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The Control of Credit

on Monday, 01 March 1954. Posted in Banks

The Overdraft — The Line of Credit

Mr. Johnson is a furniture dealer. He buys from the manufacturer. He sells to householders.

Only from his sales can Mr. Johnson get cash to pay the manufacturer. But pieces of furniture may hang for months in his store before finding a buyer. The manufacturer, having to pay his employees every week, cannot wait that long for his money. He presses the merchant to pay.

What is the solution for Mr. Johnson? His case has been eased by his local banker, just as the manufacturer's case is also eased to a certain degree by his own banker. The method used by the bank to help Johnson is the "overdraft”.

Mr. Johnson is allowed, within a specified limit, to effect his payments by overdrawing his account with the bank. This means that he can write cheques without sufficient funds in his bank account, and these cheques will be honoured by his bank. With the obvious understanding that, when he sells furniture, Mr. Johnson will deposit the net proceeds at the bank, to move the balance towards the credit side, or at least lighten the weight of the debit side.

Mr. Johnson may have to meet a bill, let us say, of $500, and not have one cent on the credit side of his account; he may even be on the debit side for perhaps $200. He will nevertheless write a $500 cheque in favour of the manufacturer, Mr. Clark. The cheque is an order, drawn on Mr. Johnson's bank, to pay $500 to Mr. Clark.

What happens? Mr. Clark will likely deposit the cheque at his own bank, where it will go to his credit. Clark's bank will then send the cheque to Johnson's bank. The latter will debit Johnson's account by $500, raising his total debit to $700. Merely bookkeeping, carried on between the banks, with all other similar transactions, at a sort of clearing house.

At other times, Mr. Johnson, having realized some sales, will deposit money at his bank, lowering the amount of his debit.

The banker may have allowed Mr. Johnson a margin of $5,000. That is his “line of credit”. The balance of his account must never go beyond that figure on the debit side.

It is a form of automatic loans on needs and re-payment on possibilities, agreed between the banker and Mr. Johnson. Of course, the banker gets paid for this service. As on all loans, he charges interest, calculated according to the varying level of Mr. Johnson's debit balance.

Mr. Johnson has been warned to watch his account closely, to cut his expenses and press his sales whenever the debit rises dangerously towards the dead line. And Mr. Johnson, whose living depends on his business, is very careful, even to the point of being absorbed in his work for sixteen hours a day.

Mr. Johnson operates on "debt money”. But who does not? No expansion in commerce or industry has ever been possible without an expansion of financial credit. And, as our financial system goes, all expansion of credit is a debt to the banking system. In fact, repayment of the debt to the banks drains some financial credit from the community. The blood of our economic life is debt money.

However, one day, Mr. Johnson is requested to report at his banker's office for an "important communication". There he is notified that from now on, his line of credit is reduced to $1,000.

—“Can't be! exclaims Mr. Johnson. This means starving my business... But why this decision, Mr. Manager?"

-“I am sorry, Mr. Johnson; but these are binding instructions received from our head office.”

Within a few days, signs of worry are apparent not only on Johnson's, but on the faces of all the business men of the community. It is soon discovered that all have been similarly struck. A policy of “restriction of credit” has been decided by the banking system, and is being carried out by all banks and all their branches throughout the country.

Orders for goods have to be reduced, expenses cut. Employees are dismissed. Purchasing power drops rapidly. Anxiety, sufferings, ill-feeling, discontent, threatening agitation, set in and grow everywhere... And the economic experts solemnly describe a new "cyclic period in economic life, — a swing of the pendulum”!

Those who control money and credit, control the lifeblood of commerce and industry; they hold all economic life in the hollow of their hand. They are the real masters of our civilized world.

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