CHAPTER IV

BUSINESS PRINCIPLES

THE physical basis of modern business traffic is
the machine process, as described in Chapter II.
It is essentially a modern fact, — late and yet in
its early stages of growth, especially as regards its
wider sweep in the organization of the industrial
system. The spiritual ground of business enter-
prise, on the other hand, is given by the institution
of ownership. “ Business principles” are corolla-
ries under the main proposition of ownership ; they
are principles of property, — pecuniary principles.
These principles are of older date than the machine
industry, although their full development belongs
within the machine era. As the machine process
conditions the growth and scope of industry, and
as its discipline inculcates habits of thought suit-
able to the industrial technology, so the exigencies
of ownership condition the growth and aims of
business, and the discipline of ownership and its
management inculcates views and principles (habits
of thought) suitable to the work of business traffic.

The discipline of the machine process enforces a
standardization of conduct and of knowledge in

66

BUSINESS PRINCIPLES 67

terms of quantitative precision, and inculcates a
habit of apprehending and explaining facts in
terms of material cause and effect. It involves a
valuation of facts, things, relations, and even
personal capacity, im terms of force. Its meta-
physics is materialism and its poimt of view is that
of causal sequence.’ Such a habit of mind con-
duces to industrial efficiency, and the wide preva-
lence of such a habit is indispensable to a high
degree of industrial efficiency under modern con-
ditions. This habit of mind prevails most widely
and with least faltermg in those communities that
have achieved great things in the machine industry,
being both a cause and an effect of the machine
process.

Other norms of standardization, more or less
alien to this one, and other grounds for the valua-
tion of facts, have prevailed elsewhere, as well as
in the earlier phases of the Western culture.
Much of this older standardization still stands
over, in varying degrees of vigor or decay, in that
current scheme of knowledge and conduct that
now characterizes the Western culture. Many of
these ancient norms of thought which have come
down from the discipline of remote and relatively
primitive phases of the cultural past are still
strong in the affections of men, although most of
them have lost greatly in their power of constraint.

1 See ch. IX,

68 THE THEORY OF BUSINESS ENTERPRISE

They no longer bind men’s convictions as they
once did. They are losing their axiomatic
character. They are no longer self-evident or
self-legitimating to modern common sense, as they
once were to the common sense of an earlier time.

These ancient norms differ from the modern
norms given by the machine in that they rest on
conventional, ultimately sentimental grounds ; they
are of a putative nature. Such are, eg., the
principles of (primitive) blood relationship, clan
solidarity, paternal descent, Levitical cleanness,
divine guidance, allegiance, nationality. In their
time and under the circumstances which favored
their growth these were, all and several, powerful
factors in controlling human conduct and shaping
the course of events. In their time each of these
institutional norms served as a definitive ground
of authentication for such facts as fell under its
particular scope, and the scope of each was very
wide in the day of its best vigor. As time has
brought change of circumstances, the facts of life
have gradually escaped from the constraint of
these ancient principles; so that the dominion
which they now hold over the life of civilized men
is relatively slight and shifty.

It is among these transmitted institutional
habits of thought that the ownership of property
belongs. It rests on the like general basis of use
and wont. The binding relation of property to its

BUSINESS PRINCIPLES 69

owner is of a conventional, putative character.
But while these other conventional norms cited
above are in their decline, this younger one of the
inherited institutions stands forth without apology
and shows no apprehension of being crowded into
the background of sentimental] reminiscence.

In absolute terms the institution of ownership
is ancient, no doubt ; but it is young compared with
blood-relationship, the state, or the immortal gods.
Especially is it true that its fuller development is
relatively late. Not until a comparatively late date
in West European history has ownership come to be
emancipated from all restrictions of a non-pecun-
lary character and to stand in a wholly impersonal
position, without admixture of personal responsi-
bility or class prerogative.’ Freedom and inviola-
bility of contract has not until recently been the
unbroken rule. Indeed, it has not even yet been
accepted without qualification and extended to all
items owned. There still are impediments in the
way of certain transfers and certain contracts, and
there are exemptions in favor of property held by
certain privileged persons, and especially by certain
sacred corporations. This applies particularly to
the more backward peoples; but nowhere is the
“cash nexus” free from all admixture of alien
elements. Ownership is not all-pervading and all-

1Cf., e.g., E. Jenks, Law and Politics in the Middle Ages, ch. VI.
and VII.

70 THE THEORY OF BUSINESS ENTERPRISE

dominant, but it pervades and dominates the
affairs of civilized peoples more freely and widely
than any other single ground of action, and more
than it has ever done before. The range and
number of relations and duties that are habitually
disposed of on a pecuniary footing are greater
than in the past, and a pecuniary settlement is
final to a degree unknown in the past. The
pecuniary norm has invaded the domain of the
older institutions, such as _ blood-relationship,
citizenship, or the church, so that obligations be-
longing under the one or the other of these may
now be assessed and fulfilled in terms of a money
payment, although the notion of a pecuniary
liquidation seems to have been wholly remote from
the range of ideas — habits of thought — on which
these relations and duties were originally based.

This is not the place for research into the origin
and the primitive phases of ownership, nor even
for inquiry into the views of property current in
the early days of the Western culture. But the
views current on this head at present — the princi-
ples which guide men’s thinking and roughly
define the right limits of discretion in pecuniary
matters — this common-sense apprehension of what
are the proper limits, rights, and responsibilities
of ownership, is an outgrowth of the traditions,
experiences, and speculations of past generations.

BUSINESS PRINCIPLES 71

Therefore some notice of the character of these
traditional views and the circumstances out of
which they have arisen in the recent past is neces-
sary to an understanding of the part which they
play in modern life." The theory of property pro-
fessed at a given time and in a given cultural region
shows what is the habitual attitude of men, for the
time being, on questions of ownership; for any
theory that gains widespread and uncritical accept-
ance must carry a competent formulation of the
deliverances of common sense on the matter with
which it deals. Otherwise it will not be generally
accepted. And such a commonplace view is in its
turn an outcome of protracted experience on the
part of the community.

The modern theories of property run back to
Locke,’ or to some source which for the present
purpose is equivalent to Locke; who, on this as
on other institutional questions, has been proved
by the test of time to be a competent spokesman
for modern culture in these premises. A detailed
examination of how the matter stood in the theo-
retical respect before Locke, and whence, and by
what process of selection and digestion, Locke de-

1 «¢Tt has been said that the science of one age is the common sense
of the next. It might with equal truth be said that the equity of one
age becomes the law of the next. If positive law is the basis of order,
ideal right is the active factor in progress.’’— H. 8, Foxwell, Intro-
duction to Menger’s Right to the Whole Produce of Labor, p. XI.
Cf. the entire passage.

2 See the essay, Of Civil Government, ch. V.

72 THE THEORY OF BUSINESS ENTERPRISE

rived his views, would lead too far afield. The
theory is sufficiently familiar, for in substance it
is, and for the better part of two centuries has
been, held as an article of common sense by nearly
all men who have spoken for the institution of
property, with the exception of some few and
late doubters.’

This modern European, common-sense theory
says that ownership is a “Natural Right.” What
a man has made, whatsoever “he hath mixed
his labor with,” that he has thereby made his
property. It is his to do with it as he will. He
has extended to the object of his labor that dis-
cretionary control which in the nature of things
he of right exercises over the motions of his own
person. It is his in the nature of things by virtue
of his havmg made it. “Thus labor, in the
beginning, gave a right of property.” The per-

1 Apart from the familiar historical materials for the study of the
growth of national rights, including the right of property, there are a
number of late writings that may be consulted ; e.g. Jellinek, Declaration
of the Rights of Man and of the Citizen; Ritchie, Natural Rights ;
Bonar, chapters relating to this topic in Philosophy and Political
Economy ; Hoffding, History of Modern Philosophy, vol. I.; Albee,
History of English Utilitarianism ; and, lately come to hand, Scherger,
Evolution of Modern Liberty. These and other writers treat of natural
rights and the law of nature chiefly in other bearings than that of
ownership ; while the legal writers treat the subject from the legal
rather than the de facto standpoint. It is also not unusual to spend
attention chiefly on the pedigree of the doctrines rather than on the
genesis and growth of the concepts. An endeavor at a genetic account
of the modern concepts of ownership is found in Jenks, Law and

Politics in the Middle Ages, so also in Cunningham, Western Civiliza-
tion in its Economic Aspects.

BUSINESS PRINCIPLES a

sonal force, the functional efficiency of the work-
man shaping material facts to human use, is in
this doctrine accepted as the definitive, axiomatic
ground of ownership; behind this the argument
does not penetrate, except it be to trace the work-
man’s creative efficiency back to its ulterior source
in the creative efficiency of the Deity, the “ Great
Artificer.” With the early spokesmen of natural
rights, whether they speak for ownership or for
other natural rights, it is customary to rest the
case finally on the creator’s discretionary disposi-
tions and workmanlike efficiency. But the refer-
ence of natural rights back to the choice and
creative work of the Deity has, even in Locke, an
air of being in some degree perfunctory ; and later
in the life-history of the natural-rights doctrine
it falls into abeyance; whereas the central tenet,
that ownership is a natural right resting on the
productive work and the discretionary choice of
the owner, gradually rises superior to criticism
and gathers axiomatic certitude. The Creator
presently, in the course of the eighteenth century,
drops out of the theory of ownership.

It may be worth while to indicate how this
ultimate ground of ownership, as conceived by
modern common sense, differs from the ground
on which rights of the like class were habitually
felt to rest in medieval times. Customary au-
thority was the proximate ground to which rights,

74 THE THEORY OF BUSINESS ENTERPRISE

powers, and privileges were then habitually referred.
It was felt that if a clear case of devolution from
a superior could be made out, the right claimed
was thereby established; and any claim which
could not be brought to rest on such an act, or
constructive act, of devolution was felt to be in
a precarious case. The superior from whom
rights, whether of ownership or otherwise, de-
volved held his powers by a tenure of prowess
fortified by usage; the inferior upon whom given
rights and powers devolved held what fell to his
lot by a tenure of service and fealty sanctioned
by use and wont. The relation was essentially
a personal one, a relation of status, of authority
and subservience. Hereditary standing gave a
presumption of ownership, rather than conversely.
In the last resort the chain of devolution by virtue
of which all rights and powers of the common
man pertained to him was to be traced back
through a sequence of superiors to the highest,
sovereign secular authority, through whom in turn
it ran back to God. But neither in the case of
the temporal sovereign nor in that of the divine
sovereign was it felt that their competence to
delegate or devolve powers and rights rested on
a workmanlike or creative efficiency. It was not
so much by virtue of His office as creator as it
was by virtue of His office as suzerain that the
Deity was felt to be the source and arbiter of

BUSINESS PRINCIPLES 75

human rights and duties. In the course of cul-
tural change, as the medizval range of ideas and
of circumstances begins to take on a more modern
complexion, God’s creative relation to mundane
affairs is referred to with growing frequency and
insistence in discussions of all questions of this
class; but for the purpose in hand His creative
relation to human rights does not supersede His
relation of sovereignty until the modern era is
well begun. It maybe said that God’s tenure
of office in the medizval conception of things was
a tenure by prowess, and men, of high and low
degree, held their rights and powers of Him by
a servile tenure. Ownership in this scheme was
a stewardship. It was a stewardship proximately
under the discretion of a secular lord, more re-
motely under the discretion of the divine Overlord.
And the question then pressing for an answer when
a point of competency or legitimacy was raised in
respect of any given human arrangement or in-
stitution was not, What hath God wrought? but,
What hath God ordained ?

This medieval range of conceptions first began
to break down and give place to modern notions
in Italy, in the Renaissance. But it was in the
English-speaking communities that the range of
ideas upon which rests the modern concept of
natural rights first gathered form and reached
a competent expression. This holds true with

76 THE THEORY OF BUSINESS ENTERPRISE

respect to the modern doctrines of natural rights
as contrasted with the corresponding ancient doc-
trines. The characteristically modern traits of
the doctrine of natural rights are of English deri-
vation. This is peculiarly true as regards the
natural right of ownership. The material, histori-
cal basis of this English right of ownership, con-
sidered as a habit of thought, is given by the
modern economic factors of handicraft and trade,
in contrast with the medixval institutions of status
and prowess. England, as contrasted with the
Continent, during modern times rapidly substituted
the occupation of the merchant and the ubiqui-
tous free artisan as the tone-giving factors of her
everyday life, in place of the prince, the soldier,
and the priest. With this change in the dominant
interests of everyday life came a corresponding
change in the discipline given by the habits of
everyday life, which shows itself in the growth
of a new range of ideas as to the meaning of
human life and a new ground of finality for human
institutions. New axioms of right and truth
supplant the old as new habits of thought super-
sede the old.

This process of substitution, as a struggle be-
tween rival concepts of finality in political theory,
reached a dramatic climax in the revolution of
1688. Asa battle of axioms the transition comes
to a head in the controversy between John Locke

BUSINESS PRINCIPLES i

and Sir Robert Filmer. Filmer was the last effec-
tive spokesman of the mediwval axiom of devolu-
tion. Locke’s tracing of natural rights, the right
of property among the rest, back to the work-
manlike performance of the Creator, marks the
form in which, at the point of transition, the
modern view pays its respects to the superseded
axiom of devolution and takes leave of it.

The scope given to the right of ownership in
later modern times is an outgrowth of the exigen-
cies of mercantile traffic, of the prevalence of
purchase and sale in a “money economy.” The
habits of thought enforced by these exigencies
and by the ubiquitous and ever recurring resort
to purchase and sale decide that ownership must
naturally, normally, be absolute ownership, with
free and unqualified discretion in the use and
disposal of the things owned. Social expediency
may require particular limitations of this full dis-
cretion, but such limitations are felt to be excep-
tional derogations from the “natural” scope of
the owner’s discretion.

On the other hand, the metaphysical ground
of this right of ownership, the ultimate fact by
virtue of which such a discretionary right vests
in the owner, is his assumed creative efficiency
as a workman; he embodies the work of his
brain and hand in a useful object, — primarily,
it is held, for his own personal use, and, by further

78 THE THEORY OF BUSINESS ENTERPRISE

derivation, for the use of any other person to
whose use he sees fit to transfer it. The work-
man’s force, ingenuity, and dexterity was the ulti-
mate economic factor,— ultimate in a manner
patent to the common sense of a generation habit-
uated to the system of handicraft, however doubt-
ful such a view may appear in the eyes of a
generation in whose apprehension the workman
is no longer the prime mover nor the sole, or even
chief, efficient factor in the industrial process.
The free workman, master of his own motions
and with discretion as to what he would turn
his efforts to, if to anything, had by Locke’s time
become an habitual fact in the life of the English
community to such a degree that free labor, of
the character of handicraft, was accepted uncriti-
cally as the fundamental factor in all human
economy, and as the presumptive original fact
in industry and in the struggle for wealth. So
settled did this habit of thought become that no
question was entertained as to the truth of the
assumption.

It became a principle of the natural order of
things that free labor is the original source of
wealth and the basis of ownership. In point
of historical fact, no doubt, such was not the
pedigree of modern industry or modern owner-
ship; but the serene, undoubting assumption of
Locke and his generation only stands out the

BUSINESS PRINCIPLES 79

more strongly and unequivocally for this its dis-
crepancy with fact. It is all the more evidently
a competent expression of the trend which Eng-
lish common sense was following at this time,
since this doctrine of a “natural” right of prop-
erty based on productive labor carries all before
it, in the face of the facts. In this matter Eng-
lish thought, or rather English common sense, has
led ; and the advanced Continental peoples have
followed the English lead as the form of economic
organization exemplified by the English-speaking
communities has come to prevail among these Con-
tinental peoples.

Such a concept belongs to the régime of handi-
craft and petty trade, and it is from, or through,
the era of handicraft that it has come down to
the present.’ It fits into the scheme of handi-
craft, and it is less fully in consonance with the
facts of life in any other situation than that of
handicraft. Associated with the system of handi-

1 What appears to be necessary to the development of such a senti-
ment is that neither slavery nor the machine system shall be present
in sufficient force to give a pronounced bias to the community’s habits
of thought, at the same time that each member of the community, or
each minor group of persons, habitually carries on its own work at its
own discretion and for its own ends. Such a situation may or may
not involve handicraft as that term is specifically understood. A pre-
sumption of similar import, but less pronounced and less defined,
seems to prevail in an uncertain degree among many peoples on a
low stage of culture. The tenet, accordingly, has some claim to stand
as an expression of ‘‘natural’’ right, even when ‘‘ natural’? is taken
in an evolutionary sense.

80 THE THEORY OF BUSINESS ENTERPRISE

craft, as its correlate, was the system of petty
trade; and as the differentiation of occupations
was carried to a high degree, purchase and sale
came to prevail very generally, and the community
acquired a commercial complexion and commercial
habits of thought. Under these circumstances
the natural right of ownership came to com-
prise an extreme freedom and facility in the
disposal of property. The whole sequence of
growth of this natural right is, of course, to be
taken in connection with the general growth
of individual rights that culminated in the eigh-
teenth-century system of Natural Liberty. How
far the English economic development is to be
accounted the chief or fundamental factor in the
general growth of natural rights is a question
that cannot be taken up here. The outcome, so
far as it immediately touches the present topic,
was that by the time of the industrial revolution
a fairly consistent standardization of economic
life had been reached in terms of workmanship
and price. The writings of Adam Smith and
his contemporaries bear witness to this. And
this eighteenth-century standardization stands over
as the dominant economic institution of later
times.’ Such, in outline, seem to be the histori-

1 Taken by and large, the standardization of conduct, knowledge,
and ideals current in the eighteenth century, and consonant with the
eighteenth-century economic situation, is in the last analysis reducible
to terms of workmanlike efficiency rather than terms of material

BUSINESS PRINCIPLES 81

cal antecedents and the spiritual basis of the
modern institution of property, and therefore of
business enterprise as it prevails in the present.!
This sketch of the genesis of the modern institu-
tion of property and of modern business principles
may seem dubious to those who are inclined to give
it a more substantial character than that of a habit
of thought, — that is to say, those who still adhere
to the doctrine of natural rights with something
of the eighteenth-century naiveté. But whatever
may be accepted as the ulterior grounds of that
cultural movement which culminated in the system
of Natural Liberty, it is plain that the industrial
and commercial experience of western Europe,
and primarily of England, from the fifteenth to
the eighteenth century, had much to do with the
outcome of the movement in so far as natural
liberty touches economic matters. It is as an
outcome of this recently past phase of economic
development that we have incorporated in the law,

cause and effect. This leaning to personal, workmanlike efficiency
as an ultimate term shows itself even in the science of that time, e.g.
in the quasi-personal character imputed to the so-called ‘ natural
laws?’ which then largely occupied scientific speculation ; similarly in
the Romantic literature and political philosophy.

1 As late as the. close of the sixteenth century English law and
usage in the matter of loans for interest and other contracts of a pecun-
iary character were in a less advanced state, admitted a less full and
free discretion, than the corresponding development on the Continent ;
but from about that time the English rapidly gains on the Continental
community in the habitual acceptance and application of these ‘‘ busi-
ness principles,’’ and it has since then held the lead in this respect,
Cf. Ashley, Economic History, vol. Il. ch. VI.

82 THE THEORY OF BUSINESS ENTERPRISE

equity, and common sense of to-day, these peculiarly
free and final property rights and obligations, that
is to say, those peculiar principles that control cur-
rent business and industry. We owe to the eigh-
teenth century a very full discretion and free swing
in all pecuniary matters. It has given freedom of
contract, together with security and ease of credit
engagements, whereby the competitive order of
business has been definitively installed.’

The subject-matter about which this modern
pecuniary discretion turns, with all its freedom
and inviolability of contract, is money values.
Accordingly there underlies all pecuniary contracts
an assumption that the unit of money value does
not vary. Inviolability of contracts involves this
assumption. It is accepted unquestioningly as a
point of departure in all business transactions.
In the making and enforcement of contracts it is
a fundamental point of law and usage that money
does not vary.” Capitalization as well as contracts
are made in its terms, and the plans of the business
men who control industry look to the money unit
as the stable ground of all their transactions.
Notoriously, business men are jealous of any
attempt to change the value or lessen the stability

1Cf£. Sombart, Kapitalismus, vol. II. ch. IT.
2 On the putative stability of the money unit, cf. W. W. Carlile,
The Evolution of Modern Money, pt. II. ch. IV.

BUSINESS PRINCIPLES 83

of the money unit, which goes to show how essen-
tial a principle in business traffic is the putative
invariability of the money unit.'

Usage fortified by law decides that when prices
vary the variation is held to occur in the value of
the vendible commodities, not in the value of the
money unit, since money is the standard of value.
There is, of course, no intention here to question
the position, familiar to all economists, that fluc-
tuations in the course of prices may as well be due

1 Economists are in the habit of speaking of money as a medium
of exchange, a ‘‘ great wheel’’ for the circulation of goods. In the
same connection business traffic is spoken of as a means of obtaining
goods suitable for consumption, the end of all purchase and sale
being consumable goods, not money values. It may be true in some
profound philosophical sense that money values are not the definitive
term of business endeavor, and that the business man seeks through
the mediation of money to satisfy his craving for consumable goods.
Looking at the process of economic life as a whole and taking it in its
rationaltzed bearing as a collective endeavor to purvey goods and
services for the needs of collective humanity, the office of the money
unit — money transactions, exchange, credit, and all the rest that make
up the phenomena of business —is perhaps justly rated as something
subsidiary, serving to facilitate the distribution of consumable goods
to the consumers, the consumption of goods being the objective
point of all this traffic. Such is the view of this matter given by the
rationalistic, normalizing speculations of the eighteenth-century phi-
losophers ; and such is, in substance, the view spoken for by those
economists who still consistently remain at the standpoint of the
eighteenth century. The contention need neither be defended nor
refuted here, since it does not seriously touch the facts of modern
business. Within the range of business transactions this ulterior end
does not necessarily come into view, at least not as a motive that
guides the transactions from day to day. The matter is not so con-
ceived in business transactions, it does not so appear on the face of
the negotiable instruments, it is not in this manner that the money
unit enters into the ruling habits of thought of business men,

84 THE THEORY OF BUSINESS ENTERPRISE

to variation on the part of the money metals as to
a variation on the part of the articles whose prices
fluctuate. In so far as the distinction so made
between variations in the one or the other member
of a value ratio has a meaning — which it is not
always clear that it has—dit does not touch the
argument. It is a matter of common notoriety,
which has also had the benefit of reiterated statis-
tical proof, that, as measured, for imstance, im
terms of livelihood or of labor, the value of money
has varied incontinently throughout the course of
history.

But in the routine of business throughout the
nineteenth century the assumed stability of the
money unit has served as an axiomatic principle,
in spite of facts which have from time to time
shown the falsity of that assumption."

The all-dominating issue in business is the ques-
tion of gain and loss. Gain and loss is a question

1 Still, latterly, in the traffic of some of the more wide-awake
business men, account is practically taken of the variations of the
unit of value. What may be the future effects of habitual and incon-
tinent variations of the unit, such as prevail in the present, is of course
impossible to foretell. These variations seem,due mainly to the exten-
sive prevalence of credit relations ; and the full development of credit
relations in business is apparently a matter of the future rather than
of the recent past, in spite of the great improvements that have been
made in the use of credit. The modern conventional imputation of
stability to the money unit dates back to the régime of a ‘“‘ money
economy,’’ such as prevailed under the circumstances of handicraft
and the earlier huckstering commerce, and it holds its place in the
developed ‘‘ credit economy” largely as a survival of this more ele-
mentary past phase of economic life.

BUSINESS PRINCIPLES 85

of accounting, and the accounts are kept in terms
of the money unit, not in terms of livelihood, nor
in terms of the serviceability of the goods, nor in
terms of the mechanical efficiency of the industrial
or commercial plant. For business purposes, and
so far as the business man habitually looks into
the matter, the last term of all transactions is their
outcome in money values. The base line of every
enterprise is a line of capitalization in money
values. In current business practice, variations
from this base line are necessarily rated as varia-
tions on the part of the other factors in the case,
not as variations of the base line. The business
man judges of events from the standpoint of
ownership, and ownership runs in terms of money.’

Investments are made for profit, and indus-
trial plants and processes are capitalized on the
basis of their profit-yielding capacity. In the ac-
cepted scheme of things among business men, profits
are included as intrinsic to the conduct of business.
So that, in place of the presumption in favor of a
simple pecuniary stability of wealth, such as pre-
vails in the rating of possessions outside of business
traffic, there prevails within the range of business

1 The conventional acceptance of the money unit as an invariable
measure of value and standard of wealth is of very ancient derivation.
(Cf. Carlile, Evolution of Modern Money, pt. II. ch. I; Ridgeway,
Origin of Metallic Currency and Weight Standards, ch. 1., II.) Its
present-day consequences are also of first-rate importance, as will be
indicated in a later chapter.

86 THE THEORY OF BUSINESS ENTERPRISE

traffic the presumption that there must in the
natural course of things be a stable and orderly
increase of the property invested. Under no eco-
nomic system earlier than the advent of the machine
industry does profit on investment seem to have
been accounted a normal or unquestionably legiti-
mate source of gain. Under the agrarian-manorial
régime of the Middle Ages it was not felt that the
wealth of the large owners must, as a matter of
course, increase by virtue of the continued employ-
ment of what they already had mm hand — what-
ever may be the historical fact as regards the
increase of wealth in their hands. Particularly,
it was not the sense of the men of that time that
wealth so employed must increase at any stated,
“ordinary” rate per time unit. Similarly as re-
gards other traffic in those days, even as regards
mercantile ventures. Gain from investment was
felt to be a fortuitous matter, not reducible to a
stated rate. This is reflected, e.g., in the tenacious
protests against the taking or paying of interest
and in the ingenious sophistries by which the
payment of interest was defended or explained
away. Only under more settled commercial rela-
tions during the era of handicraft did the pay-
ment of interest gradually come to be accepted
into full legitimacy. But even then gains from
other business employments than mercantile traffic
were apparently viewed as an increase due to

BUSINESS PRINCIPLES 87

productive labor rather than as a profit on invest-
ment.' In industrial pursuits, as distinct from mer-
cantile traffic proper, profits apparently come to
figure as a regular and ordinary incident only when
the industries come to be carried on on a mercantile
basis by relatively large employers working with
hired labor.

This orderly increase is, of course, taken account
of in terms of the money unit. The “ordinary”
rate of profits in business is looked upon as a
matter of course by the body of business men. It
is part of their common-sense view of affairs, and is
therefore a normal phenomenon.” Gain, they feel,
is normal, being the purpose of all their endeavors;
whereas a loss or a shrinkage in the values in-
vested is felt to be an untoward accident which
does not belong in the normal course of business,
and which requires particular explanation. The
normality, or matter-of-course character, of profits
in the modern view is well shown by the position
of those classical economists who are inclined to

1Cf., e.g., Mun, England’s Treasure, particularly ch. I.; Ashley,
Economic History and Theory, bk. IL. ch. VI. pp. 391-397. This,
essentially handicraft, presumption is reflected even in the classical
economists, who feel a moral necessity of explaining profits on some
basis of productivity, or even of workmanship in some sophisticated
sense. The whole discussion of the doctrine of Wages of Superintend-
ence will serve to illustrate the case ; the point is well shown in Mr.
Davidson’s article on ‘‘Harnings of Management’’ in Palgrave’s
Dictionary of Political Economy.

2 The ‘ordinary’ rate, of course, differs in detail from one line
of business to another, as well as from place to place.

88 THE THEORY OF BUSINESS ENTERPRISE

include “ordinary profits” in the cost of produc-
tion of goods.

The precise meaning of “ ordinary profits ’’ need
not detain the argument. It may mean net
average profits, or it may mean something else.
The phrase is sufficiently intelligible to the busi-
ness community to permit the business men to use
it without definition and to rest their reasoning
about business affairs on it as a secure and stable
concept; and itis this commonplace resort to the
term that is the point of interest here.

At any given time and place there is an accepted
ordinary rate of profits, more or less closely
defined, which, it is felt, should accrue to any
legitimate and ordinarily judicious business venture.
However shifty the definition of this rate of
profits may be, in concrete, objective terms, it is
felt by the men of affairs to be of so substantial
and consistent a character that they habitually
capitalize the property engaged in any given busi-
ness venture on the basis of this ordinary rate of
profits. Due regard bemg had to any special
advantages and drawbacks of the individual case,
any given business venture or plant is capitalized
at such a multiple of its earning-capacity as the
current ordinary rate of profits will warrant.'

1 This statement applies with greater aptness to the business situa-
tion of England during the earlier three-quarters of the nineteenth
century, and to the American situation of the third quarter of the

BUSINESS PRINCIPLES 89

Proceeding on the common-sense view built up out
of this range of habits of thought with respect to
normal profits and price phenomena, the business
community holds that times are ordinary or normal
so long as the accepted or reasonable rate of profits
accrues on the accustomed capitalization ; whereas
times are good or brisk if the rate of gain is
accelerated, and hard or dull if profits decline.
This is the meaning of the phrases, “brisk times”
and “dull times,” as currently used in any business
community.

Under the exigencies of the quest of profits, as
conditioned by the larger industry and the more
sweeping business organization of the last few
decades, the question of capital in business has
increasingly become a question of capitalization on
the basis of earning-capacity, rather than a question
of the magnitude of the industrial plant or the
cost of production of the appliances of industry.
From being a sporadic trait, of doubtful legitimacy,
in the old days of the “natural” and “money ”
economy, the rate of profits or earnings on invest-
ment has in the nineteenth century come to take
the central and dominant place in the economic
system. Capitalization, credit extensions, and
even the productiveness and legitimacy of any

century, than it does to the situation of the last decade. Qualifica-
tions required by the later phases of business development will be
noted presently.

90 THE THEORY OF BUSINESS ENTERPRISE

given employment of labor, are referred to the
rate of earnings as their final test and substantial
ground. At the same time the “ordinary rate of
profits” has become a more elusive idea. The
phenomenon of a uniform rate of profits deter-
mined by competition has fallen into the back-
ground and lost something of its matter-of-fact
character since competition in the large industry
has begun to shift from the position of a stable
and continuous equilibration to that of an inter-
mittent, convulsive strain in the service of the
larger business men’s strategy. The interest of
the business community centres upon profits and
upon the shifting fortunes of the profit-maker,
rather than upon accumulated and capitalized
goods. Therefore the ultimate conditioning force
in the conduct and aims of business is coming to
be the prospective profit-yielding capacity of any
given business move, rather than the aggregate
holdings or the recorded output of product.

But this latest development in the field of
industrial business has not yet come to control the
field. It is rather an inchoate growth of the
immediate present than an accomplished fact even
of the recent past, and it can be understood only
by reference to those conditions of the recent past
out of which it comes. Therefore it is necessary
to turn back to a further consideration of the
old-fashioned business traffic as it used to go on

BUSINESS PRINCIPLES 91

by the competitive method before the competitive
order began seriously to be dislocated and take on
an intermittent character, as well as to a consid-
eration of that resort to credit which has, in large
part, changed the competitive system of business
from what it was at the beginning of the nine-
teenth century to what it has become at its close.

_ OHAPTER V
THE USE OF LOAN CREDIT

CREDIT serves two main uses in the regular
course of such business as is occupied with the con-
duct of industry: (a) that of deferred payments in
the purchase and sale of goods — book accounts,
bills, checks, and the like belong chiefly under
this head; and (b) loans or debts — notes, stock
shares, interest-bearmg securities, deposits, call
loans, etc., belong chiefly here. These two cate-
gories of credit extension are by no means clearly
distinct. Forms of credit which commonly serve
the one purpose may be turned to the other use;
but the two uses of credit are, after all, broadly
distinguishable. For many purposes of economic
theory such a distinction might not be serviceable,
or even practicable ; it is here made merely for pres-
ent use. It is chiefly with credit of the latter class,
or rather with credit in so far as it is turned to use
for the latter purpose, that this inquiry is concerned.

Suppose due credit arrangements have already
been made —in the way of investments in stocks,
interest-bearing securities and the like — such as to
place the management of the industrial equipment
in competent hands. This supposition is not a

92

THE USE OF LOAN CREDIT 93

violent one, since a condition roughly approximat-
ing to this prevails in any quiescent period of
industry, when there is no appreciable depression.
Under these “normal” conditions, the capital in-
vested in any given industrial venture is turned
over within a certain, approximately definite, length
of time. The length of time occupied by the turn-
over may vary from one establishment to another,
but in any given case the length of the turnover is
one of the important factors that determine the
chances of gain for the business concern in ques-
tion. Indeed, if the general conditions of the
trade and of the market are given, the two factors
which determine the status and value of a given
sound concern, as seen from the business man’s
standpoint, are the magnitude of the turnover and
the length of time it occupies.

The busmess man’s object is to get the largest
aggregate gain from his business. It is manifestly
for his interest, as far as may be, to shorten the
process out of which his earnings are drawn,’ or,
in other words, to shorten the period in which he
turns over his capital. If the turnover consumes
less than the time ordinarily allowed in the line of

1 This, of course, has nothing to say to Béhm-Bawerk’s theory of
the enhancement of production through lengthening the processes of
industry. His theory of the ‘‘roundabout method’’ applies to the
technical, material efficiency of the mechanical process; whereas the
point in question here is the interval occupied in the turning over of
a given business capital. Bohm-Bawerk’s position may be question-
able, however, on other grounds,

94 THE THEORY OF BUSINESS ENTERPRISE

industry in which he is engaged, he gains more
than the current rate of profits in that line of busi-
ness, other things equal; whereas he loses if the
turnover takes more than the normal time. This
fact is forcibly expressed in the maxim, “Small
profits and quick returns.” There are two chief
means of shortening the interval of the turnover,
currently resorted to in industrial business. The
first is the adoption of more efficient, time-saving
industrial processes. Improvements of industrial
plant and industrial processes having this in view
are gaining in importance in the later develop-
ments of business, since a closer attention 1s now
given to the time element in investments, and
great advances have been made in this direction.’
A second expedient for accelerating the rate of
turnover is the competitive pushing of sales,
through larger and more urgent advertising and
the like. It is needless to say that this means of
accelerating business also receives due attention at
the hands of modern business men.

But the magnitude of the turnover, “the vol-
ume of business,” is of no less consequence than
its rapidity. It is, of course, a trite commonplace
that the earnings of any industrial business are
a joint function of the rate of turnover and the

1 Cf., e. g., Werner Sombart, ‘‘ Der Stil des modernen Wirthschafts-
lebens,” Archiv fiir soz. Gesetzg. wu. Statistik, vol. XVII. pp. 1-20,
especially pp. 4-15. Reprinted as ch. IV. vol. II. of Der moderne
Kapitalismus (Leipzig, 1902),

THE USE OF LOAN CREDIT 95

volume of business.’ The business man may reach
his end of increased earnings by either the one or
the other expedient, and he commonly has resource
to both if he can. His means of increasing the
magnitude of the turnover is a resort to credit and
a close husbanding of his assets. He is under a
constant incentive to increase his liabilities and to
discount his bills receivable. Indebtedness in this
way comes to serve much the same purpose, as
regards the rate of earnings, as does a time-saving
improvement in the processes of industry.” The
effect of the use of credit on the part of a business
man so placed is much the same as if his capital
had been turned over a greater number of times
in the year. It is accordingly to his interest to
extend his credit as far as his standing and the
state of the market will admit.’

1Cf., e.g., Marshall, Principles of Economics (3d ed.), bk. VI.
ch. VII. secs. 3 and 4.

2 Cf. Laughlin, Principles of Money, p. 86.

3 The turnover will count for more in gross earnings at current
rates if instead of his own capital alone the business man also en-
gages whatever funds he can borrow by using his capital as collateral.
The turnover counted on capital (value of the industrial equipment)
plus credit, at current rates, will be greater than that counted on the
capital alone used without credit extension. The turnover may be
expressed as the product of the mass of values employed multiplied
by the velocity. Hence, if credit be taken as an indeterminate frac-

tion =} of the capital used as collateral, we may say that

Turnover = J. (capital + cape hei
time n

96 THE THEORY OF BUSINESS ENTERPRISE

But on funds obtained on credit the debtor has
to pay interest, which, being deducted from the
gross earnings of the business, leaves, as net gain
due to his use of credit, only the amount by which
the increment of gross earnings exceeds the in-
terest charge. This sets a somewhat elastic limit
to the advantageous use of loan credit in business.
In ordinary times, however, and under capable
management, the current rate of business earnings
exceeds the rate of interest by an appreciable
amount; and in times of ordinary prosperity,
therefore, it 1s commonly advantageous to employ
credit in the way indicated. Still more so in
brisk times, when opportunities for earnings are
many and promise to increase. ‘To turn the propo-
sition about, so as to show the run of business
motives in the case: whenever the capable busi-
ness manager sees an appreciable difference be-
tween the cost of a given credit extension and the
gross increase of gains to be got by its use, he will
seek to extend his credit. But under the régime

The algebraic statement serves to bring out the equivalence between
an acceleration of the rate of turnover and an increase of the volume
of business capital. Cf. Jevons, Theory of Political Economy, pp.
249-258.

Sombart is mistaken in saying (Kapitalismus, vol. II. ch. VI. p. 74)
that the use of credit lengthens the time of turnover of capital.
Credit shortens the time relatively to the magnitude of the turnover ;
z.e. @ given initial capital by the help of credit turns over a larger

CG

pecuniary magnitude in a given time:

THE USE OF LOAN CREDIT 97

of competitive business whatever is generally ad-
vantageous becomes a necessity for all competitors.
Those who take advantage of the opportunities
afforded by credit are in a position to undersell
any others who are similarly placed in all but this
respect. Speaking broadly, recourse to credit be-
comes the general practice, the regular course of
competitive business management, and competition
goes on on the basis of such a use of credit as an
‘auxiliary to the capital in hand. So that the
competitive earning capacity of business enter-
prises comes currently to rest on the basis, not of
the initial capital alone, but of capital plus such
borrowed funds as this capital will support.

The competitive rate of earnings is brought to
correspond with this basis of operation; the con-
sequence being that under such competitive em-
ployment of credit the aggregate earnings of an
enterprise resting on a given initial capital will
be but slightly larger than it might have been if
such a general recourse to credit to swell the
volume of business did not prevail. But since
such use of credit prevails generally, a further con-
sequence is that any concern involved in the open
business competition, which cannot or does not
take recourse to credit to swell its volume of busi-
ness, will be unable to earn a “reasonable”’ rate
of profits. So that the general practice drives
all competitors to the use of the same expedient ;

98 THE THEORY OF BUSINESS ENTERPRISE

but since the advantage to be derived from this
expedient is a competitive advantage only, the
universality of the practice results in but a slight,
if any, increase of the aggregate earnings of the
business community. Borrowed funds afford any
given business concern a differential advantage as
against other competitors; but it is, in the main,
a differential advantage only. The competitive
use of such funds in extending business operations
may, incidentally, throw the management of some
portion of the industrial process into more com-
petent or less competent hands. So far as this
happens, the credit operations in question and the
use of the borrowed funds may increase or dimin-
ish the output of industry at large, and so may
affect the aggregate earnings of the business com-
munity. But, apart from such incidental shifting
of the management of industry to more competent
(or less competent) hands, this competitive use of
borrowed funds has no aggregate effect upon earn-
ings or upon the industrial output.

The current or reasonable rate of profits is,
roughly, the rate of profits at which business men
are content to employ the actual capital which
they have in hand.’ A general resort to credit
extension as an auxiliary to the capital in hand
results, on the whole, in a competitive lowering
of the rate of profits, computed on capital plus

1 See Marshall, as above.

THE USE OF LOAN CREDIT 99

eredit, to such a point as would not be attractive
to a business man who must confine himself to the
employment of capital without credit extension.
On an average, it may be said, the aggregate earn-
ings of the aggregate capital with credit extension
are but slightly greater than the aggregate earn-
ings of the same capital without credit extension
would be in the absence of a competitive use of
credit extension. But under modern conditions
business cannot profitably be done by any one of
the competitors without the customary resort to
credit. Without the customary resort to credit a
“reasonable ” return could not be obtained on the
investment.

To the extent to which the competitive recourse
to credit is of the character here indicated — to
the extent to which it is a competitive bidding
for funds between competent managers —it may
be said that, taken in the aggregate, the funds so
added to business capital represent no material
capital or “ production goods.” They are business
capital only; they swell the volume of business,
as counted in terms of price, etc., but they do not
directly swell the volume of industry, since they
do not add to the aggregate material apparatus of
industry, or alter the character of the processes
employed, or enhance the degree of efficiency with
which industry is managed.

The “buoyancy” which a speculative inflation

100 THE THEORY OF BUSINESS ENTERPRISE

of values gives to industrial business may indi-
rectly increase the material output of industry by
enhancing the intensity with which the industrial
process is carried on under the added stimulus;
but apart from this psychological effect the expan-
sion of business capital through credit extension
has no aggregate industrial effect. This secondary
effect of credit inflation may be very considerable
and is always present in brisk times. It is com-
monly obvious enough to be accounted the chief
characteristic of a period of “prosperity.” Tor
a theory of industry this indirect effect of credit
inflation would be its main characteristic, but for
a theory of business it occupies the place of a
corollary only.

To the view set forth above,—that borrowed
funds do not increase the aggregate industrial
equipment,— the objection may present itself that
all funds borrowed represent property owned by
some one (the lender or his creditors), and trans-
ferred, in usufruct, by the loan transaction to the
borrower; and that these funds can, therefore, be
converted to productive uses, like any other funds,
by drawing into the industrial process, directly or
indirectly, the material items of wealth whose
fluent form these funds are.'. The objection fails
at two points: (a) while the loans may be covered
by property held by the lender, they are not fully

1Cf. Laughlin, Principles of Money, ch. IV.

THE USE OF LOAN CREDIT 101

covered by property which is not already other-
wise engaged ; and even if such were the case, it
would (4) not follow that the use of these funds
would increase the technical (material) outfit of
industry.

As to the first point (a): Loans made by the
financial houses in the way of deposits or other
advances on collateral are only to a fractional
extent covered by liquid assets ;' and anything but
liquid assets is evidently beside the point of the
present question. An inconsiderable fraction of
these loans is represented by liquid assets. The
greater part of the advances made by banking
houses, for instance, rest on the lender’s presump-
tive ability to pay eventually, on demand or at
maturity, any claims that may in the course of
business be presented against the lender on ac-
count of the advances made by him. It is a busi-
ness truism that no banking house could at a
moment meet all its outstanding obligations.” A
necessary source of banking profits, ¢.7., is a large
excess of the volume of business over reserves.

As to (b): Another great part of the basis of
such loans is made up of invested funds and col-
lateral held by the lender. These at the same
time are much of the basis on which rests the

1 Property convertible into cash at will.

2 The legally obligatory reserve for the National Banks, for instance,
is 25 per cent. of combined note circulation and deposits in central
reserve bauks, 15 per cent. in others. — Revised Statutes, 5191,

102 THE THEORY OF BUSINESS ENTERPRISE

lender’s presumptive ability to pay claims pre-
sented. But these investments, in industry or
real estate, in interest-bearing securities and col-
lateral of whatever description, represent future
income of the lender’s debtors (as, e.g., government
and municipal securities), or property which is
already either engaged in the industrial process or
tied up in forms of wealth (as, e.g., real estate)
which do not lend themselves to industrial uses.
Loans obtained on property which has no present
industrial use, which cannot in its present form or
under existing circumstances be employed in the
processes of industry (as, eg., speculative real
estate), or loans on property which is already en-
gaged in the industrial process (as, ¢.g., stocks,
industrial plant, goods on hand, real estate in
use),' represent, for the purpose in hand, nothing
more substantial than a fictitious duplication of
material items that cannot be drawn into the in-
dustrial process. Therefore such loans cannot,
at least not directly, swell the aggregate industrial
equipment or enhance the aggregate productivity
of industry; for the items which here serve as
collateral are already previously in use in industry
to the extent to which they can be used. Prop-

1 This takes account of advances made by other lenders than the
regular banking houses who exclude mortgages on real estate from
their collateral ; such, e.g., as the long time advances (investments in
securities) made by savings-banks, insurance companies, minor private
and mortgage banks, private lenders, etc.

THE USE OF LOAN CREDIT 108

erty of these kinds— what is already in use in
industry and what is not of use for industrial pur-
poses — may be “coined into means of payment,”
and so may be made to serve as additional pecun-
iary (business) capital, but such property is me-
chanically incapable of serving as additional
material (industrial) capital. To a very consid-
erable extent the funds involved in these loans,
therefore, have only a pecuniary (business) exist-
ence, not a material (industrial) one; and, so
far as that is true, they represent, in the aggre-
gate, only fictitious industrial equipment. Even
such inconsiderable portion of them, however, as
represents metallic reserves also adds nothing to
the effective material apparatus of industry; since
money as such, whether metallic or promissory, is
of no direct industrial effect ; as is evident from
the well-known fact that the absolute quantity of
the precious metals in use is a matter of no con-
sequence to the conduct of either business or in-
dustry, so long as the quantity neither increases
nor decreases by an appreciable amount. Nummus
nummum non parit.

So that all advances made by banking houses or
by other creditors in a like case,— whether the
advances are made on mortgage, collateral or
personal notes, in the form of deposits, note issues,
or what not; whether they are taken to represent
the items of property covered by the collateral,

104 THE THEORY OF BUSINESS ENTERPRISE

the cash reserves of the banks, or the general
solvency of the creditor or debtor, —all these
“advances” go to increase the “capital” of which
business men have the disposal; but for the ma-
terial purposes of industry, taken in the aggregate,
they are purely fictitious items." Cash loans (such
as savings-bank deposits” and the like) belong in
the same category. All these advances afford the
borrower a differential advantage in bidding against
other business men for the control and use of in-
dustrial processes and materials, they afford him
a differential advantage in the distribution of the
material means of industry; but they constitute
no aggregate addition to the material means of
industry at large. Funds of whatever character
are a pecuniary fact, not an industrial one; they
serve the distribution of the control of imdustry
only, not its materially productive work.

Loan credit in excess of what may serve to
transfer the management of industrial materials
from the owner to a more competent user — that
is to say, in so far as it is not, in effect, of the
nature of a lease of industrial plant — serves, on
the whole, not to increase the quantity of the

1 This truism is frequently overlooked in theoretical discussions ;
hence, as the present argument requires its recognition, it is here
stated in this explicit way.

2 The cash loans made by depositors to savings-banks in the form
of deposits,

THE USE OF LOAN CREDIT 105

material means of industry nor, directly, to en-
hance the effectiveness of their use; but, taken
in the aggregate, it serves only to widen the dis-
crepancy between business capital and industrial
equipment. So long as times are brisk this dis-
crepancy ordinarily goes on widening through a
progressive extension of credit. Funds obtained
on credit are applied to extend the business;
competing business men bid up the material items
of industrial equipment by the use of funds so
obtained; the value of the material items em-
ployed in industry advances; the aggregate of
values employed in a given undertaking increases,
with or without a physical increase of the indus-
trial material engaged; but since an advance of
credit rests on the collateral as expressed in terms
of value, an enhanced value of the property affords
a basis for a further extension of credit, and so
on.!

Now, the base line of business transactions is
the money value (market or exchange value, price)
of the items involved, not their material efficiency.
The value of the money unit is by conventional
usage held to be invariable, and the lenders per-
force proceed on this assumption, so long as they
proceed at all? Consequently, any increase of

1Cf. Twelfth Census of the United States, vol. VIL. p. ¢.

2 Few, perhaps, would in set terms maintain an argument that the
value of money does not vary, but still fewer would, in a credit trans-
action, proceed on a supposition at variance with that position. As

{06 THE THEORY OF BUSINESS ENTERPRISE

the aggregate money values involved in the
current industrial business enterprises will afford
a basis for an extension of loans, indistinguishable
from any other block of capitalized values, even if
the increase of capitalized values is due to credit
advances previously made on the full cash value
of the property hypothecated. The extension of
loans on collateral, such as stock and similar values
involved in industrial business, has therefore in the
nature of things a cumulative character. This
cumulative extension of credit through the en-
hancement of prices goes on, if otherwise undis-
turbed, so long as no adverse price phenomenon
obtrudes itself with sufficient force to convict
this cumulative enhancement of capitalized values
of imbecility. The extension of credit proceeds on
the putative stability of the money value of the
capitalized industrial material, whose money value
is cumulatively augmented by this extension itself.
But the money value of the collateral is at the
same time the capitalized value of the property,
computed on the basis of its presumptive earning-
capacity. These two methods of rating the value
of collateral must approximately coincide, if the

the economists are accustomed to say, money is the standard of de-
ferred payments. It is also, in the unreflecting apprehension of those
who have practically to deal with wealth phenomena, felt to be the
standard and inflexible measure of wealth. The fact that this conven-
tional usage is embodied in law acts greatly to fortify the naive accept~

ance of money and price as the definitive terms of wealth. See pp. 82-
85 above.

THE USE OF LOAN CREDIT 107

capitalization is to afford a stable basis for credit ;
and when an obvious discrepancy arises between
the outcome given by the two ratings, then a re-
rating will be had in which the rating on the basis
of earning-capacity must be accepted as definitive,
since earnings are the ground fact about which
all business transactions turn and to which all
busmess enterprise converges. A manifest dis-
crepancy presently arises in this way between
the aggregate nominal capital (capital plus loans)
engaged in business, on the one hand, and the
actual rate of earning-capacity of this business
capital, on the other hand; and when this dis-
crepancy has become patent a period of liquidation
begins.

To give a readier view of the part played by
loan credit in this discrepancy between the busi-
ness capital and the earning-capacity of industrial
concerns, it will be in place to indicate more
summarily what are the factors at play.

The earnings of the business community, taken
asa whole, are derived from the marketable output
of goods and services turned out by the industrial
process — disregarding such earnings as accrue to
one concern merely at the cost of another. The
effective industrial capital, from the use of which
this output, and therefore these earnings, arise,
is the aggregate of capitalized material items
actually engaged in industry. The business

108 THE THEORY OF BUSINESS ENTERPRISE

capital, on the other hand, is made up of this
capitalized industrial material taken as a fund
of values, plus good-will, plus whatever funds are
obtained on credit by using this capitalized indus-
trial material as collateral, plus funds obtained on
other, non-industrial, property used as collateral.
Through the competitive use of funds obtained on
credit, as spoken of above, the nominal value of
the capitalized industrial material is cumulatively
augmented so as to make it approximately equal
to its original capitalization plus whatever funds
are obtained on credit of all kinds. On this basis
of an expanded collateral a further extension of
credit takes place, and the funds so obtained are
incorporated in the business capital and turned
to the like competitive use, and so on.’ Capital
and earnings are counted in terms of the money
unit. Counted in these terms, the earnings (in-
dustrial output) are also increased by the process
of inflation through credit, since the competitive
use of funds spoken of acts to bid up prices of
whatever products are used in industry, and of
whatever speculative property is presumed to have
some eventual industrial use. But the nominal
magnitude (value) of the earnings is not increased
in as large a ratio as that of the business capital ;
since the demand whereby the values of the out-

‘Cf. Knies, Geld und Credit, vol. II. ch. VI. sec. CO, especially
pp. 308 et seg.

THE USE OF LOAN CREDIT 109

put are regulated is not altogether a business de-
mand (for productive goods), but is in great part,
and indeed in the last resort mainly, reducible to
a consumptive demand for finished goods.

Looking at credit extension and its use for pur-
poses of capital as a whole, the outcome which pre-
sents itself most strikingly ata period of liquidation
is the redistribution of the ownership of industrial
property incident to the liquidation. The funds
obtained on credit are in great measure invested
competitively in the same aggregate of material
items that is already employed in industry apart
from the use of loan credit, with the result that
the same range of items of wealth are rated at a
larger number of money units. In these items of
wealth — which, apart from the use of credit, are
owned by their nominal owners — the creditors,
by virtue of the credit extension, come to own an
undivided interest proportioned to the advances

1 The enhancement of the market value of the output does not, in
fact, keep pace with the inflation of business capital during a period
of speculative advance, In order that it should do so, and afford
nominal earnings proportionate to the inflated capital, it would be
necessary that incomes should increase proportionately to the inflation
of. capital; but, even if this happened, the expenses of production
would thereby be so increased (through the advance of wages and the
like) as to offset the entire inflation of values for all consumptive goods
and leave only the advance in the values of productive goods as a net
margin from which to draw an increase of earnings. The discrepancy
under discussion, however, is not due entirely to the presence of credit,

and a fully detailed analysis of the causes out of which it arises can,
therefore, not properly be presented in this place.

110 THE THEORY OF BUSINESS ENTERPRISE

which they have made. The aggregate of these
items of property comes hereby to be potentially
owned by the creditors in approximately the pro-
portion which the loans bear to the collateral plus
the loans. The outcome of credit extension, in this
respect, is a situation in which the creditors have
become potential owners of such a fraction of the
industrial equipment as would be represented by the

formula:
loans

capitalization (= collateral + loans)

In a period of liquidation this potential owner-
ship on the part of the creditors takes effect to

1So long as the rating of the capitalized property remains undis-
turbed, the formula which expresses the creditors’ claim maintains the
form given above. It then signifies nothing more than that the cred-
itors hold a claim on such a proportion of the aggregate capitalized
property involved as their advances bear to the aggregate capitaliza-
tion. But so soon as a rerating of the capitalized property enters the
problem the formula becomes

loans
capitalization + A capitalization
loans
capitalization — A capitalization’
according as the rerating of capitalization is in the direction of

or

enhancement or depreciation : <r ae or Nox ae During
cap + Acap cap — Acap

brisk times, when capitalization advances, the claim represented by a
given loan covers a decreasing proportion of the aggregate capitalized
property involved (+

cap + Acap
quotient consequently decreases. Whereas, in a period of liquidation
the ratio of the creditors’ claim to the aggregate capitalization in-
creases by force of the lowered rating of the capitalized property

); the denominator increases and the

1
o —A Tl

THE USE OF LOAN CREDIT 111

the extent to which the liquidation is carried
through.'

The precise measure and proportion in which the
industrial property of the business community
passes into the hands of the creditors in a period of
liquidation can, of course, not be specified ; it depends
on the degree of shrinkage in values, as well as on
the degree of thoroughness with which the liqui-
dation is carried out, and perhaps on other still less
ascertainable causes, among which is the degree of
closeness of organization of the business community.
It is, however, through the shrinkage of market
values of the output and the industrial plant that
the transfer of ownership to the creditor class takes
place. In case no shrinkage of values took place,
no such general transfer of ownership to the cred-
itors as a class would become evident.

In point of fact, the shrinkage commonly super-
venes, in the course of modern business, when a
general liquidation comes ; although it is conceiv-
able that the period of acute liquidation and its
attendant shrinkage of values need not supervene.
Such would probably be the case in the absence of
competitive investment in industrial material on a
large scale. Secondary effects, such as perturbations
of the rate of interest, insolvency, forced sales, and
the like, need scarcely be taken up here, although

1 All those who, at a period of liquidation, are holders of fluent

funds or of claims to fixed sums of money are, for the present purpose,
in the position of creditors.

112 THE THEORY OF BUSINESS ENTERPRISE

it may be well to keep in mind that these secondary
effects are commonly very considerable and far-
reaching, and that they may in specific instances
very materially affect the outcome.

The theoretical result of this summary sketch of
loan credit so far seems to be: (a) an extension of
loan credit beyond that involved in the transference
of productive goods from their owners to more com-
petent users is unavoidable under the régime of
competitive business—credit expansion is nor-
mally in some degree “ abnormal” or “ excessive ”’ ;
(6) such a use of credit does not add to the aggre-
gate of industrially productive equipment nor in-
crease its material output of product, and therefore it
does not add materially to the aggregate gross earn-
ings obtained by the body of business men engaged
in industry, as counted in material terms of wealth
or of permanent values ;' (c) it diminishes the aggre-
gate net profits obtained by the business men en-
gaged in industry, as counted in such terms, in that
it requires them to pay interest, to creditors outside
the industrial process proper, on funds which, taken
as an aggregate, represent no productive goods and
have no aggregate productive effect ; (d) there re-
sults an overrating of the aggregate capital engaged
in industry, compared with the value of the indus-

1 This disregards the indirect effects of a speculative advance in
the way of heightened intensity of application and fuller employment
of the industrial plant.

THE USE OF LOAN CREDIT 118

trial equipment at the starting-point, by approxi-
mately the amount of the aggregate deposits and
loans on collateral; (e) the overrating swells the
business capital, thereby raises the valuation of
collateral, and gives rise to a further extension
of credit, with further results of a like nature;
(f) commonly beginning at some point where the
extension of credit is exceptionally large in propor-
tion to the material substratum of productive goods,
or where the discrepancy between nominal capital
and earning-capacity is exceptionally wide, the
overrating is presently recognized by the creditor
and a settlement ensues; (gy) on the consequent
withdrawal of credit a forced rerating of the ag-
gregate capital follows, bringing the nominal agere-
gate into approximate accord with the facts of
earning-capacity ; (4) the shrinkage which takes
place in reducing the aggregate rating of business
capital from the basis of capital goods plus loans to
the basis of capital goods alone, takes place at the
expense of debtors and nominal owners of industrial
equipment, in so far as they are solvent ; (7?) in the
period of liquidation the gain represented by the
credit inflation goes to the creditors and claimants
of funds outside the industrial process proper, ex-
cept that so much as is cancelled in bad debts is
written off; (j) apart from secondary effects, such
as heightened efficiency of industry due to inflated
values, changes of the rate of interest, insolvency,

114 THE THEORY OF BUSINESS ENTERPRISE

etc., the main final outcome is a redistribution of
the ownership of property whereby the creditor class,
including holders and claimants of funds, is bene-
fited.

Since the modern industrial situation began to
take form, there have been two principal forms of
credit transactions current in the usage of the
business community for the purpose of investment :
the old-fashioned loan, the usage of which has
come down from an earlier day; and the stock
share, whereby funds are invested in a joint stock
company or corporation. The latter is a credit
instrument, so far as touches the management of
the property represented, in that (in earlier usage
at least) it effects a transfer of a given body of
property from the hands of an owner who resigns
discretion in its control to a board of directors who
assume the management of it. In addition to
these two methods of credit relation there has,
during the late-modern industrial period, come
into extensive use a third class of expedients, viz.
debentures of one form and another — bonds of
various tenor, preferred stock, preference shares,
etc., ranging, in point of technical character and
degree of liability, from something approaching the
nature of a bill of sale to something not readily
distinguishable in effect from a personal note.
The typical (latest and most highly specialized)

THE USE OF LOAN CREDIT Lis

instrument of this class is the preferred stock.
This is in form a deed of ownership and in
effect an evidence of debt. It is typical of a some-
what comprehensive class of securities in use in
‘the busmess community, in the respect that it
sets aside the distinction between capital and credit.
In this respect, indeed, preferred stock, more
adequately perhaps than any other instrument,
reflects the nature of the “capital concept”’ cur-
rent among the up-to-date business men who are
engaged in the larger industrial affairs.

The part which debenture credit, nominal and
virtual, plays in the financing of modern industrial
corporations is very considerable, and the propor-
tion which it bears in the capitalization of these
corporations apparently grows larger as time passes
and shrewder methods of business gain ground. In
the field of the “industrials” proper, debenture
eredit has not until lately been employed with full
effect. It seems to be from the corporation finance
of American railway companies that business men
have learned the full use of an exhaustive deben-
ture credit as an expedient for expanding business
capital. It is not an expedient newly discovered,
but its free use, even in railway finance, is relatively
late. Wherever it prevails in an unmitigated
form, as with some railway companies, and lat-
terly in many other industrial enterprises, it
throws the capitalization of the business concerns

116 THE THEORY OF BUSINESS ENTERPRISE

affected by it into a peculiar, characteristically
modern, position in relation to credit. When car-
ried out thoroughly it places virtually the entire
capital, comprising the whole of the material
equipment, on a credit basis. Stock being issued
by the use of such funds as will pay for printing
the instruments, a road will be built or an indus-
trial plant established by the use of funds drawn
from the sale of bonds; preferred stock or similar
debentures will then be issued, commonly of
various denominations, to the full amount that the
property will bear, and not infrequently somewhat
in excess of what the property will bear. When
the latter case occurs, the market quotations of the
securities will, of course, roughly adjust the current
effective capitalization to the run of the facts, what-
ever the nominal capitalization may be. The
common stock in such a case represents “ good-
will,” and in the later development it usually
represents nothing but “good-will.’! The mate-
rial equipment is covered by credit instruments —
debentures. Not infrequently the debentures cover
appreciably more than the value of the material
equipment, together with such property as useful
patent rights or trade secrets; in such a case the
good-will is also, to some extent, covered by de-
bentures, and so serves as virtual collateral for a
credit extension which is incorporated in the busi-
1 See Chapter VI.

THE USE OF LOAN CREDIT 117

ness capital of the company. In the ideal case,
where a corporation is financed with due perspi-
cacity, there will be but an inappreciable proportion
of the market value of the company’s good-will
left uncovered by debentures. In the case of a
railway company, for instance, no more should be
left uncovered by debentures than the value of the
“franchise,” and probably in most cases not that
much actually is uncovered.

Whether capitalized good-will (including “ fran-
chise” if necessary) 1s to be rated as a credit
extension is a nice question that can apparently
be decided only on a legal technicality. In any
case so much seems clear —that good-will is the
nucleus of capitalization in modern corporation
finance. In a well financed, flourishing corpora-
tion, good-will, indeed, constitutes the total remain-
ing assets after liabilities have been met, but the
total remaining assets may not nearly equal the
total market value of the company’s good-will ;
that is to say, the material equipment (plant, etc.)
of a shrewdly managed concern is hypothecated at
least once, commonly more than once, and its im-
material properties (good-will), together with the
evidences of its indebtedness, may also to some
extent be drawn into the hypothecation.’

1The question of ‘‘stock watering,’ ‘‘overcapitalization,” and
the li¥ is scarcely pertinent in the case of a large industrial corpora-
tion financed as the modern situation demands. Under modern cir-
cumstances the common stock can scarcely fail to be all ‘‘ water,’*

118 THE THEORY OF BUSINESS ENTERPRISE

What has just been said of the part borne by
good-will and debentures in the capitalization of
corporations should be taken in connection with
what was said above (pp. 100-104) as to the nature
of the securities offered as collateral in procuring a
credit extension. The greater part of the securities
used as collateral, and so “ coined into means of pay-
ment,” are evidences of debt, at the first remove or
farther from their physical basis, instruments of
credit recording a previous credit extension.

In the earlier period of growth of this debenture

unless in a small concern or under incompetent management. Nothing
but ‘‘ water ’’ — under the name of good-will — belongs in the common
stock ; whereas the preferred stock, which represents material equip-
ment, is a debenture. ‘‘ Overcapitalization,’’ on the other hand, if it
means anything under modern business conditions, must mean over-
capitalization as compared with earning-capacity, for there is nothing
else pertinent to compare it with; and earning-capacity fluctuates,
while the basis (interest rates) on which the earning-capacity is to be
capitalized also fluctuates independently.

In effect, the adjustment of capitalization to earning-capacity is
taken care of by the market quotations of stock and other securities ;
and no other method of adjustment is of any avail, because capitaliza-
tion is a question of value, and market quotations are the last resort
in questions of value. The value of any stock listed on the exchange,
or otherwise subject to purchase and sale, fluctuates from time to time ;
which comes to the same thing as saying that the effectual capitaliza-
tion of the concern, represented by the securities quoted, fluctuates
from time to time. It fluctuates more or less, sometimes very slowly,
but always at least so much as to compensate the long-period fluctua-
tions of discount rates in the money market; which means that the
purchase price of a given fractional interest in the corporation as a
going concern fluctuates so as to equate it with the capitalized value
of its putative earning-capacity, computed at current rates of discount
and allowing for risks. Cf. Report of the Industrial Commission,
vol. L. p. 587 (Testimony of Rogers) ; vol. XIII. pp. 106-107 (Testi-
mony of E, R. Chapman). See also Chapter VI. below.

THE USE OF LOAN CREDIT 119

financiering in industry, as, e.g., in the railroad
financiering of the third quarter of the nineteenth
century, the process of expansion by means of de-
benture credit, in any given case, was worked out
gradually, over a more or less extended period of
time. But as the possibilities of this expedient
have grown familiar to the business community,
the time consumed in perfecting the structure of
debentures in each case has been reduced; until
it is now not unusual to perfect the whole organiza-
tion, with its load of debentures, at the inception
of a corporate enterprise. In such a case, when a
corporation starts with a fully organized capital
and debt, the owners of the concern are also its
creditors; they are, at the start, the holders of
both common and preferred stock, and probably
also of the bonds of the company —so adding
another increment of confusion to the relation
between modern capital and credit, as seen from
the old-fashioned position as to what capitalization
and its basis should be.

This syncopated process of expanding capital by
the help of credit financiering, however, is seen at
its best in the latter-day reorganizations and coali-
tions of industrial corporations; and as this class
of transactions also illustrate another interesting
and characteristically modern feature of credit
financiering, the whole matter may best be set out

120 THE THEORY OF BUSINESS ENTERPRISE

in the way of a sketch of what takes place in a
case of coalition of mdustrial corporations on a
large scale such as recent industrial history has
made familiar.

The avowed end of these latter-day business
coalitions is economy of production and sale and
an amicable regulation of intercorporate relations.
So far as bears on the functioning of credit in the
attendant business transactions, the presence or
absence of these purposes, of course, does not
affect the course of events or the outcome. These
avowed incentives do not touch the credit opera-
tions involved. On the other hand, the need of
large credit in consummating the deal, as well as
the presumptive gains to be drawn from the credit
relations involved, offer inducements of their own
to men who are in a position to effect such a coali-
tion. Inducements of this kind seem to have been
of notable effect in bringing on some of the recent
operations of this class.

Credit operations come into these transactions
mainly at two points: in the “financing” of the
deal, and in the augmentation of debentures; and
at both of these points there is a chance of gain —
on the one hand to the promoter (organizer) and
the credit house which finances the operation, and
on the other hand to the stockholders. The gain
which accrues to the two former is the more un-
equivocal, and this seems in some cases to be the

THE USE OF LOAN CREDIT 12]

dominant incentive to effect the reorganization.
The whole operation of reorganization may, there-
fore, best be taken up from the point of view of
the promoter, who is the prime mover in the
matter.

A reorganization of industrial concerns on a
large scale, such as are not uncommon at the
present time, involves a campaign of business
strategy, engaging, it is said, abilities and respon-
sibilities of a very high order. Such a campaign
of business strategy, as carried out by the modern
captains of industry, runs, in the main, on credit
relations, in the way of financial backing, options,
purchases, leases, and the issuance and transfer of
stock and debentures. In order to carry through
these large “deals,” in the first place, a very
substantial basis of credit is required, either in
the hands of the promoter (organizer) himself or in
the hands of a credit house which “finances” the
organization for him.

The strategic use of credit here involved is, in
effect, very different from the old-time use of loan
credit in investments. In transactions of this class
the time element, the credit period, is an incon-
spicuous factor at the most; it plays a very subor-
dinate and uncertain part. The volume of credit
at the disposal of a given strategist is altogether
the decisive point, as contrasted with the lapse of
time over which the incident credit extension may

122 THE THEORY OF BUSINESS ENTERPRISE

run. The usefulness of the credit extension is not
measured in terms of time, nor are the gains which
accrue to the creditor in the case proportioned to
the length of time involved.

This follows from the peculiar nature of the
work which these great captais of industry have
in hand, and more remotely, therefore, from the
peculiar character of the earnings which imduce
them to undertake the work. Their work, though
it is of the gravest consequence to industry, is not
industrial business, in that it is not occupied with
anything like the conduct of a continuous indus-
trial process. Nor is it of the same class as com-
mercial business, or even banking business, in that
there is no investment in a continued sequence of
transactions. It differs also from stock and prod-
uce speculation, as that is currently conceived,’ in
that it does not depend on the lapse of time to
bring a change of circumstances; although it has
many points of similarity with stock speculation.
In its details this work resembles commercial busi-
ness, in that it has to do with bargaining; but so
does all business, and this peculiar work of the
trust promoter differs from mercantile business in
the absence of continuity. Perhaps its nearest
business analogue is the work of the real estate
agent.

1See, e.g., Emery, Speculation on the Stock and Produce Exchanges
of the United States, ch. lV ; Hadley, Economics, ch. IV.

THE USE OF LOAN CREDIT 123

The volume of credit involved is commonly very
great ; whereas the credit period, the lapse of time,
is a negligible factor. Indeed, if an appreciable
credit period intervenes, that is a fortuitous circum-
stance. The time element in these credit operations
is in abeyance, or at the best, it is an indeterminate
magnitude. Hence the formula shown above (p. 95,
n. 3) is practically not applicable to business of
this class. So far as bears upon the credit opera-
tions involved in these transactions of the large
finance, the question about which interest turns is
almost exclusively the volume of the turnover ; its
velocity is a negligible quantity.

Such strategic use of credit is not confined to
the business of making or marring industrial coali-
tions. It is habitually to be met with in connec-
tion with stock (and produce) speculation, and
ramifications of the like use of credit run through
the dealings of the business community at large in
many directions; but it rarely attains the magni-
tude in the service of stock speculation which it
reaches in the campaign incident to a trust-making
deal. The form of credit extension employed in
these transactions with indeterminate time also
varies. The older and more familiar form is that
of the call loan, together with the stock exchange
transactions for which call loans are largely used.
Here the time element is present, especially in
form; but the credit period is somewhat indeter-

124 THE THEORY OF BUSINESS ENTERPRISE

minate, as is also the gain that accrues to the
creditor from the transaction; although the cred-
itor’s gain here continues to be counted at a (vari-
able) rate per cent. per time-unit. The strategic
use of credit in the affairs of the large business
finance has much in common with the call loan.
Indeed, the call loan in set form is often resorted
to as a valuable auxiliary recourse, although the
larger arrangements for financing such a campaign
of business strategy are not usually put in the form
of a call loan. The arrangement between the pro-
moter and the financial agent is commonly based
on a less specific stipulation as to collateral, and
the payment for credit obtained takes even less, if
any, account of the length of the credit period.
In financing a campaign of coalition the credit
house that acts as financial agent assumes, in effect,
an even less determinate credit responsibility.
Here, too, the gains accruing to the creditor are
no longer, even nominally, counted per cent. per
time-unit, but rather in the form of a bonus based
mainly on the volume of the turnover, with some
variable degree of regard to other circumstances.

Answering to the essentially timeless character
of the gains accruing to the financial agent, the
earnings of the promoter engaged in transactions
of this class are also not of the nature of profits
per cent. per time-unit, but rather a bonus which
commonly falls immediately into the shape of a

THE USE OF LOAN CREDIT 25

share in the capitalization of the newly organized
concern. Much of the increment of capital, or
capitalization, that goes to the promoter is scarcely
distinguishable from an increase of the liabilities of
the new corporation (e.g. preferred stock); and
the remainder (e.g. common stock) has also some
of the characteristics of a credit instrument. It is
worth noting that the cost of reorganization, includ-
ing the bonus of the promoter and the financial
agent, is, in the common run of cases, added to the
capitalization ; that is to say, as near as this class
of transactions may be spoken of in terms borrowed
from the old-fashioned business terminology, what
answers to the “interest”? due the creditor on the
credit extension involved is incorporated in the
“ capital” of the debtor, without circumlocution or
faltering."

The line between credit and capital, or between
debt and property, in the values handled through-
out these strategic operations of coalition, remains
somewhat uncertain. Indeed, the old-fashioned
concepts of “debt” and “property,” or “ liabili-
ties” and “assets,” are not fairly applicable to the
facts of the case — except, of course, in the way of
a technical legal distinction. The old-fashioned law
and legal presumptions and the new-fashioned facts

1 Report of the Industrial Commission, vol. I, (Testimony of W. H.
Moore) pp. 960-963, (W. E. Reis) p. 949, (Gates) p. 1032; vol. IX.
(T. L. Greene) p. 491; vol. XIII. p. viii, with corresponding testi-
mony. See also Chapter VI. below.

126 THE THEORY OF BUSINESS ENTERPRISE

and usages are parting company, at this point as
well as at some others in the affairs of modern
business.

When such a large transaction in the reorganiza-
tion of industrial concerns has been completed, the
values left in the hands of the former owners of
the concerns merged in the new coalition are only
to a fractional and uncertain extent of the nature
of material goods. They are in large part deben-
tures, and much of the remainder is of a doubtful
character. A large proportion of the nominal
collective capital resulting in such cases is made
up of the capitalized good-will of the concerns
merged.’ This good-will is chiefly a capitalization
of the differential advantages possessed by the
several concerns as competitors in business, and is
for the most part of no use for other than competi-
tive business ends. It has for the most part no
ageregate industrial effect. The differential advan-
tages possessed by business concerns as competitors
disappear when the competitors are merged, in the
degree in which they cease to compete with rival
bidders for the same range of business. To this
aggregate defunct good-will of the consolidated
concerns (which in the nature of things can make
only an imaginary aggregate) is added something

1 Report of the Industrial Commission, vol. 1. (Testimony of Dodd)
pp. 1054-1055, 1057, 1058-1059, (Gates) pp. 1021-1022; vol. XIII.
p. 1x, with testimony.

THE USE OF LOAN CREDIT Lt

in the way of an increment of good-will belonging
to the new corporation as such;' and the whole
is then represented, approximately, by the common
stock issued. The nominal capital of the concerns
merged (in good part based on capitalized good-
will) is aggregated, after an appraisement which
commonly equalizes the proportion of each by
increasing the nominal shares of all. This agere-
gate is covered with common and preferred stock,
chiefly preferred, which is a class of debentures
issued under the form of capital. The stock, com-
mon and preferred, goes to the owners of the con-
cerns merged, and to the promoter and the financial
agent, as indicated above. In case bonds are
issued, these likewise go to the former owners, in
so far as they do not replace outstanding liabilities
of the concerns merged.

“Capital” in the enlightened modern business
usage means “capitalized presumptive earning-
capacity,’ and in this capitalization is comprised
the usufruct of whatever credit extension the
given business concern’s industrial equipment and
good-will will support.” By consequence the ef-
fectual capitalization (shown by the market quota-
tions) as contrasted with the nominal capital
(shown by the par value of the stock of all de-

1 Report of the Industrial Commission, vol. I. (Testimony of Dos
Passos) p. 1170; vol. XIII. (C. R. Flint) p. 48. Testimony to the
same effect recurs elsewhere in the Report. See p. 126, n. 1 above.

2 See Chapter VI. below.

128 THE THEORY OF BUSINESS ENTERPRISE

scriptions) fluctuates with the fluctuations of the
prevalent presumption as to the solvency and
earning-capacity of the concern and the good faith
of its governing board.

When the modern captain of industry reorgan-
izes and consolidates a given range of industrial
business concerns, therefore, and gives them a
collective form and name as an up-to-date corpora-
tion, the completed operation presents, in synco-
pated form and within a negligible lapse of time,
all that intricate process of cumulative augmenta-
tion of business capital through the use of credit
which otherwise may come gradually in the course
of business competition. At the same time it in-
volves a redistribution of the ownership of the
property engaged in industry, such as otherwise
occurs at a period of liquidation. The result is,
of course, not the same at all points, but the
equivalence between the two methods of expanding
business capital and distributing the gains is close
in some respects. The resemblances and the dif-
ferences between the two processes, so far as relates
to credit, are worth noticing. The trust-maker is
in some respects a surrogate for a commercial
crisis.

When credit extension is used competitively in
the old-fashioned way for increasing the business
of competing concerns, as spoken of above (pp. 94-
100, 109-114), the expansion of business capital

THE USE OF LOAN CREDIT 129

through credit operations occupies a period of some
duration, commonly running over an interval recog-
nized as a period of speculative advance or “rising
prosperity.” The expansion of capitalized values
then takes place more or less gradually through a
competitive enhancement of the prices of industrial
equipment and the like. The creditors then com-
monly come in for their resulting share in the
industrial equipment only at the period of liquida-
tion, with its attendant shrinkage of values. In
the timeless credit transactions involved in the
modern reorganizations of industrial business, on
the other hand, the creditors’ claim takes effect
without an appreciable lapse of time, a liquidation,
or a shrinkage of values.

The whole process of credit extension, augmen-
tation of business capital, and distribution of pro-
ceeds is reduced to a very simple form. ‘The credit
extension is effected in two main forms: (a) the
“financing”’ undertaken by the credit house in
conjunction with the promoter, and (b) the issu-
ance of debentures. The bonus of the financing
house and promoter, as well as the debentures,
are all included in the recapitalization, together
with an increment of good-will and any other
incidental items of expense or presumptive gain.
The resulting collective capitalization (assets and
liabilities) is then distributed to the several parties
concerned in the transaction. The outcome, so far

30 THE THEORY OF BUSINESS ENTERPRISE

as touches the present argument, bemg that when
the operation is completed the ownership of the
recapitalized industrial equipment, with whatever
other property is involved, appears distributed
between the former owners, the promoter, and the
credit house which financed the operation. But,
by virtue of the debentures distributed, the former
owners, together with the other parties named,
appear in the rdle of creditors of the new corpora-
tion as well as owners of it; they commonly come
out of the transaction with large holdings of pre-
ferred stock or similar debentures at the same
time that they hold the common stock. The
preferred stock, of course, is presently disposed of
by the large holders to outside parties. The ma-
terial equipment is then practically the same as
it was before; the business capital has been aug-
mented to comprise such proportion of the good-
will of the several concerns incorporated as had
not previously been capitalized and hypothecated,
together with the good-will imputed to the new
corporation and such debentures as these items of
wealth will float.

The effective capitalization resulting is, of course,
indicated by the market quotations of the securi-
ties issued rather than by their face value. The
value of the corporation’s business capital so indi-
cated need suffer no permanent shrinkage ; it will
suffer none if the monopoly advantage (good-will)

THE USE OF LOAN CREDIT 131

of the new corporation is sufficient to keep its
earning-capacity up to the rate on which the
capitalization is based.

It appears, then, that in the affairs of latter-
day business, as shown by modern corporation
finance, capital and credit extension are not al-
ways distinguishable in fact, nor does there appear
to be a decisive business reason why they should
be distinguished. “Capital” means “ capitalized
putative earning-capacity,” expressed in terms of
value, and this capitalization comprises the use of
all feasible credit extension. The business capital
of a modern corporation is a magnitude that fluc-
tuates from day to day; and in the quotations of
its debentures the magnitude of its credit extension
also fluctuates from day to day with the course of
the market. The precise pecuniary magnitude of
the business community’s invested wealth, as well
as the aggregate amount of the community’s in-
debtedness, depends from hour to hour on the
quotations of the stock exchange ; and it rarely
happens that it remains nearly the same in the
ageregate from one week’s end to the next. Both
capital and credit, therefore, vary from hour to
‘hour and, within narrow limits, from place to
place. The magnitude and fluctuations of business
capital, —“ capital” in the sense in which that
term is used in business affairs, — of course, stand
in no hard and fast relation to the material magni-

132 THE THEORY OF. BUSINESS ENTERPRISE

tude of the industrial equipment; nor do variations
in the magnitude of the business capital reflect
variations in the magnitude or the efficiency of
the industrial equipment in any but the loosest
and most indecisive manner. So also, and for the
same reason, the magnitude and the variations of
the aggregate credit afloat at a given time bear,
at the most, but a remote, indirect, and shifty
relation to the aggregate of material wealth and
the material changes to which this wealth is subject.
All this applies with peculiar cogency wherever and
in so far as industry and business are carried on
by modern expedients and in due contact with
the market.