There is a subtler relationship between the bank and the community than this function of furnishing a medium of exchange. It, however, grows out of the latter phase of bank activity. If a bank actually puts out something which is used instead of money, and if it be true that the quantity of money in circulation has an influence upon the rate at which money exchanges for goods, the question may be asked whether it is not true that the bank has an important influence in raising or lowering prices. Before this question can be answered very satisfactorily, however, it is necessary to remind the reader that goods are exchanged not only through the use of money or bank notes, but they may also be exchanged by action of bank customers in drawing checks upon deposits which have been credited to them upon the books of banks. It would seem, then, that both when they issue notes and when they create deposits on their books the banks provide a means of exchanging goods, and so tend to enable the community to do without money, and that they thus influence prices. The question whether banks by furnishing paper currency do not act upon prices should thus be put in a rather different way by inquiring whether banks do not, as a matter of fact, by extending credit in either form - notes or deposit accounts - act upon prices. As to this there can be no question. When a bank gives to an individual funds in the form of notes or deposits which enable him to buy more freely, it enables him to make an effective demand for commodities. If the customer makes use of this demand the effect is to raise prices. Conversely, by withholding credit the bank tends to hinder the customer from making his demand effective, and so tends to prevent prices from rising, or tends to lower them, relatively speaking.

It should be noted in this connection that the bank does not in such case create purchasing power or make something out of nothing. It simply recognizes the existence of value, and enables that value to become effective. The service rendered is somewhat like that of a railway. If at point A there is a shortage of food while at B, one hundred miles distant, there is more food than is needed, a railway line between the two places will enable those who have an excess of supplies to transfer them to those who need them. The railway does not create the food, but it merely renders exchange more quickly possible than would otherwise be true. In a certain sense it may be said that the working of the road tends to lower prices in the town where scarcity exists by bringing food from another point, but' this, of course, is on the assumption that the food exists and is ready to be shipped. Bank credit enables commodities of one kind to be more freely exchanged for others. It can be seen, however, that if in the two points A and B of which we have spoken there was scarcity of certain things and abundance of certain other things, the railway might simply permit shipments in one direction which were offset by shipments in another, with the result that some prices would be higher and some would be lower in A than would otherwise have been the case, while a like situation would prevail in B. The railroad in this case would have tended to bring about a more uniform level of prices in the two places and to adjust prices to one another more accurately in each place. This is exactly what banking does. Its effect, in other words, is to raise some prices and lower others, and so to eliminate fluctuations. This is a different kind of influence from that which is ordinarily ascribed to banking in its monetary relations, but it is a highly important service and one whose value to the community can scarcely be overestimated.

Banks, however, may be inefficiently or badly managed, and as a result they may grant credit (notes or deposits) to persons who are not entitled to them - that is to say, who have not the actual value which will enable them to settle their obligations. On the other hand, banks may give immediate purchasing power (notes or deposits) to borrowers who are solvent in the sense that they have wealth which will eventually be realized, although not for a long time. In this case what the banks do is to give persons with long-term wealth a chance to consume immediately. The result is to disturb prices rather than to average them, and this is what takes place in a period of inflation. Credit is too readily granted and results in enabling many persons to buy and consume commodities when they are not, economically speaking, in position to do so. The result is unduly high prices - usually followed later on by unduly low ones. The bank's influence here has been reversed - instead of averaging or smoothing out price levels it has accentuated their fluctuations. A situation of this kind is often spoken of as if it showed that the explanation of the influence of bank credit upon prices already given were in some way erroneous. The contrary, however, is the inference to be drawn from it. Bank credit exerts a certain kind of influence upon prices, but, as with every force, this influence may be used to lessen disturbance or to increase it. The theory of its application, however, is the same in either case.