If the debtor—the government or a bank—keeps against the whole amount of moneysubstitutes a reserve of money proper, we call the moneysubstitute a moneycertificate. The individual moneycertificate is—not necessarily in a legal sense, but always in the catallactic sense—a representative of a corresponding amount of money kept in the reserve. The issuing of moneycertificates does not increase the quantity of things suitable to satisfy the demand for money for cash holding. Changes in the quantity of moneycertificates therefore do not alter the supply of money and the money relation. They do not play any role in the determination of the purchasing power of money.
If the money reserve kept by the debtor against the moneysubstitutes issued is less than the total amount of such substitutes, we call that amount of substitutes which exceeds the reserve fiduciary media. As a rule it is not possible to ascertain whether a concrete specimen of moneysubstitutes is a moneycertificate or a fiduciary medium. A part of the total amount of moneysubstitutes issued is usually covered by a money reserve held. Thus a part of the total amount of moneysubstitutes issued is moneycertificates, the rest fiduciary media. But this fact can only be recognized by those familiar with the bank’s balance sheets. The individual banknote, deposit, or token coin does not indicate its catallactic character.
The issue of moneycertificates does not increase the funds which the bank can employ in the conduct of its lending business. A bank which does not issue fiduciary media can only grant commodity credit, i.e., it can only lend its own funds and the amount of money which its customers have entrusted to it. The issue of fiduciary media enlarges the bank’s funds available for lending beyond these limits. It can now not only grant commodity credit, but also circulation credit, i.e., credit granted out of the issue of fiduciary media.
While the quantity of moneycertificates is indifferent, the quantity of fiduciary media is not. The fiduciary media affect the market phenomena in the same way as money does. Changes in their quantity influence the determination of money’s purchasing power and of prices and—temporarily—also of the rate of interest.
Earlier economists applied a different terminology. Many were prepared to call the moneysubstitutes simply money, as they are fit to render the services money renders. However, this terminology is not expedient. The first purpose of a scientific terminology is to facilitate the analysis of the problems involved. The task of the catallactic theory of money—as differentiated from the legal theory and from the technical disciplines of bank management and accountancy —is the study of the problems of the determination of prices and interest rates. This task requires a sharp distinction between moneycertificates and fiduciary media.
The term credit expansion has often been misinterpreted. It is important to realize that commodity credit cannot be expanded. The only vehicle of credit expansion is circulation credit. But the granting of circulation credit does not always mean credit expansion. If the amount of fiduciary media previously issued has consummated all its effects upon the market, if prices, wage rates, and interest rates have been adjusted to the total supply of money proper plus fiduciary media (supply of money in the broader sense), granting of circulation credit without a further increase in the quantity of fiduciary media is no longer credit expansion. Credit expansion is present only if credit is granted by the issue of an additional amount of fiduciary media, not if banks lend anew fiduciary media paid back to them by the old debtors.
12. The Limitation on the Issuance of Fiduciary Media
People deal with moneysubstitutes as if they were money because they are fully confident that it will be possible to exchange them at any time without delay and without cost against money. We may call those who share in this confidence and are therefore ready to deal with moneysubstitutes as if they were money, the clients of the issuing banker, bank, or authority. It does not matter whether or not this issuing establishment is operated according to the patterns of conduct customary in the banking business. Token coins issued by a country’s treasury are moneysubstitutes too, although the treasury as a rule does not enter the amount issued into its accounts as a liability and does not consider this amount a part of the national debt. It is no less immaterial whether or not the owner of a moneysubstitute has an actionable claim to redemption. What counts is whether the moneysubstitute can really be exchanged against money without delay and cost.16
Issuing moneycertificates is an expensive venture. The banknotes must be printed, the token coins minted; a complicated accounting system for the deposits must be organized; the reserves must be kept in safety; then there is the risk of being cheated by counterfeit banknotes and checks. Against all these expenses stands only the slight chance that some of the banknotes issued may be destroyed and the still slighter chance that some depositors may forget their deposits. Issuing moneycertificates is a ruinous business if not connected with issuing fiduciary media. In the early history of banking there were banks whose only operation consisted in issuing moneycertificates. But these banks were indemnified by their clients for the costs incurred. At any rate, catallactics is not interested in the purely technical problems of banks not issuing fiduciary media. The only interest that catallactics takes in moneycertificates is the connection between issuing them and the issuing of fiduciary media.
While the quantity of moneycertificates is catallactically unimportant, an increase or decrease in the quantity of fiduciary media affects the determination of money’s purchasing power in the same way as do changes in the quantity of money. Hence the question of whether there are or are not limits to the increase in the quantity of fiduciary media has fundamental importance.
If the clientele of the bank includes all members of the market economy, the limit to the issue of fiduciary media is the same as that drawn to the increase in the quantity of money. A bank which is, in an isolated country or in the whole world, the only institution issuing fiduciary media and the clientele of which comprises all individuals and firms, is bound to comply in its conduct of affairs with two rules:
First: It must avoid any action which could make the clients—i.e., the public—suspicious. As soon as the clients begin to lose confidence, they will ask for the redemption of the banknotes and withdraw their deposits. How far the bank can go on increasing its issues of fiduciary media without arousing distrust, depends on psychological conditions.
Second: It must not increase the amount of fiduciary media at such a rate and with such speed that the clients get the conviction that the rise in prices will continue endlessly at an accelerated pace. For if the public believes that this is the case, they will reduce their cash holdings, flee into “real” values, and bring about the crack-up boom. It is impossible to imagine the approach of this catastrophe without assuming that its first manifestation consists in the evanescence of confidence. The public will certainly prefer exchanging the fiduciary media against money to fleeing into real values, i.e., to the indiscriminate buying of various commodities. Then the bank must go bankrupt. If the government interferes by freeing the bank from the obligation of redeeming its banknotes and of paying back the deposits in compliance with the terms of the contract, the fiduciary media become either credit money or fiat money. The suspension of specie payments entirely changes the state of affairs. There is no longer any question of fiduciary media, of moneycertificates, and of moneysubstitutes. The government enters the scene with its governmentmade legal tender laws. The bank loses its independent existence; it becomes a tool of government policies, a subordinate office of the treasury.
The catallactically most important problems of the issuance of fiduciary media on the part of a single bank, or of banks acting in concert, the clientele of which comprehends all individuals, are not those of the limitations drawn to the amount of their issuance. We will deal with them in Chapter XX, devoted to the relations between the quantity of money and the rate of interest.
At this point of our investigations we have to scrutinize the problem of the coexistence of a multiplicity of indepe
ndent banks. Independence means that every bank in issuing fiduciary media follows its own course and does not act in concert with other banks. Coexistence means that every bank has a clientele which does not include all members of the market system. For the sake of simplicity we will assume that no individual or firm is a client of more than one bank. It would not affect the result of our demonstration if we were to assume that there are also people who are clients of more than one bank and people who are not clients of any bank.
The question to be raised is not whether or not there are limits to the issuance of fiduciary media on the part of such independently coexisting banks. As there are even limits to the issuance of fiduciary media on the part of a unique bank the clientele of which comprises all people, it is obvious that there are such limits for a multiplicity of independently coexisting banks too. What we want to show is that for such a multiplicity of independently coexisting banks the limits are narrower than those drawn for a single bank with an unlimited clientele.
We assume that within a market system several independent banks have been established in the past. While previously only money was in use, these banks have introduced the use of moneysubstitutes a part of which are fiduciary media. Each bank has a clientele and has issued a certain quantity of fiduciary media which are kept as moneysubstitutes in the cash holdings of various clients. The total quantity of the fiduciary media as issued by the banks and absorbed by the cash holdings of their clients has altered the structure of prices and the monetary unit’s purchasing power. But these effects have already been consummated and at present the market is no longer stirred by any movements generated from this past credit expansion.
But now, we assume further, one bank alone embarks upon an additional issue of fiduciary media while the other banks do not follow suit. The clients of the expanding bank—whether its old clients or new ones acquired on account of the expansion—receive additional credits, they expand their business activities, they appear on the market with an additional demand for goods and services, they bid up prices. Those people who are not clients of the expanding bank are not in a position to afford these higher prices; they are forced to restrict their purchases. Thus there prevails on the market a shifting of goods from the nonclients to the clients of the expanding bank. The clients buy more from the nonclients than they sell to them; they have more to pay to the nonclients than they receive from them. But moneysubstitutes issued by the expanding bank are not suitable for payments to nonclients, as these people do not assign to them the character of moneysubstitutes. In order to settle the payments due to nonclients, the clients must first exchange the moneysubstitutes issued by their own—viz., the expanding bank—against money. The expanding bank must redeem its banknotes and pay out its deposits. Its reserve—we suppose that only a part of the moneysubstitutes it had issued had the character of fiduciary media—dwindles. The instant approaches in which the bank will—after the exhaustion of its money reserve—no longer be in a position to redeem the moneysubstitutes still current. In order to avoid insolvency it must as soon as possible return to a policy of strengthening its money reserve. It must abandon its expansionist methods.
This reaction of the market to a credit expansion on the part of a bank with a limited clientele has been brilliantly described by the Currency School. The special case dealt with by the Currency School referred to the coincidence of credit expansion on the part of one country’s privileged central bank or of all banks of one country and of a nonexpansionist policy on the part of the banks of other countries. Our demonstration covers the more general case of the coexistence of a multiplicity of banks with different clientele as well as the most general case of the existence of one bank with a limited clientele in a system in which the rest of the people do not patronize any bank and do not consider any claims as moneysubstitutes. It does not matter, of course, whether one assumes that the clients of a bank live neatly separated from those of the other banks in a definite district or country or whether they live together with those of the other banks. These are merely differences in the data not affecting the catallactic problems involved.
A bank can never issue more moneysubstitutes than its clients can keep in their cash holdings. The individual client can never keep a larger portion of his total cash holding in moneysubstitutes than that corresponding to the proportion of his turnover with other clients of his bank to his total turnover. For considerations of convenience he will, as a rule, remain far below this maximum proportion. Thus a limit is drawn to the issue of fiduciary media. We may admit that everybody is ready to accept in his current transactions indiscriminately banknotes issued by any bank and checks drawn upon any bank. But he deposits without delay with his own bank not only the checks but also the banknotes of banks of which he is not himself a client. In the further course his bank settles its accounts with the bank engaged. Thus the process described above comes into motion.
A lot of nonsense has been written about a perverse predilection of the public for banknotes issued by dubious banks. The truth is that, except for small groups of businessmen who were able to distinguish between good and bad banks, banknotes were always looked upon with distrust. It was the special charters which the governments granted to privileged banks that slowly made these suspicions disappear. The often advanced argument that small banknotes come into the hands of poor and ignorant people who cannot distinguish between good and bad notes cannot be taken seriously. The poorer the recipient of a banknote is and the less familiar he is with bank a/fairs, the more quickly will he spend the note and the more quickly will it return, by way of retail and wholesale trade, to the issuing bank or to people conversant with banking conditions.
It is very easy for a bank to increase the number of people who are ready to accept loans granted by credit expansion and paid out in an amount of moneysubstitutes. But it is very difficult for any bank to enlarge its clientele, that is, the number of people who are ready to consider these claims as moneysubstitutes and to keep them as such in their cash-holdings. To enlarge this clientele is a troublesome and slow process, as is the acquisition of any kind of good will. On the other hand, a bank can lose its clientele very quickly. If it wants to preserve it, it must never permit any doubt about its ability and readiness to discharge all its liabilities in due compliance with the terms of the contract. A reserve must be kept large enough to redeem all banknotes which a holder may submit for redemption. Therefore no bank can content itself with issuing fiduciary media only; it must keep a reserve against the total amount of moneysubstitutes issued and thus combine issuing fiduciary media and moneycertificates.
It was a serious blunder to believe that the reserve’s task is to provide the means for the redemption of those banknotes the holders of which have lost confidence in the bank. The confidence which a bank and the moneysubstitutes it has issued enjoy is indivisible. It is either present with all its clients or it vanishes entirely. If some of the clients lose confidence, the rest of them lose it too. No bank issuing fiduciary media and granting circulation credit can fulfill the obligations which it has taken over in issuing moneysubstitutes if all clients are losing confidence and want to have their banknotes redeemed and their deposits paid back. This is an essential feature or weakness of the business of issuing fiduciary media and granting circulation credit. No system of reserve policy and no reserve requirements as enforced by the laws can remedy it. All that a reserve can do is to make it possible for the bank to withdraw from the market an excessive amount of fiduciary media issued. If the bank has issued more banknotes than its clients can use in doing business with other clients, it must redeem such an excess.
The laws which compelled the banks to keep a reserve in a definite ratio of the total amount of deposits and of banknotes issued were effective in so far as they restricted the increase in the amount of fiduciary media and of circulation credit. They were futile as far as they aimed at safeguarding, in the event of a loss of confidence, the prompt redemption of the banknotes and
the prompt payment of deposits.
The Banking School failed entirely in dealing with these problems. It was confused by a spurious idea according to which the requirements of business rigidly limit the maximum amount of convertible banknotes that a bank can issue. They did not see that the demand of the public for credit is a magnitude dependent on the banks’ readiness to lend, and that banks which do not bother about their own solvency are in a position to expand circulation credit by lowering the rate of interest below the market rate. It is not true that the maximum amount which a bank can lend if it limits its lending to discounting short-term bills of exchange resulting from the sale and purchase of raw materials and half-manufactured goods, is a quantity uniquelydetermined by the state of business and independent of the bank’s policies. This quantity expands or shrinks with the lowering or raising of the rate of discount. Lowering the rate of interest is tantamount to increasing the quantity of what is mistakenly considered as the fair and normal requirements of business.
Human Action: A Treatise on Economics Page 63
