Demand deposits, while not money, clearly perform the function of a reserve of purchasing power for depositors, and reduce by so much the amount of money each must keep at hand to meet his current needs of purchasing power. If the depositor's credit balance bears no interest, he has no motive to keep a balance greater than he would require of actual money, and he has the motive to spend it or invest it in income-bearing capital whenever his balance (plus his cash in hand) exceeds his monetary needs. Payment of in terest on credit balances reduces the motive to withdraw for investment elsewhere any such excess, and mingles in the depositor's thought monetary and investment motives. De mand deposits are often spoken of (somewhat inaccurately) as "deposit currency," being funds at the command of de positors which are as disposable and as active and current for the monetary function as so much actUal money would be. It is estimated that the rate of turnover of deposits in the United States is about fifty times a year. We may view the demand deposits subject to check as either a substitute for money or as a means by which the rapidity of circulation and the monetary efficiency of actual money held in bank re serves is multiplied 12 In the United States in 1920 individual deposits in banks could be classified as follows: Payable on demand $17,500,000,000 Time deposits (or not classified) 20,200,000,000 Total 37,700,000,000 Of,the total $14,000,000,000 were in national and $23,700,000,000 were The method of payment by bank drafts in domestic ex change reduces the need for, or increases the efficiency of, money in just the same way as does the use of checks. By the mutual credit of banks in different parts of the country, very large payments may be made in both directions with the movement of only the comparatively small amount of physical money needed to pay the balance after the cancella tion of drafts, bills of exchange, and checks.
The use of bank-notes reduces the amount needed of other kinds of money more directly, though not more effectively, than do deposit accounts. Bank-notes are money, and as long as their amount is limited by prompt redemption they circulate instead of so much of other kinds of money. Re demption is possible by the use of a reserve of standard (or of legal-tender) money very much smaller than the amount of notes outstanding.
§ 12. Productive services of banks. There have always been some erroneous ideas regarding the magic power of banks to multiply the power of money. But there should be no more mystery about banking credit than about the nature of money itself. Banks are the labor-saving machin ery of finance. They gather loanable funds, reduce hoard ing, make money move more rapidly, and create a central in other banks. All the demand deposits were subject to check, ex cepting $1,300,000,000 of demand certificates. Of the time deposits $7,500,000,000 were in savings accounts, $2,600,000,000 in time certi ficates, and $10,100,000,000 not classified, of which a large part was "time deposits on open account," for the withdrawal of which ordi narily no notice is required. It appears, therefore, that at least $25,000,000,000 of deposits are almost as good as cash in hand for the depositors' current needs. This was more than four times the
$6,000,000,000 of cash in circulation and in banks at the same time, and was twenty-five times the $1,000,000,000 cash in these same banks (the Federal Reserve banks not included) at that time. These figures indicate the great influence that banking has in increasing the average efficiency of the circulating medium of the country. (Figures from Annual Report of the Secretary of the Treasury, 1920, pp. 1188, 1430, 1431).
market between borrowers and lenders for the sale of credit. While not creating more physical wealth directly, they add to the efficiency of wealth; they simplify and quicken the movement of nearly all commercial transactions. Banks per form incidentally a further service in developing better busi ness methods in the community. They enforce promptness and exactitude in business dealings. In supplying credit to enterprises banks are constantly passing judgment on the collateral security presented to them and on the soundness of the enterprises that are seeking support. This gives to bankers great economic power, capable at times of misuse in political and social affairs, especially where a group of men comes to exercise a practical monopoly of business credit in any community, and uses this power for its own greedy and selfish ends.
§ 13. Earnings of banks. The earnings of banks are drawn from different sources, according to the size of the community and the nature of the banks. While in the villages and smaller cities the commercial banks perform a number of functions, in the larger cities they usually specialize in a far greater degree. The trust companies, however, with their greater versatility have been increasing in number. The earnings of banks are derived from discounts, interest on their own capital, charges for exchange and collection, dividends, interest and rents on investments, and profit from their bank-notes. The capital with which a bank starts in business 13 could be lent with less trouble and more cheaply without starting a bank, but used as a banking capital it can be lent in part while still serving to attract deposits, which are the main source of the income of banks to-day. In the past it has been customary for many banks, especially "coun try banks," to charge for remittances and for the collection of checks from other banks; but under the Federal Reserve system great progress has been made toward parity of ex change, or parity of checks, everywhere in the United States.
13 See above, 11 3.
While many small banks have strenuously opposed this be cause it cuts off a considerable source of revenue, they gain in other ways by performing this service freely for their cus tomers. Banks make few investments in real estate or other physical property; it is, in fact, their duty to keep out of ordinary enterprises; but they are forced sometimes to take for unpaid debts things that have been held as security. Profits on bank-notes have at times been the main, almost the sole, motive for starting banks; but that is not the case to-day, when the right of issue is so strictly limited.