Rapid redemption, it was seen, is the most effective guarantee against the passive development of overexpansion. The nature of the cheek was shown to be such that without any external pressure there is a strong tendency to get the check back to the bank on which it is drawn, and thus to redeem the credit which it represents. Where the employment of checks is widespread and where there is a thoroughgoing organization of domestic clearings this rapidity of redemption also acts as a considerable restraining force on individual banks and on the banks of whole communities. But the nature of the bank note, on the other hand, was seen to be such as usually to require some extraneous pressure to stimulate redemption.

The discount rate offers the best possibility

Centralization important in this connection

In determining how best to bring pressure to bear on notes for the purpose of expediting redemption it must be borne in mind that there are two aspects of the problem: first, getting notes out of general circulation into the hands of the banks, and, second, getting them from receiving banks not banks of issue to the banks of issue.

Getting notes out of circulation is not an easy matter. The success of the notes in first instance depends upon their broad acceptability. Hence no form of pressure can be exerted which would tend to lessen general acceptability. Therefore, apart from providing numerous redemption agencies, whatever be the original system of issue, it is difficult to see how pressure can be brought to bear on the noteholder.1 The return of the notes is largely a matter of chance as based on the proportion which the bank notes constitute of the entire monetary circulation, and on the relative importance of note issue as compared with deposits. From this point of view, as well as from otners, a progressive diminution in the importance of the bank note, both absolute and relative, is to be desired.

Rapid redemption important in preventing passive development of over-expansion

Pressure must be exerted on notes

First in the field of circulation

1 Notes might be made legal tender in all payments to banks, but not legal tender as between private individuals, while at the same time adequate reserves would be required and facilities for redemption be provided. But the necessary guarantees of redemption and reserves would themselves tend to make notes so generally acceptable that the restriction in the legal-tender powers of the notes would in normal times be ineffective as a stimulus to redemption.

Assuming notes to have come into the hands of banks, however, pressure may be applied in several ways.

Under a monopolistic system of note issue banks may be required to turn in for redemption or for deposit all notes received. Such a requirement would, however, involve serious administrative difficulties. Notes newly obtained to meet possible increases in demand would have to be kept rigidly separated from the notes which have come from circulation. There would obviously be much waste in such a system. The requirement might, however, be simply that for local banks the notes of the bank of issue should not be available for reserve purposes. This, as will be seen, is the form of pressure relied upon in our new Federal Reserve System in forcing member banks to deposit in their respective reserve banks all federal reserve notes received. But the objection to this expedient is that it militates against thoroughgoing reserve centralization, in that the local bank could not profitably carry "dead" till-money when through redemption it could obtain money in forms available for reserve purposes. The seriousness of this objection depends upon the extent to which bank notes are likely to influence the credit situation as a whole. If the notes are a relatively small factor in the whole system, and if at the same time till-money requirements are small, the loss in economy will not be great. Some loss would, however, appear to be unavoidable, and as a practical question the loss due to this partial rigidity of reserves must be weighed against the need of enforcing redemption of note issue.

Under a competitive system of note issue the all-sufficient requirement is the prohibition against carrying in any bank as a part of reserves the notes of any other bank. Where all the banks are banks of issue there will then be the same incentive to send bank notes for redemption as there is for the sending back of checks. In Canada the chartered banks daily "clear" their notes in just the same way that they do their checks. On the other hand, where only a proportion of the banks are banks of issue, non-issuing banks would not retain any greater amount of notes of the issuing banks than they expected immediately to pay out again, or, in other words, than such amount for which a real demand existed. The incompatibility of competitive note issue and thorough-going centralization of reserves, however, throws the argument against competitive issue from the outset.

Then in connection with the banks

Under monopolistic system of issue

Under the competitive system

In view of the importance of clearing in the economical operation of the banking system it may also be said that in a good system intelligent provision will be made for the widest possible application of the clearing principle in domestic trade. In the purely local exchanges the local clearing houses supply an effective instrument for this purpose. In intercommunity clearings, however, wider organization is necessary. Machinery must be provided to facilitate the verification and the collection of individual items, while the system of remittance must also be arranged. The possibilities in this direction were discussed in the special chapter dealing with this subject, but here again the effectiveness of centralized reserves is to be emphasized. The more thoroughly reserves are centralized the simpler is the task of clearing. The machinery for sending out individual items for verification and collection can be more efficiently designed under a system of centralized reserves, while at the same time the system of remitting for such items, through which the principle of clearing is brought into practical operation, can be made to resolve itself into a mere matter of bookkeeping.