Bank notes and bank deposits are essentially alike. Both are liabilities of the bank, deposits being payable to the depositor or his order as evidenced by the check, notes being payable to the holder, and both being payable on demand. Moreover, reserves are held against both, and both notes and deposits increase the purchasing power of their holder wherever the bank's credit is accepted.
To judge from the prevalence of erroneous and misleading statements by newspapers and the general public, it would seem that the writers on banking theory have not given sufficient emphasis to the essential likeness of bank notes and deposits. The bank itself is largely indifferent as to which of these two forms of credit the customer requests, and the customer acts as occasion demands, turning in bank notes for credit to his deposit account, or having his check "cashed" in bank notes, both bank and customer distinguishing these two credit forms only with respect to convenience. Neither form increases directly the wealth of the bank, the customer, or the country; they are both credits and give the holder claim to existing wealth, but are not themselves wealth. The issue of a billion dollars of bank notes or the creation of a billion dollars of deposits by the process of loans and discounts does not of itself increase the wealth of the country one whit. To regard the deposits of the banks of a country as an index of the growth of the country's real wealth is a serious error. It is still more serious to measure the strength or greatness of a bank or banking system by its deposits, such a measure indicating an error, not only in not adding bank notes to deposits but also in regarding a liability of a bank as an element of strength. It is assets alone which constitute the strength of any institution.
The failure to recognize the similarity of bank notes and deposits appears most often, however, in statements about inflation. It is not often realized that inflation of price levels is caused by deposits no less than by bank notes - and indeed that the influence of deposits is the sooner felt. The offer of either bank notes or checks will effect a purchase. The mere existence of a large amount of either bank notes or deposits does not affect prices; it is only as notes or deposits are offered for goods that the demand side of the market expands and raises prices. In the actual process of economic life it happens that purchases, and therefore inflation, through the medium of deposits often precede inflation through the medium of bank notes. Generally in times of increasing trade activity wholesale prices rise before retail prices, and the wholesale prices are affected almost wholly by deposits. The dispersion of these deposits by manufacturers, jobbers, and retailers for wages and materials requires circulating notes, which then in the hands of small holders occasion retail demand and consequent rise of retail prices. The point is illustrated by the recent process of percolation of the huge war credits through the munitions manufacturers to the wage-earners, with the consequent increase in the quantities of federal reserve notes and the rise in the cost of living.