips of paper are only evidence of the credit agreement, which in itself is a thing as intangible and as invisible as that for which it was given-viz., business opportunity and business reputation. Still, credit is bought and sold in the market; in fact, credit is one of the chief items of exchange in mercantile business.

ESSENTIAL CHARACTERISTICS OF CREDIT

Good-will, membership in a society of brokers, business opportunity and reputation are the properties that have changed hands. They have not been given away. None of them have been exchanged for the other-they have not

been bartered, yet no money has passed. They have been bought and sold, full payment has been given and received, and the full title has passed. What represents arises out of the other side of the transaction? As a result

Credit

exchange. of the exchange there came into being and still exist Gates's notes for $330,000. All these promises have purchasing power, and so long as they exist they may serve again and again in any number of transactions till paid, or their values are lost by depreciation.

To understand the nature of credit it may be well to reflect on the underlying principles of exchange. In the first place, why did Morgan and Gates trade? Morgan had a business that was bringing him in a net profit of $10,000 per month-$120,000 per year. This was its net incomeproducing power to him. Much of the return was due to continued personal effort, but the reputation of the firm was so well established that its clientage in large measure would be retained, though its management were changed. Mor

The principles of exchange as applied to credit.

gan, however, wished to avoid the nervous strain and the responsibilities of an active broker. In his judgment he would rather have $300,000 in gold than the business which he has

sold-i. e., he estimated or valued $300,000 more highly than the business. Gates, on the other hand, would rather have the business than $300,000 in gold; each found the transaction to his advantage and $300,000 was agreed upon as the price. Here was a difference as to valuation but an agreement as to price, and the exchange took place as a result.

Now after the price has been agreed upon there follows another transaction. Instead of Gates delivering the $300,000 in gold first agreed upon as the price, he offers to Morgan his three notes, each for $100,000, with interest-obligations for the future delivery of money, amounting in all to $330,000 when due. Morgan accepts these in lieu of the $300,000 in gold. Why does Gates offer the notes, and