§ 11. Banking credit as a medium of trade. The credit which, in various ways, banks sell 11 serves, in most cases, the purposes of money to their customers. On the contrary, this is not usually true of time deposits, for the motive of the depositor in such cases is usually to invest his funds for a time rather than to keep them available as money. However, there are many cases in which persons save for some moderately distant use - such as the purchase of furniture, of a piano, of a house. The safety and convenience of time deposits, combined with the reward of a small rate of interest, cause great sums, in the aggregate, to be deposited as temporary savings, which otherwise would be hoarded in the form of money and thus withdrawn from circulation. In such cases the time deposit may serve both as an investment and as a monetary fund for future use. This is a great economy in the use of money, for experience shows that in the savings banks of America the average reserves of actual money kept against deposits are only about 1 1/2 per cent. In countries where banks are little known, the amount of actual money hoarded is therefore vastly greater than it is in the United States, where there are $6,500,000,000 of individual deposits in regular savings banks, besides large sums in time deposits in commercial banks.

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 interest 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. Demand deposits are often spoken of (somewhat inaccurately) as "deposit currency," being funds at the command of depositors 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 reserves is multiplied manyfold.12 Of the total $14,000,000,000 were in national and $23,700,000,000 were in other banks. All the demand deposits were subject to cheek, excepting $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 certificates, and $10,100,000,000 not classified, of which a large part was "time deposits on open account," for the withdrawal of which ordinarily 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).

12 In the United States in 1920 individual deposits in banks could be classified as follows:

The method of payment by bank drafts in domestic exchange 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 cancellation 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. Redemption 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 machinery of finance. They gather loanable funds, reduce hoarding, make money move more rapidly, and create a central 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 perform incidentally a further service in developing better business 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 " country 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 exchange, or parity of checks, everywhere in the United States.

13 See above, § 3.

While many small banks have strenuously opposed this because it cuts off a considerable source of revenue, they gain in other ways by performing this service freely for their customers. 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.

References

Agger, E. E., Organized banking. P. 385. New York. Holt. 1918. Cleveland, F. A., Funds and their uses. N. Y. Appleton. 1902. Conant, C. A., History of modern banks of issue. 5th ed. N. Y.

Putnam. 1915. Dunbar, G. F., Theory and history of banking. New ed. N. Y.

Putnam. 1917. Fiske, A. K., The modern bank. N. Y. Appleton. 1903. Holdsworth, J. T., Money and banking. N. Y. Appleton. 1914. Phillips, C. A., ed., Readings in money and banking. N. Y. Mac millan, 1916. Chs. IX, X. Same, A study of the principles and factors underlying advances made by banks to borrowers. P. 374. New York. Macmillan.

1920. Pratt, S. S., The work of Wall Street. P. 447. An account of the functions, methods, and history of the New York money and stock markets. New York. Appleton. 1921. Scott, W. A., Money and banking. N. Y. Holt. 1916. White, Horace, Money and banking illustrated by American History Bost. Ginn. 1914. Bk. III. Chs. MIL