Thorstein Veblen
CREDIT AND PRICES

The Journal of Political Economy, Vol. 13, No. 3. (Jun., 1905), pp. 460-472.
---------------------------------------------------------------------------------

At its last meeting (1904) the American Economic Association gave up one session 
to a discussion of the relation between credit and prices. The point of the 
discussion was, in substance, the question Does the use of credit raise general 
prices? This was the only strictly theoretical topic taken up at the meeting. It 
is perhaps needless to say that the question was not finally disposed of, even 
in the apprehension of those who took part in its discussion. There was apparent 
a general reluctance to admit that credit is a price-making factor of 
considerable importance, at the same time that there seemed to prevail an 
apprehensive hesitancy about saying so in so many words. This is true. only with 
exceptions, however. On the whole, there may be said to have been a rough 
consensus to the effect that credit does not have much to do with prices in 
ordinary times and in the general run of business, however opinions may differ 
as to its effect on prices in exceptional circumstances. It should be added that 
the discussion at the meeting was directed mainly, or almost wholly, to those 
forms [461] of credit instruments which serve as currency or as a substitute for 
currency.
It is, of course, not intended here to offer an off-hand solution of this large 
question of credit and prices, but certain phases of the use of credit in modern 
business, neglected in the arguments of the association's experts, may well be 
taken up. What is of immediate interest to modern theory is, of course, the 
current use of credit in business, and the relation of this business credit to 
the current price-level. rather than the occasional resort of credit under 
relatively primitive circumstances. Credit is an expedient of business, and as 
such it is unquestionably a factor of great importance. The price-level is 
similarly a fact upon which the business community's hopes and fears center. If 
one looks to the field of business, sun ply, and neglects to go behind the 
immediate facts of business traffic to those of die industrial process and the 
output of consumable goods, certain commonplace facts bearing on credit stand 
out in relief - obvious facts which have commonly been overlooked, perhaps 
because they are too obvious to be seen except with the naked eye. These are 
such facts as the following: The issuance of a large government loan advances 
the general rate of discount and depresses the price of investment securities; 
Business men resort to credit for the sake of gain, the gain being counted in 
money values; The securities covering the capitalization of a modern corporation 
commonly have a larger aggregate market value than the underlying tangible 
assets have before the incorporation Banking is profitable, also in terms of 
money values; Prosperous times are attended with a large extension of credit as 
well as an advance in general prices Crises and depression bring a shrinkage of 
credit and a decline of general prices.
From these and other phenomena of the same commonplace character the rough 
generalization may he drawn that an advance of prices commonly accompanies a 
pronounced expansion of credit. It is not plain from these facts which of the 
two correlated phenomena is cause and which is effect, but the great generality 
with which they are found in company indicates that they stand in a causal 
relation to one another, possibly as being the effects of the same causes. There 
is nothing in these general facts to preclude the view that they are mutually 
related as cause and effect. That a pronounced advance in prices results in an 
increased extension of credit seems plain from what happens during a period of 
prosperity, or speculative advance. [462] The circumstantial evidence runs to 
that effect, at the same time that such a result is to be expected from the 
nature of die case. Notoriously, a period of advancing prosperity is a period of 
relatively high prices, at least in some of the important branches of industry, 
and usually it is also a period of advancing prices. Extensions of credit, of 
course, run in terms of money, and are based on the money value (price) of the 
property submitted as collateral. If this market value of the collateral 
advances, then the amount of the credit which it will support will likewise 
increase. The market value of the collateral may increase immediately, as an 
incident of the advance of general prices; or it may increase through the 
increased earning capacity of the business property submitted as collateral, 
this increased earning capacity being in part due to the increased price at 
which the output of the business can be disposed of, in part, perhaps to the
increased volume of output which the market will carry off. In the latter case,
the increased demand for the output is, at least in part, a consequence of the
high course of general prices. In the case of crisis or pronounced depression
all this chain of consequences is reversed. Such seems to be the rough and
general run of correlation between credit and prices as conditioned by the
circumstances of prosperity or depression. A closer analysis would show
variations of detail under this general rule, and would afford material for
detailed study.
The general statement which these facts seem to warrant is that in this 
connection an advance or decline of general prices brings an expansion or 
retrenchment of credit. Further attention to the same range of facts seems to 
warrant the further generalization that an expansion of credit in periods of 
prosperity, at the same time, causes an advance of general prices; while a 
general retrenchment of credit, such as occurs in time of crises or acute 
depression, acts to lower general prices. This point has been noted by nearly 
all writers on crises and inflation, and no argument need be spent in enforcing 
it. The manner in which it works has also been analyzed repeatedly. Movements of 
general credit and general prices have apparently a mutual accelerating effect 
upon one another, both in case of advance and in case of decline, giving rise to 
the well-known cumulative process of expansion or of contraction that marks a 
period of prosperity or of crisis or depression. In practice this cumulative 
movement of credit and prices is more or less disguised and disturbed by certain 
(secondary) phenomena, such as the issuance of large loans, particularly 
government loans; extensive incorporation of new companies [463] and 
consolidation of old ones, with the attendant recapitalization of the various 
items of wealth involved in these operations; the promotion or - in the case of 
depression or crisis - the collapse of extra-hazardous, speculative business 
enterprises, etc. These "disturbing causes" would have to be taken up 
separately. It will probably be admitted that the cumulative movement of credit 
and prices spoken of has substantially the character assigned it above.
Among the phenomena that usually accompany a period of marked prosperity, and 
closely related to the expansion of credit during such a period, is a large 
volume of new capitalization in the form of new incorporations or expansions and 
coalitions of corporations already in existence. The issuance of corporation 
securities is a credit transaction, in the sense in which economists have been 
accustomed to use the word. Indeed, the sale of such securities involves the 
typical form of credit, as contemplated by the older economists, in that its 
immediate effect is to transfer the use of the property which it covers from the 
owner to the debtor, who is presumed to be a more competent it user than the 
owner. All this applies perhaps more patently to the sale of preferred stock and 
bonds than to that of common stock, but for the present purpose there seems to 
be no very substantial difference between these different descriptions of 
securities. It is currently believed, probably on sufficient grounds, that the 
corporations can make more profitable use of the property than the buyers of the 
securities, particularly a more profitable use than the buyers could make of it 
without spending additional time and attention in the management of the 
property. It is this presumed differential advantage in favor of the 
corporations that makes incorporation practicable on any appreciable scale. 
Except for the presumed advantage in gainfulness, it is safe to say, the 
organization of joint-stock companies would not have become a general practice. 
This presumed greater earning capacity of the corporations, above the earning 
capacity of the properties in severalty, may be due to economies of production, 
superior management, economies of sale, or what not. For the present argument it 
is only necessary to note that the corporations are presumed to have a greater 
earning capacity than their underlying properties, and that this presumption 
shows itself in the market value of the corporations' securities. This market 
value of the securities is commonly larger in the aggregate than the aggregate 
value of the underlying properties. [464] That is to say, the credit transaction 
which results in the organization of a corporation and an attendant issue of 
marketable securities commonly increases the aggregate price of the property 
involved. It is not unusual, latterly, to incorporate a business concern at a 
nominal capitalization of about 200 per cent. of the current market value of the 
underlying properties; the resulting securities will sell below par; but in the 
case of an ordinarily sound and sagacious incorporation the total capitalization 
will still have a market value of something more than 100 per cent. of the value 
of the underlying properties.
In this ease, then, a credit transaction raises the price of the property 
immediately involved. Whether and how it affects the prices of other items of 
wealth is a question not easily 
answered. If the advantages of incorporation are in all cases differential 
advantages only, then the presumption would be that the prices of other property 
engaged in similar lines of business should be depressed in consequence of the 
incorporation. It does not seem probable that the depression in the prices of 
similar property outside of the given corporation, if such a depression results 
at all, is sufficient to balance the increase in the price of the assets of the 
corporation. In case the given incorporation results in a monopoly, a more or 
less extensive enhancement of prices may be expected to follow in its marketable 
output of goods or services, apparently without any necessary countervailing 
effect upon the prices of other goods. Price changes of this latter class, 
however, will probably be regarded as the effects of monopoly rather than of the 
credit transactions which initiate the monopoly. They need therefore not be 
discussed here. They could properly be discussed here only in so far as credit 
relations are to be accounted a necessary basis of any efficient monopoly. Under 
existing conditions this is probably the case, but the relation between the 
credit relations which enable monopolies to be organized and to operate and the 
resulting effect on prices is, after all, so remote that an analysis of its 
consequences would take the present argument out of its way.
Again, the issuance of a very considerable loan, such as a war loan of the 
larger sort, is known to lower the general market value (prices) of securities 
with a fixed interest or dividend charge. At such a juncture, because of the 
large demand for credit, general interest advances, and the general level of 
capitalization correspondingly declines that is to say, the market value of 
incorporated business declines, while the "price of money" advances. The prices 
of [465] such lines of goods as are to be bought with the borrowed funds are 
likely to advance, and this may induce an advance in such capital as is 
concerned with the supply of these goods, but all that is an indirect 
consequence of the credit transaction rather than an immediate effect of it.(1*)
The phenomena spoken of so far are of the class which the older economists would 
call "disturbances," rather than developments in the normal course of business. 
What happens in the case of such disturbances need not be taken as evidence of 
the effect of credit upon prices in the regular course of business in ordinary 
times, where no such perturbations occur, or apart from all perturbations of 
this kind. in the regular course of business there is, no doubt, a larger 
aggregate volume of credit, proportionately either to the stock of specie or to 
the aggregate amount of tangible wealth owned in the community, in use at 
present and in this country than here formerly or now anywhere else. Will 
general prices range higher or lower because of such a more extended use of 
credit? Does the more extended and the increasing use of credit during the past 
thirty or forty years affect the general course of prices during the same 
period? This question has been argued by comparing the state of things at 
present with the corresponding facts of a generation ago, but without conclusive 
results. No canvass of the statistical material bearing on the case can directly 
reach a solution of the question, because the variables included in the problem 
are too many and too unprecise. On the other hand, something in the way of 
tenable general conclusions may probably be arrived at through an examination of 
the aims which actuate borrowers and lenders, and of the method by which the 
work of credit extension is carried on, although such a line of inquiry can not 
be expected to yield anything like precise results.
As has just been noted, the credit transaction known as the floating of 
corporation securities results in an increased market value of [466] the 
aggregate properties involved. This increased market value is more or less 
permanent, somewhat in proportion as the capitalization is more or less 
"conservative." At the same time, it is one of the reasons for the promoting of 
new corporations. The promoter's bonus, with other like charges and perquisites, 
comes out of the margin of increase in price. The incentive to credit extensions 
of this kind is a prospective gain in terms of price, and in this class of 
transactions the business man's hope of gain is at least not commonly 
disappointed, even if the permanent increase of the values which lie manipulates 
may not be as large as his anticipations.
In other credit transactions which differ from the floating of new companies in 
that they do not materialize in the form of corporation securities, but which 
are of the same kind in that the borrowed funds are made to serve the conduct of 
business, the end sought is of the same kind - a gain in terms of price. This 
gain may appear primarily as an increase in the market value of the property in 
which the borrowed funds are invested, as in the case of a real-estate 
speculation and the like; or it may appear only as a secondary effect, as an 
increase in the aggregate value of the output of an industry in which the funds 
are invested. The presumption would be that in this case also the hope of gain 
is not altogether disappointed. But even if the business man's hopes of gain 
could be shown to be false in the average of cases of this class of loans, it 
would not follow that credit transactions of this class initiate no enhancement 
of prices.
Loans of the kind just spoken of, procured with a view to investing the borrowed 
funds in a somewhat fixed form in business, have the direct effect of enhancing 
the market value of the general description of property in which they seek 
investment. The borrowers bid up the kind of property which they seek to buy. 
Whether there is a countervailing decline in the general prices of other 
property is doubtful and may be left on one side for the present, particularly 
as the argument of the next few pages approaches that question from another 
side.
In the ordinary conduct of business there is an extensive and increasing resort 
to credit in the way of loans, extended by banks in the form of deposits and by 
other credit institutions, such as trust companies, insurance companies, and the 
like, without their taking the form of deposits. In general, but more 
particularly where such a loan takes the form of a deposit, these extensions of 
credit would, by [467] economists who hold that normal credit does not affect 
prices, be considered to be an expedient for facilitating an exchange of goods. 
The goods which serve as collateral for the loan, it is held, are by a more or 
less roundabout process of accounting exchanged for the goods paid for out of 
the deposits. This is in substance the theory which has felicitously been named 
"the refined system of barter." As bearing on the question of credit and prices, 
this doctrine declares that such loans do not affect prices, because the 
borrowed funds are nothing but the fluent form of the value of the underlying 
collateral. The loan and the collateral are held to offset one another as demand 
and supply, the loan adding no more to the demand side - the effective 
purchasing power seeking goods than the collateral adds to the supply side of
the market situation - the effective offering of goods seeking sale. Hence, it
is held, no enhancement of price can arise from such loans, the increase of
funds offered in purchase being no greater than the underlying increase of
goods offered for sale.
A singular query presents itself at this point. Not only is it true that the 
funds procured by loans of this kind, in a case of "normal" credit extension, 
are no larger than the value of the underlying collateral, but in the ordinary 
run of things the loan is not as large as the value of the collateral. No banker 
would be held blameless if he should extend his loans to the full ascertained 
value of the collateral. If the argument of the " refined system" is sound, will 
it not lead to the conclusion that credit extensions of this class lower general 
prices,  since it should follow that the increase of the market demand due to 
the borrowed funds is overbalanced by the increase in the supply of goods 
represented by the collateral? The answer to the question comes into sight, if 
this argument is pursued a step farther.
The argument for "the refined system of barter" assumes that the collateral is 
of the nature of a bill of sale. It appears to break down immediately in so far 
as the collateral is not of this character, fit consists of property not sold or 
not designed presently to be sold; as, e. g., where the collateral is 
corporation securities or paper similar to corporation securities in the respect 
that it represents property which the borrower has not sold and is not trying to 
sell, but which is held as security during the term of the loan. The doctrine 
seems tenable only in so far as the collateral is of the nature of a bill of 
sale. A good share of current deposits and the greater part of other current 
loans are not of this character, The borrower's resort to credit in these cases 
is not an incident in the sale of the collateral. The pre-[468]sumption, indeed, 
is that he does riot wish to sell. But it is safe to say that he ordinarily 
wishes to buy, whether it be goods, securities, or what not. Here the balance 
which is sought to be established between goods sold and goods bought, in the 
doctrine of "the refined system of barter," is upset by the fact that property 
not sold and not designed to be sold is made a basis of credit extension. The 
(discounted) value of this collateral enters the market as a factor in the 
demand for goods. If the determination of price is conceived in the customary 
way to be an outcome of the play of demand and supply, it appears that these 
considerations force the admission that general prices should advance as a 
result of these credit extensions. The general demand has been increased by 
"coining into means of payment" property which is not included in the general 
supply. It appears that, in so far as it is of this character as it is to a very 
large extent, credit should raise prices.
The objection is ready, indeed it has in substance been made by those who speak 
for the view under discussion, that in the end the borrower must sell something 
or other in order to meet obligations falling due, and that in this way the 
balance is maintained and the transaction reduces itself to a virtual barter. 
All of which may conceivably be true as applies to a given transaction, although 
it is not unusual for such a transaction to be followed immediately on the 
maturity of the loan by another like transaction which virtually continues the 
life of the original loan. But this line of defense overlooks the time element, 
which is of the essence of any credit transaction. During the credit period the 
balance between demand and supply is not maintained, supposing the argument of 
the "refined system" to be otherwise sound. And from this it follows that the 
balance between general demand and general supply (conceiving supply in terms of 
goods) fails, constantly and in the nature of things, by the whole amount of 
outstanding credit obligations, after deducting such loans as have been sunk in 
the purchase of industrial equipment or have otherwise been withdrawn from the 
active market as a means of payment - indeed, it may even be an open question 
whether this deduction should be made, or just what force should be assigned to 
this qualification. Evidently this argument applies to the whole mass of 
outstanding credit, whatever the nature of the collateral. During their term the 
loans secured by ordinary commercial paper constitute an addition to the means 
of purchase as well as those loans that are secured by property not intended for 
sale.(2*)
[469] Accordingly, such portion of the outstanding mass of credit as is 
available as a means of purchase must be taken to constitute an effective price-
making demand and to have a force, as a price-making factor, equal to that of a 
like amount of hard cash used as currency. The rest of the credit outstanding at 
any given time, not available as a means of payment, is, perhaps, larger than 
this that may be called the mass of active credit, and if this "dormant" credit 
be deducted it appears that what is left as an active price-making factor is an 
indeterminate fraction of the whole. The secondary price-making effects of the 
loans sunk in investment are here disregarded; they seem, on the whole, to go in 
the direction of an enhancement of general prices, but they are complex and 
variable, and cannot be taken account of here except as a factor for which an 
indefinite allowance is to be made. It remains true that the mass of active 
credit, which senses as a current means of payment and so immediately affects 
prices, is a function of the whole mass of credit out standing.
Now, when the mass of outstanding credit shrinks appreciably, as in a period of 
depression or crisis, the shrinkage ordinarily affects the credit available for 
current means of payment first or primarily. The consequence is a shrinkage of 
prices, both of goods in the open market, actively seeking a purchaser, and 
(secondarily) of the prices of the industrial equipment and similar items of 
property not intended for direct sale. Herewith the value of the collateral 
shrinks, forcing a reduction of outstanding loans, leading to a sale of 
collateral and so to an increased supply of things for sale, at the same time 
that the effective demand has been reduced by a shrinkage of the credit 
extensions used as a means of purchase.
In the doctrines of the classical economists, who at this point have not been 
superseded, the phenomena of credit are formulated in terms of their presumed 
social expediency. The actual motives and aims which animate those business men 
who seek credit, as well as those who carry on the traffic in credit - bankers, 
brokers, etc. - are disregarded, and in the stead of these business motives the 
presumed beneficial results of the traffic are imputed to these business men as 
the motives of their traffic. Perhaps for this reason the question of the 
banker's gain and its relation to credit and prices is commonly not broached in 
the received doctrines of credit and prices. Without the prospective gain the 
banker would not do business. So the question [470] suggests itself: Why is 
banking profitable? And what, if any, relation is there between prices and the 
profits of banking?
Broadly speaking, banking is profitable chiefly because the banker lends more 
than he has or borrows. This is his chief, though not his only, source of gain. 
His gains are derived from payments for two distinct kinds of service which he 
renders his customers. The two are currently not distinguished, the remuneration 
for both being indiscriminately spoken of as discount or interest, but for the 
present purpose a distinction seems desirable. (a) Banks discount commercial 
paper, and (b) banks and other concerns doing a credit business make loans on 
collateral which is not of the nature of a bill of sale.
(a) In discounting commercial paper the banker does not create credit or 
increase the volume of outstanding credit obligations. In substance he 
guarantees or authenticates the credit extension already created by the writing 
of the commercial paper which he discounts. A bill of sale for future payment is 
a credit instrument, and the extension of credit involved in its use is effected 
in the sale for future payment which it covers. The volume of credit so covered 
by the bill of sale is by the banker's authentication converted into a form 
available for circulation. In substance, he insures and authenticates it, and 
for this service he is paid in the discount of the bill. The form of the 
transaction gives the appearance of no increased demand for goods, since the 
volume of credit, and so the volume of money values available for purchase, has 
not been increased by the banker's intervention, This gives color to the claim 
that in this transaction there is no addition to the available purchasing power, 
and therefore no effect on prices; but this color is due to oversight of the 
fact that the bill itself is an instrument which covers an extension of credit 
already effected. It is an open question whether the banker's intervention in 
such a case, as authenticator of an existing volume of credit, is to be 
conceived as increasing the effective demand for goods. But a negative answer to 
this question is only an evasion. If the increase of available credit in such a 
case is not made by the banker, it is made by the makers of the bill. The net 
result is much the same.
(b) In making a loan on collateral which is not of the nature of a bill of sale, 
but represents property not intended to be sold, the banker, or any similar 
concern doing a credit business of this kind, creates a new volume of credit. 
The remuneration for this service also is called interest or discount, Such a 
transaction creates credit, and so adds to the borrower's funds available for 
purchase, and there-[471]fore increases the effective demand for goods, and by 
so doing helps to enhance prices. In such a transaction the banker lends funds 
which he does not possess. He is enabled to lend more in the aggregate than the 
whole of the funds which seek emplacement in loans through his agency. Or, to 
phrase it differently, he coins into means of payment goods which do not change 
hands in the resulting transactions of purchase and sale. Hence borrowers are 
enabled to borrow more in the aggregate than all the funds which the ultimate 
lenders have to dispose of - more than the whole of the funds seeking investment 
as loans plus that collateral which represents property sold or seeking sale. 
The purchasing power placed at the disposal of debtors is larger because of the 
banker's mediation than it would be without it.(3*)
From this augmented purchasing power the banker deducts his remuneration as a 
discount. This discount is not withdrawn from the aggregate loan fund. It serves 
the same purpose as any other item of banker's assets, and enables him to lend 
more than the whole of it, or, if the wording be preferred, it enables him to 
make advances on collateral exceeding its own amount.
The banker's debtors, of course, negotiate their loans with a view to using the 
funds as a means of payment. The funds have no other use, except further 
lending, as in the hands of borrowing bankers. Hence, other things equal, it 
should follow that bank credit acts to raise prices by as much as it increases 
the nominal purchasing power in the hands of the business community. When the 
funds so secured by unmarketed collateral have been spent in the purchase of 
goods, the goods so purchased may in their turn be hypothecated in the 
negotiation of a further loan; with the result that there is a further 
augmentation of the volume of credit, a further increase of the effective demand 
for goods, and a further effect on prices. The whole movement may therefore take 
on a cumulative character, as it does in a marked degree in a period of 
prosperity, or speculative advance. Something of this cumulative character there 
no doubt is in the credit situation at any given time during ordinary times.
For some time past the mass of outstanding credit has been [472] growing 
gradually larger, on the whole, and the effect of this movement should logically 
have been to advance general prices in a corresponding degree. The enhancement 
of general prices due to this cause has apparently been offset by cheapened 
production of goods, due to technological improvements. How far this 
countervailing effect of cheapened production has neutralized, or more than 
neutralized, the enhancement due to credit cannot be considered here. The volume 
of goods seeking a market has also greatly increased during the same period, and 
this should also have a countervailing effect. It should mask or offset the 
enhancement of prices due to an increased resort to credit, but this is also a 
matter that does not belong here So also the relation of credit, as a price-
making factor, to the production of the precious metals is no doubt a matter of 
some consequence in this connection, but that, too, is question of detail that 
requires treatment by itself.
THORSTEIN VEBLEN.
THE UNIVERSITY OF CHICAGO.

NOTES:
1) This phenomenon of an equilibration between the rate of discount and the 
market value of securities is one of the most characteristic and indicative 
features of the modern business  situation. An exhaustive study of it may be 
expected to result in a revision of the received views of credit, capital, 
interest, and prices, and of the interdependence of these several phenomena; but 
it is out of the question to pursue an inquiry of that magnitude here. It seems 
evident, however, that a fuller inquiry along that line should confirm the view 
here spoken for, that general credit and prices are intimately bound together in 
a relation of mutual cause and effect.
2) Cf. also pp. 37-39 below.
3) It may be that a closer analysis would show that the banker's service to his 
customers is also in this case, as in case (a), that of guarantor or 
authenticator of their credit and that his remuneration in the discount obtained 
is of the nature of a payment for responsibility assumed. If this view be taken, 
the form of the argument changes, but its bearing on the question in hand is not 
materially changed.
--- End ---