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X-998 .. ..,. Release for morning papers of June 18. ADDRESS BmFORE TRADE ACCEPTANCE COUNCIL CHICAGO- JUNE 17, 1918. BY PAUL M. WARBURG. For at least three years after the automobile :r.."lde itrf npp"..:rs.~sthere still were men and women wr.o argued passionately that the people who used it were snobs and murderers, and that such machines should not be permitted on the public highways. The exponents of this view, at that time, were still dealing with the automobile r..s with a th~ory; they did not realize that, while they were debating, the automobile had already proven its worth, had been definitely adopted and had begun to gain an ever-growing importance in the economic life of all nationso I well remember that similar discussions took place concerning the Federal Reserve System during the first year or two of its operation. urging that it was an impossible system to old banking practices; an The men who eJ~:pressed expen~ive conc~iv3d People were still by theorists and doing violence luxury that might be dispensed with. these vie·ws did net reali?.e that, whi:}.e they were protest- ing, the system had driven its rc<lta sc firmly int'.) thEJ gro·..utd that it could no longer be removed. past as the backbo:m~ It is now recognized by even its severest critics of the of the bank:i.ng organization of the United States. A similar condition prevails at present with respect to the trade acceptance. It is at this time the subject of heated debate. Some consider it im- practicable and not suited for the use of American business men; others consider it dangerous and think it ought not to be encouraged or perhaps even permitted. But, as in the two cases just cited, while the trade acceptance is being discussed as a theory, it already had become a fact. The trade acceptance is here - it has proven its worth in thousands of cases, it has come to stay, and now that the first and roost difficult step in popularizing it has been tak6n, its general use will grow by leaps and bounds. X-998 - 2- In this di~cussion concerning the merits and demerits of the trade accept- ance, both sides, to my mind, have made the mistake of over-stating their case;: } The champions of i.he trade accep-~ance are not warranted in saying that it is the only proper instrument of credit, that it should . o:- will~ drive out rapidly all and the cash discount syete;.n, single name paper lthat to use H is the highEJst degree of patriotism and that to refrain from using it shows a lack of publlc spirit& On the other hand it is e1fU6.lly unwarranted to assert -thfl"t the l.!se of the trade acceptance by the busi- ' ness men and bankers i.n the UYJH8d States is :.l.;npracticable, or that ite adoption makes for bad and unsound business habi t.s • Why should anyone who sells goods for cash be expected to change his method and attempt to sell his goods on long lterm credit for the mere satisfaction of using trade acceptances, unless he finds that the cash discount which he offers, in order to avoid the granting of credi'l:,, is so heavy that · ~t would pay him better to make the change, or unless he finds that in particular cases he may render a public service by permitting his purchasers to pay by trade acceptances. While, therefore, we readily concede that it is fcolish to believe or to argue that the trade ac·::Gptance should be used in settlement of any and all business transactions, it is equally foolish to deny that hundreds of millions some estimate called "open billions of dollars - worth of goods are sold today on acco~mts", s~,; and wherever that is done there can be no vestige of doubt that it makes for better business methods when seller and purchaser agree upon a definite obligation to pay on a certain date and express this in a negotiable instrument, permitting the seller to finance himself on favorable terms for the period of the credit granted by him to the purchaser of his goode. The Trade Acceptance Council informs me that there are today over 4 •.('\00 firms that have adopted the trade acceptance, and the list of these firms embraces concerns of great importance as well as small houses. It includes the - 3 - X-998 flour mills of Oregon as well as the lumber mills in Florida. month two trades of During the last great importance have declared themselves in favor of using the 1:trade acceptance. The Raw Silk Trade Council passed a resolution that ''On and after July 1st, 1918 all raw silk, except for transactions based upon Bankers letter of credit or the dre.wing of foreign drafts direct upon the buyer, shall be sold, or contract of sa~e made with buyers, without any exception what~oever, upon terms of cash settl8ment, !=lrompt or within ten days, or trade acceptance, if other than cash terms are !'l.p..~eed upon. Such trade acceptances are to be given by the buyer to the sene·(" within not later than thirty days from date of invoice. All trade accepta~o~a shall be made payable at a bank, located p~efer ably at a free or discretionary point, otherwioe the cost of collection is to be charged to and paid by the acceptor". The buyer is not, however deprived of the privilege of offering cash less proportionate discount, at the rate of six per cent per annum, in settlement of an invoice calling for trade acceptance, but he must do either one or the other within thirty days from the date of the invoice rendered. This change of terms is made on the conviction that the adcption of the trade acceptance method of settlement will eventually work out to the benefit of both seller ~nd buyer. The circular sent out giving notice of this agreement is signed by thirtysix of the leading firms in the silk trades. A highly important action was taken on June 8th at a. meeting of a Commit.tee, appointed on May 4, by the National Association of Cotton Manufacturers, representing spinners, cotton shippers and bankers. the conference. Governor Harding was present at A resolution was unanimously adopted, recommending that in addition to present facilities, the bankers' acceptance and the trade acceptance - 4 • x-99S be used whenever practicable and as far as possible in financing sext season's cotton crop. These developments .speak f0r themselvesu Moreover it is of no small significance that other countries, whose financial methods (since the adoption of the Federal Reserve System) we are approaching more and more, are using th'3 t:rade acceptance almost exclusively,. inconceivable that in these cou':',+.ries the trado It is acceptance should so excellently serv-e its purposo i.f it. were really as devoid of merit as its critics assert. About two years ago I had the honor of addressing the Credit Men's Association at a meeting in New York u~-:lon the topic of the trade acceptance, and since then so much has been said about. the advantages in the use of that method of financing that it would be needlessly taxing your patience were I to undertake to demonstrate again to you that the trade acceptance, when properly used, turns .a frozen asset into a liquid one, and that the firm which organizes its business on the basis of the trade acceptance is plncji:lg itself in a very much stronger position than its competHor wb: refuses to moderni:te on the same lines. would be needless repetition W13re l to you are familiar. :t~eiterate It -the oth'3r arguments with which It may, however, be useful to analyze this question: Why is the adoption of the trade acceptance so vigorously opposed by some bankers and business men! Let us consider first the reasons given by the bankers: Some bankers assert that in buying 6 promissory note the mere fact that they are con- scious of buying the naked note of a customer furnishes a reason for their feeling obliged to carefully analyze the statement of the customer and to judge the merit of the borrower upon the statement of the latter's financial condition. X-998 - 5 .. They allege that this practice is safer than that of purchasing a trade acceptance issued by the ~rume firm because, as they say, in that case they are likely to rely on the legitimate character of this double name paper without examining as cautiously as they otherwise would the general condition of the borrower; the likelihood of their adopting they urge, might lead to the manufacture and sale ~f ·~bat course, fictitious accommoda- tion acceptances on the part of their borrowers, and they cite experience in support of their contentionQ Other banke!'s state with great force t.hat they are opposed to the trade acceptance because they would not feel justified in continuing to buy the single name paper of a borrower who has adopted the habit of selling his trade acceptances. The reason given for this view is that whoever buys a trade acceptance acquires the first lien on what would otherwise have ~epreeented one of the accounts receivable of the concern which drew the acceptance, and in addition to that lien, in case of bankruptcy of the drawer of the acceptance, the holder of that acceptance would rank equally ·with the unsecured noteholder as a general creditor acceptance which the acceptor might not have paid. fo~ any part of the As you can readily see, it is impossible that both of these opposed views should be correct; one banker asserting that he will not buy trade acceptances because he does not think they are safe enough, the other that he opposes the trade acceptance because it is so good as to render unsafe the purchase of X-998 - 6 - single name paper of any customers haviug sold trade acceptances. Which of the two arguments is sound? To my mind neither. It has never peen contended by the champions' of the trade acceptance that these acceptances should be bought by anyone who has not familiari:ea himself thoroughly with the financial condition of the maker ef the paper; he should take this precaution just as if he were buying a single name uote and as long as he does that there is no reason whatever why he should not be capable of judging solvency and standing from the statement of a borrower who sells the trade acceptances he receives just as he can today from the statement of a firm which borrows only on its own note. Indeed- one of the main virtues of the trade acoeptance is that it clarifies the statement, inasmuch as lt shows on the asset side exactly how much there is availa~le in liquid i~ems, amongst which are the trade acceptances owned, against outstanding liabilities. on his single name w~ld not~, funds If the b~rr~er wishes to obtai!/ ' in addit:lotl. to trade acceptances sold (which be shown as a contingent liability), he would have to satisfy the banker that these funds are required for temporary working capital or for the purchase of material used in the p~ocess of manufacturing; unless, indeed, the borrower were pawing for the pl.:rct.ases by giving his own trade acceptance. In the latter cas~ the trade acceptance would show as an obligation on the liability side. ·Thies leads us to the objection made by the banker who is unwilling to buy the single name note of a firm which sells trade acceptances. The canadian and European methods indicate, I believe, the proper answe~. In Canada and England and on the European continent it is quite customary for banks to grant a customer an overdraft credit. Such a 11 line" re-pre-:-:; X998 - 7 -· sents the sum on which the customer may count with fair regularity. I~ addition to that. the Canadian bank will buy freely the customer's trade acceptances, though of course within given limHs. Generally speaking, it may be said that if the customer be stroi"..g and solvent, and i f ho be considered fairly conservative in choos5.ng his purchasers, the bank w.'\.11 be found ready always to buy a handsome amount of tr-ade acceptances h1 addition to the regular overdraft granted, relying on the fact that even in case of insolvency on the part of the customer the larger percentage of these trade acceptanceswill usually be paid, the risk being so large- ly divided. When our ba~ks begin to look upon the trade acceptance from this, let us call it., llanad.ian point of view; I th~.nk thP-y may well conclude that it is perfectly proper and safe for them to buy a certain amount of single name paper (corresponding to the overdraft) and in addition to take a liberal amount of the customers' t~ade acceptances, provided they use care in scrutinizing the statement of the borrower. I believe many of them will be willing to admit that the f:.ag::.--ant cases cited by them of losses ofi fictitious trade acceptances were those 'lfuere the bankers neglected to ask for or to insist on getting the cust.omers' statement. It may be timely for me to add that sin~e the heg:O:.nnl.ng of the operatiJ7'J.S of the Federal Reserve System, the Board has rlu:r.o.e all in its power, by regulation and admonition to insist on full and frank statements on the part of business firms, as well a.s of banks, and bankers themselves.. banking and business the greatest safety lies in publicity and :..n frankne~8. I am willing to admit that I have a lingering suspicion that certain banks which oppose the trade acceptance may be somewhat influenced by the ~i·.· tact that siugle name paper ibffers a better interest return than the trade X-998 acceptance. I ~ glad, however. to state my belief that the vast majority of the banks take a different point of view in this respect, and that to them the facts that the trade acceptance has been recognized as a preferred type of paper by the Federal Reserve Banks and that :i.t has a wider and more favorable market than eingle name paper, §re of sufficient force to make them very ;villine; and even anxious to buy these trade acceptances in spite of the lower interest return, just as they buy, by preference, bankers' accept·ances on account of the greater liquidity of the latter, even though at present such accep'ttances net only 4~ as against the commercial paper rate of 6% or more. No1; let us examine the reasons why some business men oppose the development of the use of the trade acceptance. Some, I believe, fight it because they are jealous of maintaining their business on a cash basis that is to say, they are willing to pay even a high premium in order to avoid the cares and risks of sales on credit. That is a question Which every business man must decide for himself, and, as I said in the beginning, we should not attempt to force anyone to do anything in this respect that he does not consider to his own best advantage. It is im~ possible, however, for me to understand why any business man should be alarmed, or excited, because of the use of the trade acceptance by othe·t's who are obliged to sell their goods '!on open account". Valid objectio11S could be raised only by one of two classes of business men: ~eak or un- reliable purchasers who object to binding .,hemselves to a definite obHgat1on $o pay on a certain date (in which case, however, the reasons for the opposition on the part of the purchaser ought to be the very arguments for the preference on the part of the seller); or certain firms of great X:•998 - 9 - financial or commercial strength, who desire to preserve their posit ion of advantage as agai::'lst weaker competitors. note, the strong firm, wj When borrowing on its 0wn th well established credit, can obtain larger loans and on more favorable terms than its small competitor, and H l.s,therefore, in position to finance its purchases and its sales on a moro favorable basis than the small firm. It gains the advantage both as to the larger· scope of business it can do and the lower interest rate it en·· joys. True, it could probably do a larger business than at present by adopting the trade acceptance pla.n,but by thus adopting the trade acceptance basis small firms would probably profit more ih proportion than the larger ones; -their handicap would be The general use of lightened~ the tiade acdeptance is likely to tend towards greater standardization of banking paper &nd.greater equali~ation of interest rates, and I am inclined to think that we might cail it a step towards greater democracy in commerce· and ban'JI:ing. That is one of sey;eral reasons why the Federal Reserve Board favors the policy of granting a preferential rate for trade accept a.DCes. But, speaking broadly, the Fed- eral Reserve System is interested in seeing the business of' the country done on the soundest possible basis. 1Vhatever makes tor prompt paymeont may be considered an actual gain at a time when our efforts must be tent upon saving as much as possible, not only in material and labor, but a:' so time and credit. It is one of the most difficult problems at this juncture when hundreds of millions of dollars have to be shifted every day, to shorten the many circles in which it travels, not only in the large operations of the government, ~t in every individual transaction. It is in the general X-998 -- 10 - interest that money paid out for wages and material return as fast as can to the produce:..· wli.en b.j_s goods are .sold. ~t Pending the return of t?:te monies due to him he must rely on bai"..k credit, which naturally iE limited, and consequently he has to adjust the scope of his operations to the epeed WithwhiCh hiS "turn-over" Can be COmpleted. plays a most important part in this respect. The trade liCCeptanCA By securing trade acceptance~ even though he may hold them to maturity. the manufacturer can figure with greater exactness what are his obligations and his assets, and,b~·removing ava~lable cash elements of·uncertainty. he is enabled to carry on a larger business and to do it in greater safety. At a time when so much depends upon using every possible advantage in order to speed up production, so as to avoid an unnecessary tie-up of funds, the use of the trade to the national welfare. acce~ance may be considered a contribution It must not be said that whoever fails to use the trade acceptance is unpatriotic, but it may be said that it is essential that every one . do what lies in his power. to remove anything that stands in the way of securing ttie g~eatest possible efficiency of our country at this time,and anything done in this direction is patr:l.otic, It has lately been explained to me that canneries are facing a rather difficult situation, inasmuch as all prices for cans, boxes anc wages have risen so much that during the coming canning season the credits usually available for t~e canneries may ~tt be sufficient, the amount of money involved having doubled and the 10% limit in many cases prOhibiting the country banks from providing locally the necessary advances, cussing this problem and tr1.ing to sug~;est In dis- means o:f relief, I asked the question "How do the canneries pay for their cans and their boxes?" 1 was told that they pay cash •• I inquired "Could not the can manufacturers t:."'l.{r> t,,.~.rlP- 8 ~~ept ances in payment for their cans?".. The answer w~'~ that X-998 - 11 - the can company must ?r:w ca:;h itseif r.'cr the tin that it buys from the steel manufacturer; th::J.t possi b1_y next year something of the sort mie;bt be arrane,'Bd~ but that for t'b.:ls ~;·ea.scn j_t would he too late.. I dl(j :•J.''lt have the time to look further into the matter, nor is it my intentloL to venture any opin:.on as to whether or not it might be practica'!:lle tc these important companies to change their methods of selling their goods· No doubt they consider themselves better protected in selling for cash and probably they control the market sufficiently to enable them to insist on cash terms. On the other hand, it is clear from the situation that I have described that great relief could be given in this particular case to the canneries, -provided, of coutse, that their credit warrants it if they could be permitted to pay for their tins and their boxes by 90day trade acceptances. The process of canning is so rapid that probably even a shorter te~ than 9Q-days of credit might prove sufficient. As prooess . soon as the canni~ is ebmpleted• .t am tbldt the ~anners are able to secure their loans by warehousing and pledging their finished product, and the difficulty of financing is dVetcome. But for the short period of the peak of the load the use of the trade acceptance might be of the gl"eates-.. adva.ntat;;e to them. Facilitating ~he process of manufacture of food products is certain- ly a service which contributes to the national interest at this time, and, while I have mentioned this case merely far the purpose of illustration, I hope that it will not be taken amiss if I venture to urge the large industrial concerns in dealing with this question not to elusively from the point Of vi~ ~nsider it ex- of what is to their own best advantage, but to bear in mind that in many cases they have the opportunity of rendering a distinct service to tho national interest, an o~portunity which, when once crearly recognized, they will not wish to miss at this juncture. In this connection, it nay be us3ful to remind you of a ruliug given by the Federal Reserve Boa)"d (printed in the March 1917 Fedrn·a 1. Reserve Bulletin) to the effect that a trade acceptance, i f drawn wi ~h in reasonawle time after the shipment or delivery of the goods, rna) be considered as a bill of exchange drawn against actually existing value, so that a national bank may buy such trade acceptancus from its customers even after it has re~ched the limit of 10% of its capital and surplus, which constitutes the maximum credit such bank may grant a customer on his single name note. In view of the greatly increased price of practically all goods and the consequent larger amount of money involved in production, the facility thus afforded by the use of trade acceptances may prove of the greatest service, as you may readily see from the problem of the canneries just described. Great efforts are being made at present to reduce bank loans as far as possible where they are made for the carrying on of business transactions not strictly compatible with the public interest - that is to say. not absolutely necessary for the successful prosecution of the war or the health and necessary comfort of the people. X-998 - 13 - The single name note easily oerves as "camouflage" • It is very difficult to trace exactly what transaction is being financed by any particular note. The trade acceptance, on the other hand, bears on its faco the evldencc of its legitimate character - it is capable of proving a most convincing "alibi" where there is doubt as to the purpose for which tho proceeds havo been used, and it may, therefore, be a great help to the bnnks in carrying out the national object of conserving to the utmost material, labor, transportation and credit. It may be proper for me to avail myself of this opportunity of pointing to the great importance to the Federal Reserve System of finding ways and means of discriminating between essential and non-essential credits. The great speed with which new dollar values are being created at this time and the enormous doma~d of governments for goods render it imperative that we counteract the resulting inflation of prices by setting tho brakes upon every unnecessary use of credit or material. Normally these brakes would be applied by enforcing higher interest rates. In view, however, of the necessity of keeping the money market in a condition of sufficient ease to enable the government successfully to carry through its vast financial operations, it would be to the greatest public advantage if contraction of credit could bo brought about by voluntary discrimination rather than by the compulsion of higher rates. May I enlist, therefore, your earnest interest and hearty co-operation in this most important phase of "War E~onomy"? Owing to tho Government's heavy demands upon the investment market it has become very difficult for industrial corporations to raise money X-998 " - 14- on reascnable tetms through the sale of securities. . . This is a source of embarrassment felt more keenly by the large corporations, which normally depend upon the securities market for their financing, than for the smaller concerns normally operating upon bank credit. In consequence a good deal of pressure has been brought to bear upon the Federal Reserve Board by these corporations in order to enlist its interest in securing legislation The i3oard permitting the rediscount of notes secured by bonds or stocks. possib~y f~vor could not such a step since it would tend to undermine the liquid character of. the Federal R eserve Banks' investments; but it en- couraged these corporations to study carefully the question whether it would not be· possible for many of them to avail themselves of the facilities of the Jaderal Reserve Banks by financing some ot their purchases sales in the form of trade acceptances. .In some cases that has or been done; . · before long it is likely to be done on a much lafg•r scale tho war procoods an increasing burdon will be placod upon tho. · of the banks o.f the countr)C# Fedbral Reserve Banks. The rapid increase of deposits and loans./wMch As wo must look forward to as· incidental to the unparalleled scope of war expenditures, will create a constantly jrowing demand for moans with which to, maintain the corresponding increase in the reserve balances required by law. The only reliable key to the Federal Reserve Banks' credit ta- cUities is "eligible paper" and the most liquid paper which outside of the .. Federal Reserve Banks commands the widest market and the lowest rates is the "Acceptance", be it the bankors' or the trade acceptance. for both is certain to grow in importance. On The market the one band oui' banks, Q.nd particularly the country banks, will become regular and eager buyers X-998 - 15 - as they realize in increasing numbers that instead of keeping balances with other banks they do better in holding acceptances which produce a higher interest. return and serve at the same time as a reliable secondary reserve ...On the other hand several discount companies, recently established, or organizing, will prove; important new factors, as purchasers market for trade acceptances. as well as distributors, in widening the A growing volume of such paper, coupled with a growing habit on the part of the banke" {of investing therein, will furnish an additional and most valuable element of safety in the present emergency, and it is sincerely to be hoped that the banks and the business men will join their efforts in promoting the widest possible use and development of this important means of exchange. There has been quite a prolonged discussion as to whether the community of the buyer or the seller should carry the trade acceptance; indeed the critics of the trade acceptance state as one of their objections that it is apt to throw the burden of financing primarily upon the seller's community. The truth of the matter is, however, that in case a wide market is developed for bankers' and trade acceptances, they will be carried by that community which is the most eager to invest its funds, be it the seller or the buyer's neither the one nor the other. cornrr~nity, or one that is lt is one of the main virtues of the acceptance system that it makes for greater fluidity of credit. Instead of permitting one section of the country to become overloaded in consequence of local seasonal requirements, absorbing all available cash resources, bankers' and trade acceptances bring relief by flowing into discount markets of other districts where money is more plentiful. The adoption of the plan of financing the coming cotttn crop largely through bankers' and trade acceptances ought to re~ult ~ easing the burden to be carried by the South during the coming season. gTeatly • X-998 - 16 • In closing, may l be permitted. on behalf of the Federal Reserve Board, to express its genuine and warm appreciation for the excellent work done ~Y the Trade Acceptance Council. For the benefit of the country you hav6 unself- . ishly undertaken a difficult task, a canipaign of educe:tion; wl1ich require. energy, consistency, patience, inteiligence and tact. win only ir The trade acceptance can the particular charac~eristies and requirements of each trade ate studied carefully and sympathetically; only where a ~asis can be tound which ·permits the adaptation to the use of the trade acceptance without undue vi6lenee or he.rm may we expect quick and permanent success. ln meeting ail these C.JS&d.ss-· your Council has shown itself fully equal to ite task .. From experience of my own, I believe I may safely say that nobody kriows better than members of the Federal Reserve Board that campaigns of in banking exact a maximum of patience and persistence. ed~cation. The very experience, however, of the Federal Reserve Board will, I hope, serve as an encouragement to the Trade Acceptance Council. There was as much active and passive resistance. to the adoption of the bankers' acceptance as there now is exhibited in opposition to the trade acceptanee. Today no one doubts any longer that the bankers' acceptance has come to stay and that it has proved its worth as one of the most important media of exchange, an additional element of strength, and an indi&pens•ble ~rt 'eomponent of the vast structure of liquid asse:ts upon the solidarity of which the aafety" of the Federal Reserve System and with that the safety of the country ia predlcated. If the trade acceptance, in years to come, should occupy a similar po'Bition and render a similar service - as I hope and trust it will - the Tre.d.e Acceptanc• Councilwill enjGy the keen satisfaction of having done its full• share in a de•elopment so greatly to the benefit of -9 ~r ;coun~ry_