While on the one hand it is desirable to guard against the Seylla of stringency, on the other there is a Charybdis that is equally threatening, namely, overexpansion. Over-expansion is dangerous because it may lead to an inflation of prices, to an unproductive investment of capital and to a weakening of reserves to such an extent that the whole credit superstructure is undermined.

The acceptability of bank credit as a substitute for money depends upon its instant convertibility into money. As was previously shown, the preservation of confidence in this convertibility is contingent upon the maintenance of adequate cash reserves. The potency of any given sum of cash reserves depends obviously on the ratio of such cash to the total liabilities resting upon it. This ratio is usually expressed in rates per centum. When in any case the percentage of cash reserves held by a bank against its demand liabilities falls below the point at which the reserves suffice to guarantee the convertibility of the liabilities, the bank is said to be overextended. The same thing may be true of the community as a whole, that is to say, there may be a general overextension or overexpansion of credit.

Overexpansion involves also the question of the security lying behind credit. Cash reserves guarantee the immediate convertibility of credit, but its solidity as a whole depends upon the other assets besides cash upon which it is based. For demand liabilities these assets must be of the most liquid character, of a character, namely, that implies self-liquidation or that involves ready salability. Moreover, the underlying assets must be sound. The liquidation of the obligations payable to the bank as they mature from day to day, is essential to the preservation of the bank's own credit. Any extensive collapse of the underlying individual credit implies an almost inevitable breakdown of the superimposed bank credit. Where individual credit is buttressed by collateral security, the security must not only be readily salable but also salable at a price which will amply cover the credit extended. The process of extending credit by a bank involves, as a practical matter, making available for exchange purposes wealth yet to be produced or existing wealth offered as collateral. Hence there is always the possibility of extending more credit than is actually warranted by such wealth. Any excess must be made good. It may ultimately be made good by the debtor out of other assets, or it may be made good by the bank itself out of profits or out of capital and surplus, but in the first instance because of the immediate guarantee function of the reserves excessive extension of credit represents an additional burden on reserves.

Over-expansion must also be guarded against

The acceptability of credit depends upon convertibility

This depends upon cash reserves

Over-expansion involves also the question of security

One of the dangers involved in overexpansion, it was said above, is the inflation of prices. Professor Laughlin1 maintains that "normal" credit does not influence prices at all, but he, together with almost all other authorities, admits the stimulating effect of excessive, or what he calls "abnormal" credit. Convertible credit in the control of a prospective purchaser of goods would seem to be as potent as gold itself in affecting the demand for the goods purchased. By means of credit advances on certain goods as security, these goods are made the source of a demand for other goods. This demand, in the absence of credit, could not have arisen unless the goods acting as a security had first been sold, or unless they were offered in direct barter for the goods purchased. Similarly, the extension of credit without any security but based only on expected production in the future has the effect of adding the future wealth to the wealth which is the source of present demand. It is, of course, true that demand and supply, considered in the large, are simply obverse sides of the same thing, but it is also true that the "supply" here involved is not the potential but rather the active supply, namely, that which is directly involved in the process of exchanging. Wealth hidden or buried cannot be a source of demand for other wealth. When, however, wealth is bartered or sold, or when credit is extended on it, it becomes a source of demand. Hence any extension of credit tends to intensify demand for the goods to the purchase of which such credit is directed, and, unless there is a corresponding offset on the supply side, the normal outcome of the increased demand is an upward tilt in the price of the goods concerned. The effect on general prices will depend upon the volume of the new credit and upon how widely it is diffused. An instantaneous and uniform increase of prices all along the line, if such a thing were conceivable, would not seem to be a circumstance of particular importance. If all prices were exactly doubled and if all money incomes were similarly doubled it would apparently make little difference to anyone. But the difficulty in practice is that it is impossible to get an instantaneous and uniform price readjustment. Price readjustments come about only through involved changes in the buying and selling operations actually going on in society, and a change in the price of a single commodity carries with it, theoretically, not only a realignment of wants, but also a consequent reordering of the whole distribution of the social dividend. When credit is expanded the goods that increase in price are those which first feel the impact of the new credit demand. These goods are usually the commodities which, like stocks, wheat, cotton, etc., are dealt in on the organized speculative markets. Such markets are more directly and intimately connected with the money or credit market than are others, and changes in the credit situation are consequently first reflected there. Then, depending upon the strength of the original influence and upon the readjustments that are induced, the changes in price tend to be carried, like the concentric waves on the surface of the water, to the outermost margin of the interrelated economic interests.