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The Use Of Credit Instruments In Payments In The United States

The Supply Of Cash

The credit balances on checking accounts and the notes of commercial
banks are payable on demand in the legal-tender money of the nation to
which they belong, and such banks must at all times be prepared to
meet these obligations.

The term employed to designate the funds provided for this purpose is
reserves, and in this country they consist of money kept on hand
and of credit balances in other banks. In other countries there is
also included under this head commercial bills of the kind which can
always be discounted. The term secondary reserve is sometimes
employed in this country to designate certain securities, such as
high-class bonds listed on the stock exchanges, which can be sold
readily for cash in case of need.

The amount of reserve required can be determined only by experience.
In ordinary times it depends chiefly upon the habits of the community
in which the bank is located regarding the use of hand-to-hand money
as distinguished from checks and upon the character of its customers.
These habits differ widely in different nations, and considerably in
the different sections and classes of the same nation. In most
European and Oriental countries, for example, checks are little used
by the masses of the people, while in the United States and England
they are widely used. In these latter countries, however, they are
less widely used by people in the country than in the cities, and by
the laboring than the other classes in the cities. Within the same
city one bank may need to keep larger reserves than another on account
of the peculiarities of the lines of business carried on by its
customers and the classes of people with whom it deals.

In times of crisis and other periods of extraordinary demand, bank
reserves must be much larger than in ordinary times. Hoarding,
unusually large shipments of money to foreign countries and between
different sections of the same country, and payments of unusual
magnitude, increase the demands for cash made upon banks at such

The manner in which clearing and other balances between banks are met
also has an influence on the amount of reserves required. If such
balances are paid daily and always in cash, the amount needed for this
purpose is much larger than if they are paid in checks on some one or
a few institutions and at longer intervals.

The note issue privileges of a bank also affect its reserve
requirements. Since, if not prohibited by law, notes may be issued in
all denominations needed for hand-to-hand circulation within a nation,
and since for all purposes except small change such notes are as
convenient as any other form of currency, a bank with unrestricted
issue privileges can supply all the demands of its customers for
currency for domestic use, except those for small change, without
resort to outside sources of supply. In this case, however, it needs
to keep a reserve in order to meet demands for the redemption of
notes. Such demands arise on account of the need of coin for small
change or for shipment abroad or of means for meeting domestic
clearing and other bank balances. The aggregate needed for the supply
of such demands, however, is much less than would be required if the
privilege of issuing notes did not exist.

In the maintenance of reserves the chief reliance of commercial banks
is the circulation of standard coin within a nation and the
importation of such coin. The coin within the borders of a nation
passes regularly into the vaults of banks by the process of deposit,
and on account of the credit balances they carry with foreign
institutions, the loans they are able to secure from them, the
commercial paper they hold which is discountable in foreign markets,
and the bonds and stocks sometimes in their possession which are
salable there, they are able to import large quantities in case of
need. Since the standard coin in existence in the world adjusts itself
to the need for it in substantially the same manner that the supply of
any other instrument or commodity adjusts itself to the demand, banks
ordinarily have no difficulty in supplying their needs, and under
extraordinary circumstances, though difficulties along this line
sometimes arise, means of overcoming them are available which will be
discussed in the proper place.

If, as is the case in the United States, certain forms of government
notes are available as bank reserves, these find their way into the
banks' vaults by the process of deposit in the same manner as coin.
The possession of such notes by a bank enables it, to the extent of
their amount, to throw the responsibility for the supply of standard
coin upon the government, and in the circulation of the country such
notes take the place of an equivalent amount of standard coin. Whether
or not a government ought to assume such a responsibility is a
question which will be discussed in a subsequent chapter.

For the nation as a whole, the balances in other banks and the
discountable commercial paper and bonds which a bank may count as a
part of its reserves are not reserves except to the extent that they
may be employed as a means of importing gold. They are only means
through which real reserves of standard coin are distributed. The
payment in cash of a balance with another bank or the discount of
commercial paper with another domestic bank or the sale of bonds on
domestic stock exchanges do not add to the sum total of the cash
resources of the banks of a nation. Their only effect is to increase
the cash resources of one bank at the expense of another.

Adequate facilities for the distribution of the reserve funds of a
country, however, are second in importance only to the existence of
adequate supplies of standard coin. If such facilities are lacking,
existing reserves can be only partially and uneconomically used, with
the result that much larger aggregate reserves are required than would
otherwise be necessary and that the entire credit system is much less
stable than it otherwise would be.

Next: The Selection Of Loans And Discounts

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