Machlup’s theoretical paper examines short-term lending from the standpoint of the productive system. Its central problem is the discrepancy between creditors’ expectations of rapid repayment and the duration of the investments financed by their funds.
THE object of this paper is to discuss the question, Can short-term capital remain liquid?
Answering this requires distinguishing the liquidity of an individual claim from that of capital committed to production. A creditor or entrepreneur may recover money by transferring an asset to another investor without releasing the underlying productive capital. What appears liquid to one owner may therefore remain tied up economically. Ordinary business terminology obscures this distinction:
But the business usage is by no means free from ambiguity. For there are, in everyday life, many forms of capital which are liquid—in this sense—at one time and not at another. This would appear to be a contradiction in terms.
Section I develops this distinction against both the business definition of liquidity as convertibility into money and Keynes’s treatment of goods in process and finished stocks as liquid capital. Accounting classifications cannot establish whether capital is available for repayment. A machine may constitute circulating stock for its manufacturer while representing fixed capital for its purchaser. Its sale changes ownership and accounting status, not the productive commitment embodied in it.
Section II follows capital through successive stages of production. An entrepreneur’s recovery of funds may depend on another entrepreneur’s willingness to undertake a durable investment.
For example, iron and coal—which are at first said to be liquid—may, after passing through the various stages of production, become fixed capital in the form of machines.
Even production close to final consumption can stimulate expansion in earlier stages. More fundamentally, maintaining output requires renewing working capital. Turnover makes funds available for reinvestment, but not necessarily for withdrawal. Repayment without replacement financing may require production to contract. Machlup provisionally identifies a narrow possible exception in temporary increases in consumers’ goods production that require no expansion of higher-stage production.
This systemic approach also challenges the doctrine of self-liquidating bank advances. The visible purpose of an individual loan does not determine its ultimate economic effect. Credit financing inventories can release the borrower’s own funds for machinery; repayment of debts and changes in trade credit can similarly support investment elsewhere. Assessing liquidity therefore requires tracing the wider consequences of lending rather than merely inspecting an advance’s immediate security or use.
Sections III and IV consider whether additional credit will flow into genuinely temporary uses. Drawing on Strigl, Machlup argues that lower interest rates particularly encourage fixed investment, whose profitability is more sensitive to financing costs than production dominated by wages and materials. Additional working capital consequently tends to accompany increased durable investment rather than constitute an independent, readily reversible outlet.
His discussion of Haberler qualifies this argument. Machlup acknowledges that a lower interest rate can also make additional working-capital investment profitable. He nevertheless regards its direct cost advantage as limited and potentially offset by higher input prices. The argument then shifts toward demand: cheaper capital especially stimulates purchases of durable investment goods. His conclusion concerns an initial equilibrium. Structural changes in population, technology, or tastes may increase working-capital requirements, but these usually create continuing commitments; seasonal demand remains a special problem.
Section V situates the analysis in relation to Hayek and Keynes. While finding support in their accounts of capital formation, Machlup questions whether credit expansion begins with greater consumers’ goods production and whether re-employment necessarily establishes an immediate increase in aggregate consumption.
Section VI explains how routine short-term repayment can coexist with long-lived productive commitments. Repayment normally depends on replacement savers taking over the financing withdrawn by others. If this succession breaks down, maintaining production requires further saving; otherwise output must shrink. Invoking Menger’s distinction between productive capital and resources available too briefly for productive use, Machlup concludes that short contractual maturities do not ensure short economic commitments. Individual liquidity rests on continued financial substitution, while collective withdrawal reveals the underlying illiquidity of production.
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