The Theory of Money and Credit

Since it is not the object of a redemption fund to provide for the redemption of such money substitutes as are returned to the bank because of lack of confidence in their goodness, but only to provide the bank’s customers with the media of exchange necessary for dealing with persons who are not among its customers, it is obvious that such a fund might be composed at least in part of such things as, without being money, can be used like money for dealings with outsiders. These things comprise not only foreign money substitutes but also all such claims as form the basis of the international clearing business, primarily, that is to say, foreign bills, that is, bills on foreign places. The issue of money substitutes cannot be increased beyond the quantity given by the demand for money (in the broader sense) of the customers of the bank for intercourse within the clientele of the bank. Only an extension of the clientele could prepare the way for an extension of the circulation; for the national central bank-of-issue, whose influence is limited by political boundaries, such an extension remains impossible. Nevertheless, if part of the redemption fund is invested in foreign banknotes, or in foreign bills, foreign checks, and deposits at short notice with foreign banks, then a larger proportion of the money substitutes issued by the banks can be transformed into fiduciary media than if the bank held nothing but money in readiness for the foreign dealings of its customers. In this way a credit-issuing bank may even transform into fiduciary media almost all the money substitutes that it issues. The private banks of many countries are now no longer far removed from this state of affairs; they are in the habit of providing for the prompt redemption of the money substitutes issued by them by holding a reserve itself consisting of money substitutes; only so far as these covering money substitutes are money certificates do the issued money substitutes not bear the character of fiduciary media. It is only fairly recently that the central banks-of-issue also have begun to adopt the practice of admitting money substitutes and foreign bills into their conversion funds.

Just as the goldsmiths once began to lend out part of the moneys entrusted to them for safekeeping, so the central banks have taken the step of investing their stock of metal partly in foreign bills and other foreign credits. An example was set by the Hamburg Giro Bank, which was accustomed to hold part of its reserve in bills on London; it was followed during the last quarter of the nineteenth century by a series of banks-of-issue. It was with regard to their profits that the banks accepted this system of cover The investment of a part of the redemption fund in foreign bills and other foreign balances that could be easily and quickly realized was intended to reduce the costs of maintaining the reserve. In certain countries the central banks-of-issue acquired a portfolio of foreign bills because the domestic discount business was not sufficiently remunerative.13  Generally speaking, it was the central banks-of-issue and the governmental redemption funds of the smaller and financially weaker countries that tried to save expense in this way. Since the war, which has made the whole world poorer, their procedure has been widely imitated. It is clear that the policy of investing the whole redemption fund in foreign claims to gold cannot become universal. If all the countries of the world were to go over to the gold-exchange standard and hold their redemption funds not in gold but in foreign claims to gold, gold would no longer be required for monetary purposes at all. That part of its value which is founded upon its employment as money would entirely disappear. The maintenance of a gold-exchange standard with the redemption fund invested in foreign bills undermines the whole gold-standard system. We shall have to return to this point in chapter 20.

• 13See Kalkmann, “Holland’s Geldwesen im 29. Jahrhundert,” in Schmoller’s Jahrbuch, vol. 25, pp. 2249 ff.; Witten, “Die Devisenpolitik der Nationalbank von Belgien,” in ibid., vol. 42, pp. 625 ff.