The Theory of Money and Credit

There is nothing remarkable in the fact that money substitutes, as completely liquid claims to money against persons whose capacity to pay is beyond all doubt, have a value as great as the sums of money to which they refer Admittedly, the question does arise: Are there any persons whose capacity to pay is so completely certain as to be quite beyond all doubt? And it may be pointed out that more than one bank, whose solvency nobody had dared to call in question even the day before, has collapsed ignominiously; and that so long as the remembrance of events of this sort has not entirely vanished from human memory, it must evoke at least a small difference between the valuation of money and that of claims to money payable at any time, even if, as far as human foresight goes, these latter are to be regarded as completely sound.

It is undeniable that such questions reveal a possible source of a certain lack of confidence in notes and checks, which would necessarily result in money substitutes having a lower value than money. But, on the other hand, there are reasons which might cause individuals to value money substitutes more highly than money, even if demands for the conversion of money into money substitutes were not always satisfied immediately. We shall have to speak of this later. Furthermore, quite apart from all these circumstances, it should be clearly pointed out that doubts as to the quality of fiduciary media are hardly tenable nowadays. In the case of money substitutes of medium and small denominations, among which token coins occupy the most important place, doubts of this nature do not come into consideration at all. But in the case also of the money substitutes that are used to meet the requirements of large-scale business, the possibility of loss is as good as nonexistent under present conditions; at least the possibility of loss is no greater in connection with the money substitutes issued by the large central banks than is the danger of demonetization that threatens the holders of any particular kind of money.

Now the complete equivalence of sums of money and secure claims to immediate payment of the same sums gives rise to a consequence that has extremely important bearings on the whole monetary system; namely, the possibility of tendering or accepting claims of this sort wherever money might be tendered or accepted. Exchanges are made through the medium of money; this fact remains unaltered. Buyers buy with money, and sellers sell for it. But exchanges are not always made by the transfer of a sum of money. They may also be made by the transfer or assignment of a claim to money. Now claims to money which fulfill the conditions mentioned above pass from hand to hand without those who acquire them feeling any need for actually enforcing them. They completely perform all the functions of money. Why then should the bidders burden themselves with the trouble of redeeming them? The claim which has been set in circulation remains in circulation, and becomes a money substitute. So long as confidence in the soundness of the bank is unshaken, and so long as the bank does not issue more money substitutes than its customers require for their dealings with one another (and everybody is to be regarded as a customer of the bank who accepts its money substitutes in place of money), then the situation in which the right behind the money substitute is enforced by presentation of notes for redemption or by withdrawal of deposits simply does not arise. The bank-of-issue may therefore assume that its money substitutes will remain in circulation until the necessity of dealing with persons outside the circle of customers forces holders to redeem them. This, in fact, is the very thing which enables the bank to issue fiduciary media at all, that is, to put money substitutes in circulation without maintaining in readiness the sum that would be necessary to keep the promise of immediate conversion that they represent.

The body which issues the fiduciary media and is responsible for maintaining their equivalence with the sums of money to which they refer must nevertheless be able to redeem promptly those fiduciary media which their holders present for conversion into money when they have to make payments to persons who do not recognize these fiduciary media as money substitutes. This is the only way in which a difference between the value of money on the one hand and of the notes and deposits on the other hand can be prevented from coming into existence.