The relation of money and credit brings to light the great importance of the distinction between credit in general and credit instruments. The former does not serve as a medium of exchange in any degree except as it is transformed into the latter. If the use of credit merely postpones a payment of cash, and nothing more, it may serve a useful purpose to the individual but it does not in any degree perform a money function or diminish the demand for money. A credit instrument may, however, be used to effect any number of exchanges besides that which originally gave rise to it, and thus it may perform a real money service.
It is quite possible to conceive of notes and similar obligations as performing this function without the interposition of the banker. But in the modern world it is thru the banker that credit serves as a medium of exchange, and any explanation of things as they are must take the banker into account. He is the intermediary thru whom credit is distributed to those who desire to utilize it. While the full descrip tion of banks and their operation must necessarily be reserved for the Modern Business Text on "Bank ing," their relation to the general credit situation may be briefly set forth here.
12. Bank notes.—The methods pursued by the banks in different countries in loaning money vary. In some countries credit is extended chiefly thru the use of bank notes. The applicant for a loan receives its proceeds in the notes of the bank, which he uses as money for the payments that he has to make. Such notes are simply the promissory notes of the bank. People are willing to accept them because in form they are similar to money, and because the bank is known generally to be solvent. This sol vency is maintained by holding in the bank a reserve of standard money with which to redeem the notes on presentation. Such notes are always payable on demand. The reserve of money held against them is either fixed by law or dictated by experience, but the reserve is only a fraction of the amount of the notes issued. With a reserve of 20 per cent, for example, the potency of money to effect exchanges is multiplied five times as long as the bank holds it in reserve for the redemption of notes issued against it.
The amount of gold held and the amount of notes issued against it varies with the demand for capital.
In dull times it is curtailed, and in easy times it increases in amount. These changes are brought about by the issue and the redemption of the notes. If notes are in excess of' needs they flow back into the banks. In common speech such bank notes are usually spoken of' as money, but the economist recog nizes the important credit element which enters into them and calls them, as we have seen in the preceding chapter, credit money.
In the hodge-podge of bank note issues which pre vailed in the United States before the enactment of the National Banking Act, there were some banks which issued notes on the principle which has been described and, in a general banking situation which has frequently been spoken of as riotous and chaotic, preserved an honorable record. 13ut so many abuses arose that people regarded the issue of bank notes more as a government issue than as a function of credit: In the national banking system, regulation superseded redemption as a controlling principle in the issue of bank notes. Neither the national bank notes nor the Federal Reserve bank notes which are to replace them rest on the demand for capital, but on bonds deposited for their security. On the other hand the Federal Reserve notes as described in the last chapter rest in part upon this demand and can be issued to meet the varying needs of the business comrnunity.
Bank deposits.—In the United States the de velopment of banking credit has been chiefly thru the growth of the deposit and check system. Under this plan credits circulate thrti checks and drafts drawn against deposit credits. Bank loans are not made ' by handing the borrower the proceeds either in its own notes or in other currency but by opening a credit to his account. Against this credit he may draw checks. The recipient of the check does not as • a rule cash it, but deposits it in the same or another bank. Thru a bookkeeping arrangement in the bank. or an adjustment between the banks when two are involved, the right to draw checks passes to the new owner. By this process, indefinitely continued, the credit of the country is mobilized thru the banks and serves the purpose of a medium of exchange.
The volume of credit swells as the business of the country increases, and contracts when the business diminishes. It serves most, if not all, the purposes of money much better than money itself, among those who are accustomed to its use. Whenever large payments have to be zuade to persons not familiar with credit transactions money is required, and this strains the credit situation. The need of "money to move the crops" is a familiar illustration. Wizen crops are har vested actual currency is needed to make payment for them. This seasonal demand for cash is, however. diminishing as the western farmer becomes more and more accustomed to the use of banks.
14. Liquidation of credit.—Thru the agency of credit a vast munber of obligations payable in money are created. Obviously it would be impossible to redeem them all at one time. Against such credit there is kept a certain reserve of gold. If demands for redemption lessen the quantity, it must be replen ished. It can be replenished only by curtailing credits. Such a process does not, as we have seen, lessen in any degree the amount of existhig wealth, but none the less it may necessitate painful readjust ments in business. Those who had counted upon the continuance of credit accommodations are forced to curtail or even abandon their operations.
If the demand for a liquidation of outstanding credits is widespread, panic and business depression ensue. Wealth is not destroyed. But the control of wealth passes more and more into the hands of those who own the wealth, and its activity is lessened. 1 Capin.' or wealth used in production is diminished, and with the decrease in capital the creation of new wealth slackens.
On the other hand, in times of reviving business, the prospect of gain lures wealth into productive uses, and thru credit the available capital is increased. Permission to use another's capital, as Mill would say, is more and more freely granted. Thus it is that business is never stationary, that there arise alternate periods of prosperity and depression. The crux of the situation lies in credit.
No device has been conceived by society which will prevent these ups and downs, nothing which will give credit freely when credit is most wanted. But thru a wise ad justment of credit agencies much can be done to mitigate the severity of periods of stress and strain. It is hoped that the reorganization of our banking sys tem film the Federal Reserve Act has created an organization which in the future will make panics less severe than they have been in the past.