Whether it be regarded as merely rendering money more efficient, enabling a unit of money to perform a larger number of exchanges, or as permitting exchanges to take place without the use of money, the effect is about the same - that is to say, banking tends to create a condition of exchange in which it is easier to dispose of goods, or in which goods are enabled to command the widest possible market. This being granted, it is clear that the effect of banking is to bring about an equalization of the demand for and supply of goods. Improvement in banking methods tends to render this equalization process more perfect, and thus enables the owner of goods to command a return corresponding more truly to the real exchange value of his product than he otherwise could get. Of course the reverse set of factors would tend to bring about the reverse situation. If banking credit be freely extended to borrowers the effect of it is that of rendering the borrowers' wealth, whatever it might be, more readily available as purchasing power. For example, if A owned 1,000 kegs of nails, it might be quite impossible for him to exchange even a small part of them for food or clothing at any given time. He could do so only if he found an immediate demand for nails either in his own or some other cornmunity which he could reach. If, however, he could convert the nails into credit on the books of a bank, the bank would have practically guaranteed that the nails would have a certain purchasing power in the market, the understanding being, of course, that in the event of the bank's judgment proving erroneous the borrower would make up the difference out of other wealth of which he might stand possessed. It is at all events safe to say that the effect of banking as already indicated is to perfect exchange and hence to enable commodities to gain their widest market.

Just here the question arises whether the analysis which has just been given is not based upon the assumption that the bank can always recognize value and that it can correctly appraise it. The answer, of course, must be in the negative. Banks are not always, even with the best application of judgment, wise in estimating the value of goods. If sugar, say, is sold at ten cents a pound, it is too much to expect the bank to be able to predict a decline in the price of such sugar to, say, five cents per pound. If the bank, however, converts the sugar into purchasing power at the rate of ten cents per pound, giving the credit on its books, it has enabled the owner of the sugar to act in the market as if he had definite assurance or certainty that the sugar would be worth ten cents a pound up to the time that he disposed of it. When banks are over-confident in their estimates of future value and grant to each applicant an undue proportion of credit on the strength of goods offered to them as security, or when they accept goods that are not really salable as the basis for such advances, they place in the hands of the borrowers purchasing power which the latter are not entitled to - that is to say, purchasing power which the owners of the goods really do not possess. In this case the borrowers are given a control over the commodities of others which they ought not to have, and if they exercise or apply it they are able to make an artificial demand for the commodities of others. The effect of such action on their part is to raise prices, and the resulting condition is called inflation. Withdrawal of such support by banks, and the restoration of the price level to the point it would have occupied had not such extensions of credit been made, is called deflation.

The bank is thus seen to possess a very broad and far-reaching power over prices which, although self-corrective in the long run, may be used for a time to distort the normal price level. The classical theory of banking holds to the view that this danger is limited or largely avoided if banks are constantly compelled to redeem their outstanding credits in money. As prices rise, more money is needed for circulation in order to exchange actual goods. This tends to draw out cash from the vaults of the banks, and their ratio of reserve to liabilities becomes smaller. Thus the banks are led to contract their liabilities. The safeguard which is thus supposed to exist is, however, temporarily absent if redemption is suspended or if the movement of specie out of and into a country is checked or interfered with. It is entirely lacking when banks are relieved of the necessity of redeeming their obligations, as they were during the European War. In such circumstances the automatic relationship to money disappears and bank credit becomes an independent factor in the price equation.

The question properly to be asked in this connection relates to the standards or measures which banks can or should apply in determining whether the credit extensions they make are likely to have the moderating influence already spoken of or the disturbing influence. It seems to be assumed by some writers that there is no definite means by which the banker can assure himself of the effect of the credit he grants, so that as a matter of fact he can never be certain of the social influence produced by his work. This is an erroneous view of the situation. There is a perfectly safe and reliable guide which can almost invariably be applied by the banker. If the credit that he grants is for a period not longer on the average than the period of commercial credit in his community, his extension of credit will tend to bring about a steadier, smoother flow of goods from producer to consumer, and so will tend to "even up" prices. If, on the other hand, the period of credit allowed by the banker is much longer than that which is necessary to bring about the transfer of goods from producer to consumer, the banker is practically supplying the producer with capital, or in other words is enabling him to keep turning over his operations. In this case the counter effect of the credit already spoken of sets in. It may easily be that in any given loan or at any given moment the banker may find it difficult to decide whether his extension of credit is safe or sound or not, or whether it is being used to bring about fluctuations of prices. An analysis of the general port-folio or body of investments of the bank, however, always shows the real character of the average credit extended by the banker and gives him an unquestionable standard of judgment. If his loans are constantly growing longer, being renewed and seldom completely liquidated or cleaned up by the borrowers, the banker is in what is technically called an "over-extended condition." In such a case the bank is tending to accentuate price fluctuations.

Recognition of this important function on the part of the bank has led in some quarters to a demand for government regulation of banking, or to complaints that a money autocracy or money trust was able to control the business of the public, enhance prices (or reduce them), or otherwise work against the public interest. Whatever might be the abstract possibility of the creation of such a "trust" experience shows that it cannot carry matters as it chooses for more than a very short time, and that mistakes or unwise policies in banking simply react upon the banks themselves. The banks, in other words, are not the proprietors of "money," but they are service institutions whose function it is to exchange goods. They prosper as their customers prosper and suffer as the latter suffer. Governments have no means of testing credit or of ascertaining whether it is being wisely or unwisely extended, except those that the banks themselves have devised and furnished. The whole history of money and banking is adverse to government interposition in or management of banking. As we have already seen, most modern banking systems provide for some participation or oversight by the government, but this is rather to insure fair play, avoid possibilities of favoritism, guarantee thorough examination, and otherwise maintain the rules of the game, than it is to furnish standards of control or canons of banking that are better or fairer than those developed by the banking business itself.