money left with the bank subject to draft by checks involves in itself an act of creation. The man who deposited the money has not thereby lessened the amount of purchasing power, or media of payment, at his immediate disposal. He has simply converted the media of payment into another form, the possession of which makes him no less effective a factor in the market. He has loaned the bank nothing; he has postponed neither his right, nor, probably, his intention to spend. The fact that he is willing to accept a book credit at the bank in lieu of lawful money, in the confidence that he can make equal use of either, is another matter altogether: it merely explains why it is that the cash deposit enables the bank to make a loan that duplicates the original depositor's undiminished command of media of payment. The significant point is that, to the extent that the people of a community are willing to keep their current purchasing power in the form of balances in their check accounts, even the individual bank is able to cause two units of media of payment, each as active as legal tender money itself would be, to exist where there was one before. We might, to be sure, regard the check as merely transferring by proxy the primary deposit which made the created deposit possible, and insist that simply an increase in the velocity of circulation of the original deposit is involved. But there is no more reason to do this than there is to regard bank notes as mere proxies that accelerate the circulation of other forms of cash, instead of treating them as being themselves media of payment.

Nor is it a helpful point of view to contend that, since the initial depositor could, by pressing his demand claim upon the bank, destroy the latter's ability to continue the new loan, the bank has borrowed from this man that which it lends to another. For, aside from the fact that the bank has already given an equivalent for the cash received, it is with the deposit in the generic sense that we are concerned with the sum totals of deposits and of cash reserves rather than with specific ones. If a depositor withdraws cash that is soon replaced by another patron, no essential change has been made with reference to the lending ability of the bank. To be sure, the bank is able to make loans only because its depositors as a group refrain from withdrawing the reserves upon

which the deposits are based. But this is merely equivalent to saying that banking can extend credit upon the basis of certain cash reserves only so long as those reserves continue to exist.

Still again, -for the problem is a treacherous one, if the individual bank could function simply as a middleman, passing on to borrowers funds that are left by cash depositors, it would be impossible for us to read into the operations of the banking system as a whole any more than this. For, obviously, if no single bank creates the deposits it lends, the group of banks taken together cannot do so.

By way of final argument - and we return now to the point of view of the banking system at large- let us ask what would happen were the habits of a community to change overnight and were checks to be used to a much less degree in making payments. To simplify the analysis, let us say that the government reserved for itself the privilege of issuing paper money. Assume that one million dollars were suddenly and permanently withdrawn from bank reserves, to circulate in making payments hitherto accom. plished by the drawing and depositing of checks. The aggregate of bank deposits would immediately shrink by the amount of one million dollars through the action of depositors in exercising their rights against the banks. But would the matter stop there? Obviously not, for the banks would have to contract their loans by several million dollars until the proper reserve ratio had been restored by the resultant contraction of deposits. Surely one can hardly regard the banking system as serving simply in an intermediary capacity if the withdrawal by depositors of a given amount of cash, diminishing the aggregate of reserves in the system, causes a contraction of loans to several-fold the amount of the deposits cancelled.

CHAPTER XII

PRINCIPLES OF NOTE ISSUE - CONVERTIBILITY

The need of convertibility little understood in the colonies. — Convertibility was generally assumed in the later period. - Belated land-bank projects. — Other advocates of an inconvertible currency. The banking principle as basis for such a proposal. Stephen Colwell's notable statement of the thesis.

THE importance of maintaining the immediate convertibility of paper money was but little appreciated in the colonial period. One of the most interesting chapters in colonial banking literature is concerned with that problem, and the extent to which security, now in the form of real estate mortgages and now in the form of staple commodities as well, was substituted for specie reserves in the schemes of the day, is familiar knowledge to all students of colonial banking. The operations of the deposit banks of continental Europe (which virtually issued warehouse receipts, reduced to common denominations, for the sundry coins in circulation) were familiar to the colonists, and to many of them, as to monetary "reformers" of later periods, it seemed but a logical step to issue like receipts to circulate as media of payment against real and personal property of recognized value.

We find in some cases definite traces of the influence of the English land-bank schemes, and frequent references to John Law leave no doubt as to the extent of his influence. Franklin thought that land is a better basis for note issue than specie, in that the latter is liable to depreciate from sudden increase in its quantity, whereas land is more stable in value, and probably appreciates slowly with the gradual growth of population.1 "The Earth endures forever," several tracts remind us, and must obviously be the best type of security.2

John Colman, one of the most ardent and best known of the friends of a plentiful currency, expressed a common disparage

1 Franklin, "Modest Inquiry," etc. (1729), Works, ii, 268.

2 "Money the Sinews of Trade" (1731), Davis's Reprints, ii, 435; "A Proposal to Supply a Medium of Exchange" (1737), Reprints, iii, 174.

ment of the precious metals as the basis of paper money when he asked:

What intrinsick value is there in Silver, or Gold more than in Iron, Brass, or Tinn, but only the common acceptation of it by men in Trade, as a Medium of exchange.... Is not every thing in this World, just as men esteem and value it: If a man give me his Bond, it is as good in my Opinion as Silver; and the only reason why it is so, is, because it will pay my Debt, or command wherewith to Pay it: Surely then if a Bank Note will answer for that end, and will purchase for me Food, Physick, and Cloathing, and all necessaries of Life, it answers all the ends, which Silver & Gold can answer for.1

A medium of payment, in the opinion of a later writer, is none the better for having "intrinsic value." The significant thing is the amount of goods for which a unit of the currency will exchange, and the writer rebuked the merchants for raising the prices, in terms of bills of credit, of coins and commodities. "The only Thing needful then to keep up its Value, is the making a proper and resolute Stand against that inconsiderate Folly." 2

Such emphasis upon the mere customary exchange value of a paper currency, without question as to the source of that value, would lead, logically, to a minimizing even of the need of ultimate security, such as land mortgages. The fiat theory, however, did not usually stand by itself, but was used to buttress arguments for a currency secured by land. Franklin, for example, in his polemic addressed to the Board of Trade in 1764, urged that, although the colony bills lacked convertibility,

the legal tender, being substituted in its place, is rather a greater advantage to the possessor; since he need not be at the trouble of going to a particular bank or banker, finding (wherever he has occasion to lay out money in the province) a person that is obliged to take the bills."

The land-bank projects frequently provided that the subscribers were to bind themselves to receive the notes at a given value. The advocates of inconvertible paper did not rest their case upon the claim of its absolute desirability. We have seen that the

1 "Distressed State of... Boston Once More Considered" (1720), Reprints, ii, 88. Cp. "A Modest Apology for Paper Money" (1734), Reprints, iii, 91, 92.

2 "A Letter Relating to a Medium of Trade" (1840), Reprints, iv, 20, 21. Similarly, "A Word of Comfort," etc. (1721), Reprints, ii, 193.

Franklin, "Remarks and Facts" (1784), Works, ii, 348; cp. p. 354. See Davis's Reprints, ii, 85.

vogue of land banking and of paper currency, which became most extensive about the years 1714, 1720, and 1740, was intimately connected with cheap-money agitation; and in part the failure to provide for convertibility into specie was caused by the fact that the projects of the time were intended to remedy the very difficulty that the supply of specie was supposedly inadequate. Even if a convertible currency were to be preferred, it was commonly argued, the want of sufficient specie prevented its adoption. Paper money possessed this superiority over metallic money, namely, that the country could not be deprived of it by an unfavorable balance of trade.1 This raised the question, with which we have dealt in a preceding chapter, whether the issue of paper money had caused the drain of specie, or the reverse.2

It must not be thought, however, that there was none to insist that paper money should be payable in specie. "I would thank no man," wrote one critic, "for his Note or Bond, obliging himself always to owe me a Thousand Pounds, for if he always owes it, he never pays it, and so I shall never be the better for it." 3 The land security given for notes, Governor Hutchinson observed, "is a sufficient Surety to the Province, that they shall be paid in again, but it is no Security to the Possessors or the Persons that give a Credit to them, that they shall purchase as much Silver or Gold the next Year, as it does the present." 4

Most of the proposals for specie-paying banks contemplated notes redeemable in silver at some future date. The silver for this purpose was usually to be secured by requiring that the loans through which the notes had been put into circulation should be repaid in metallic money, perhaps by installments. The found

1 "A Word of Comfort," etc. (1721), Reprints, ii, 167; "Inquiry into the Nature and Uses of Money" (1740), Reprints, iii, 412-423.

2 See Chapter III.

"Addition to the Present Melancholy State," etc. (1719), Reprints, i, 381. Cp. "Objections to the Bank of Credit,” etc. (1714), Reprints, i, 252.

4 "A Letter to a Member of the House," etc. (1736) Reprints, iii, 153.

"A Project," etc. (1720), Reprints, ii, 140 ff.; "A Letter to a Member of the House," etc. (1736), Reprints, iii, 157; "Communication to the Weekly Journal" (Jan. 1, 1740), Reprints, iii, 289–297. An interesting suggestion, rejected by its author as impracticable, was that of Hugh Vance for a bank to issue bills "promising a certain Sum payable in 3 or 6 Months, to the Possessor, in Sterling-Drafts.” "Inquiry into the Nature and Uses of Money" (1740), Reprints, iii, 413.