Front Page Titles (by Subject) VI. The Role of Deposits, Bills of Exchange, and Credit in the Currency System - Studies in the Theory of International Trade
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VI. The Role of Deposits, Bills of Exchange, and “Credit” in the Currency System - Jacob Viner, Studies in the Theory of International Trade 
Studies in the Theory of International Trade (New York: Harper and Brothers, 1965).
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VI. The Role of Deposits, Bills of Exchange, and “Credit” in the Currency System
It was, as we have seen, the position of the banking school that bank notes and bank deposits were both means of payment and parts of the circulating media, and that, since the proposals of the currency school dealt only with bank notes and left bank deposits free of control, they were bound to operate unsatisfactorily if put into practice. In a memorandum to Tooke in 1829, Pennington insisted that the deposits of London bankers performed exactly the same function as did the notes of country bankers: “the book credits of a London banker, and the notes of a country banker, are but two different forms of the same species of credit.” 1 This statement by Pennington is often credited with being the first statement of the identity between the economic functions of notes and deposits. It undoubtedly exerted a considerable influence not only on the members of the banking school, but also on the currency school, and especially on Torrens.2 But Pennington was merely repeating an old doctrine. At the very beginning of paper money in England, it was recognized that the transfer of bank notes and the transfer of book credits at the bank were alternative means of making payments.3 During the restriction on cash payments at the beginning of the nineteenth century the part played by the expansion of bank deposits in bringing about rising prices and the premium on bullion never became a subject of controversy, but a number of writers, both bullionist and anti-bullionist, in their analysis of the monetary process, assigned to bank deposits a role identical with that of bank notes. Boyd, in 1801, held that the “open accounts” of London bankers were, equally with country bank notes, an “addition to the powers of the circulating medium of the country.” Bank notes were the “active circulation” of the banks; book credits were the “passive circulation” because they circulated only as their owners issued orders upon the bank.4 Thornton in 1802 treated bank deposits as a substitute for paper money.5 James Mill, in 1807, accepted “the common cheque upon a banker” as in the same class with the bank note, both being “currency,” but neither being “real money.” 6 Lord Stanhope in 1811 presented a resolution in the House of Lords to authorize the Bank of England to establish branches throughout England, and to substitute for bank notes book credits with the Bank, to be legal tender and transferable without cost. Stanhope claimed for this proposal that it would avoid the disadvantage of paper money of its liability to forgery, and the disadvantage of metallic currency, of the influence on its quantity of the international balance of payments.7 He clearly regarded bank deposits as identical with bank notes in their monetary significance. Torrens, who was later radically to change his monetary views, in 1812 claimed that checks and bills of exchange were more important elements in the circulation than bank notes.8 Samuel Turner pointed out that “A country bank was a kind of clearing-house, where, without any actual interchange of notes or money, the greater part of all payments between man and man was effectuated by mere transfers in the books of their bankers.” 9 Senior stated that deposits subject to check were more important banking instruments for making payments than were bank notes.10 Other writers, while denying to bank deposits the dignity of constituting an independent element in the circulating medium, conceded that they were “economizing devices,” which rendered a smaller amount of bank notes sufficient to mediate a given volume of monetary transactions.11
There might be debate among economists today as to whether bank deposits are “money” or are “currency.” There would be general agreement, however, that they are, like bank notes, means of payment and therefore a part of the circulating medium. Many early writers, however, insisted that bills of exchange were also part of the circulating medium. Henry Thornton, in 1797, included as “means of payment,” not only coin and bank notes, but also bills of exchange “when used as such,” i.e., when they served as a means of final settlement of a transaction.12 An anonymous author wrote in 1802 that “Cash, or ready money, when considered as the medium of payment in a commercial country, comprehends every species of negotiable paper....” 13 Ravenstone stressed the importance of bills of exchange as a means of payment, and declared that “I do not know how this species of paper has entirely escaped the attention of those who have treated this subject.” 14 Burgess,15 Parnell,16 and subsequently many other writers, included bills of exchange as parts of the circulating medium.
Some writers included “credit” as a part of the circulating medium, but meant by “credit” bank credit, and regarded it not as an item additional to bank notes and bank deposits, but as the source from which the two latter items arose.17 But other writers, most notably J. S. Mill, included credit in a broader sense as an element of “purchasing power”:
The purchasing power of an individual at any moment is not measured by the money actually in his pocket, whether we mean by money the metals, or include bank notes. It consists, first, of the money in his possession; secondly, of the money at his banker's, and all other money due to him and payable on demand; thirdly, of whatever credit he happens to possess. To the full measure of this threefold amount he has the power of purchase. How much he will employ of this power, depends upon his necessities, or, in the present case, upon his expectations of profit. Whatever portion of it he does employ, constitutes his demand for commodities, and determines the extent to which he will act upon price.... Bank notes are to credit precisely what coin is to bullion; the same thing, merely rendered portable and minutely divisible. We cannot perceive that they add anything, either to the aggregate of purchasing power, or to the portion of that power in actual exercise.18
Modern writers on money as a rule include specie, government or bank notes, and bank deposits payable on demand by check, as constituting “money,” or the “circulating medium,” or the stock of “means of payment.” They exclude bills of exchange and promissory notes, and treat checks as merely the instruments whereby bank deposits are transferred or “circulate.” But during the early part of the nineteenth century bills of exchange for small amounts were still commonly used in some parts of England, and especially in Lancashire, as a means of payment between individuals, and sometimes passed through many hands in settlement of transactions before they matured and were canceled. To the extent that the receivers of these bills passed them on to others before their maturity in payment of debts or as payment for purchases, they functioned just as did bank notes and were properly to be included in the circulating medium. As one contemporary writer, Edwin Hill, pointed out, anticipating Francis Walker's dictum that “Money is that money does,” the correct test of whether something is “currency” or not is not what it is, but what it does; bills of exchange, to the extent that they settled transactions without involving the use of any other medium, acted as currency.19 But even when bills of exchange do not pass from hand to hand, they are still entitled to be ranked with checks as instrumentalities whereby bank deposits are transferred, provided, as was generally the case in England, these bills were made payable at the acceptor's bank and when they matured were passed through clearings and credited to and debited against bank accounts in the same manner as checks.
In including personal command over credit and individual claims on other individuals as part of the stock of “purchasing power,” J. S. Mill went too far. If valid individual claims to immediate payment are included as means of payment, then individual liabilities to immediate payment should be subtracted therefrom. Since these items are necessarily equal, they cancel each other, although they may in practice affect in different degree the willingness of the creditors and the unwillingness of the debtors to use their cash balances in other transactions. The case of command of credit in making purchases presents more difficulty. If all who can purchase on credit were simultaneously to do so, prices would rise even if demand deposits and notes in circulation remained unchanged in volume, for it is purchases which raise price levels, rather than payments for purchases. But the maintenance of the higher level of purchases requires, after some interval, an augmentation of the volume of payments, and this in turn requires either more means of payment of their greater “velocity” or rapidity of use. But the whole discussion as to what is and what is not “money” retains the appearance of significance only while velocity considerations are kept in the background. What mattered for the currency school-banking school controversy was the extent and the causes of the fluctuations in the volume of payments, i.e., of amount of money times its payment velocity, and therefore the wrongful inclusion as money of something which did not serve as a means of payment was of little consequence if its velocity coefficient was recognized to be zero. Moreover instruments which were not money at some particular moment could be so at some other moment. In this connection bills of exchange, time deposits, and overdraft privileges could be regarded as a sort of “potential money.” The quality which one writer attributed solely to bills of exchange, as the result of which “they can be either kept in the circulation, as media of payment, or withdrawn from the circulation, and held for a time as interest-bearing investments,” 20 was possessed also by time deposits, which could without much delay be transformed into demand deposits.
That differences in their velocity of circulation were the significant basis on which bank notes, deposits, and bills of exchange could be distinguished from each other with respect to their possession of the qualities of “currency” was by no means overlooked during this period. The existence of such differences was, indeed, the main ground on which the currency school refused to include deposits and bills of exchange, with their comparatively low velocity of circulation, on a parity with bank notes as parts of the circulating medium. This could be conceded to the currency school, however, without accepting their conclusion that deposits and bills of exchange should be treated as not constituting any part of the circulating medium, and should have led only to the assignment of greater weight to a given quantity of bank notes than to the same quantity of deposits. This was in effect done by several writers. Gilbart, for instance, although insisting that deposits were means of payment just like bank notes, argued that the extent to which they perform the functions of money must be measured, “not by the amount of the deposits, but by the amount of the transfers.” Because only deposits payable on demand could be transferred, he considered only such deposits as a part of the currency.21 Longfield, similarly, held that the greater velocity of circulation of bank notes was a significant, but the only significant, difference between deposits and notes, in so far as their influence on prices was concerned.22 J. W. Lubbock expounded the same doctrine for cash, checks, and bills, with the aid of an algebraic formula which has close resemblance to Irving Fisher's celebrated “equation of exchange.” 23
Although the members of the currency school all supported a system of currency regulation which would place the issue of bank notes under rigorous control but would leave deposits wholly free from interference, they did not agree on the grounds which justified this discriminatory treatment of deposits and notes.24
Torrens freely conceded that bank deposits and bank notes were coordinate means of payment and acted similarly on prices. He claimed, however, that payments in specie and notes bore a constant proportion to payments by check and that an expansion of deposits could therefore not take place without an increase of gold or notes,25 regulation of the volume of note issues thus automatically involved regulation of the volume of bank deposits.26 Sir William Clay conceded the similarity between bank deposits payable upon demand and bank notes,27 and even admitted that the latter were a subsidiary circulating medium, and one whose importance was bound to decrease.28 He nevertheless insisted that the issue of bank notes needed to be and could be closely controlled. As for deposits, however, he knew of no practicable means of controlling their volume, and in any case there was no desire for such control in any quarter.29
Norman's main argument against the inclusion of deposits as a part of the currency was that the velocity of circulation of deposits was much less than that of bank notes or coin.30 He also claimed that the volume of deposits and bills of exchange was dependent on the volume of underlying credit, which in turn was regulated by the amount of bank notes and coin, and that in any case the influence on prices of these “economizing expedients” was only “trifling and transient.” 31 It was no more reasonable, moreover, to object to proposals for regulating note issues because the “economizing expedients” were left unregulated than it would be, in the absence of paper money, on similar grounds to object to the regulation of coin.32 Norman argued also that all that the currency school proposed was that the currency should be made to operate as if it were a purely metallic currency; but even under such a currency, i.e., even if bank notes did not exist, “the trade in money, like other trades, would be occasionally out of joint, although not probably so often or to so great an extent as now.” 33
Overstone's case for limiting regulation to note issues also consisted mainly of this argument that if a currency system which included bank notes could be made to operate as would a currency system in which bank notes did not exist, that was all that could be expected of it:
The utmost that can be expected from a paper-currency is that it shall be the medium of adjusting the various transactions of a country without greater inconvenience to the community than would arise under a metallic circulation.34
Deposits, debts owing, indeed credit in any form, may be made the means of purchasing and paying, of adjusting transactions; and they may therefore, in one sense, be considered as forming a part of what has been called “auxiliary currency.” But the whole superstructure of “auxiliary currency” forms a subject, distinct from that of the management of the circulation. It may be raised equally upon a metallic or a paper circulation, and the fluctuations which it may undergo are subject to laws distinct from those which ought to regulate the substitution of paper for metallic money.35
The final outcome of the discussion was that the currency school agreed with the banking school that deposits and other forms of “auxiliary currency” or “economizing expedients,” as well as bank notes, could be a source of difficulty, but that the two groups appraised differently the relative importance of variations in the two types of means of payment as causes of currency and credit disturbances. The currency school were not prepared to support government regulation of the credit operations of the banking system, but believed that statutory limitation of the note issues would bring a substantial measure of improvement. The banking school refused to support statutory restrictions on either bank deposits or bank notes, and maintained that the strict limitation of the amount of uncovered note issue would either have no effect or would operate to accentuate rather than to moderate the fluctuations in business conditions.36
It is not sufficient, to refute the currency school argument, to show that note circulation and bank deposits have divergent fluctuations, or even that there are divergent fluctuations in the volumes of payments by means of bank notes and checks, respectively, if, as the currency school assumed to be the case, the relative use of notes and checks is at any one moment, given the circumstances and habits then prevailing, fairly definitely fixed, and if the regulation of the quantity of notes does not of itself operate to induce a change in these relations. But given their price and business-stabilizing objectives, the currency school should have proposed such a method of regulation of note issue as would have resulted at all times, if velocity is left out of account, in the desired aggregate volume of means of payment, or taking velocity into account, in the desired aggregate volume of payments. Since the different stages of a business cycle are marked by variations in the proportions between bank notes and deposits, mere limitation of the amount of uncovered note issue would not suffice, and no method of regulation of note issue would suffice which did not make provision for cyclical changes in the ratio between bank notes and deposits and in their relative velocities, as well as for any changes in these ratios which the regulation of one type of means of payment might itself tend to bring about. Since these provisions could not be reduced to a simple formula, regulation of note issue alone, though it might still operate on the whole to make a “mixed currency” conform more closely to a “purely metallic currency” than if left wholly unregulated, would fail to bring about the desired results with respect to prices and the volume of business activity. An additional difficulty, with respect to the timing of regulatory measures, would arise, if, as appears to have been the case, the fluctuations in deposits preceded, instead of being simultaneous with or following, the fluctuations in note issues, so that if attention was confined to note issue alone the danger signals would come too late.37
During this period, however, the relative importance of bank notes in the English circulating medium, while steadily decreasing, was much greater than it is today. It is possible, moreover, to defend the currency school against these criticisms, even if deposits are acknowledged to be coordinate with notes as means of payment, if their objective of limiting the fluctuations in the volume of means of payment to such as would exist under a “purely metallic currency” is accepted as adequate, and if it is conceded that the variations in the proportions of deposits to specie and notes under a “mixed currency” would correspond, caeteris paribus, to the variations in the proportions of deposits to specie under a “purely metallic currency.”
“Paper communicated by Mr. Pennington,” printed as appendix no. I in Thomas Tooke, A letter to Lord Grenville, 1829, pp. 117–27.
Pennington repeated his argument in a paper sent to Torrens, which the latter published as appendix no. ii to his A letter to ... Melbourne on the causes of the recent derangement in the money market, 2d ed., 1837, pp. 76–80. Torrens, under Pennington's influence, finally accepted most of the banking school doctrine with respect to the role of bank deposits.
Cf. A discourse concerning banks, 1697, p. 6; A vindication of the faults on both sides , in Somers' Tracts, 2d ed., 1815, XIII, 5.
Letter to Pitt, 2d ed., 1801, p. 22, and appendix, p. 9. In testimony before the Lords Committee of 1797 Boyd had denied that discounts by private bankers were an addition to the circulating medium; they were only one of the many ways in which “the circulating medium really existing may be employed.” (Report of the Lords Committee of Secrecy, 1797, p. 54.)
Paper credit, 1802, p. 55.
Review of Smith, “Essay on the theory of money and exchange,” Edinburgh review, XIII (1808), 52.
Hansard, Parliamentary debates, 1st series, XX (July 12, 1912), 908 ff.
An Essay on money and paper currency, 1812, p. 289, note.
Considerations upon the agriculture, commerce and manufactures of the British Empire, 1822, p. 54.
N. W. Senior, Three lectures on the transmission of the precious metals, 2d ed., 1830, pp. 21–22.
Cf. the Bullion Report, 1810, p. 63.
Report of the Lords Committee of Secrecy, 1797, p. 71.
Of the utility of country banks, 1802, p. 3.
Piercy Ravenstone, A few doubts as to the correctness of some opinions generally entertained on the subjects of population and political economy, 1821, p. 376.
Henry Burgess, A letter to ... George Canning, 1826, p. 21.
Sir Henry Parnell, Observations on paper money, 2d ed., 1829, p. 73.
Fullarton, per contra, maintained that only coin with an intrinsic value equal to its face value was “money,” and that all other instruments of exchange, including bank notes, bank deposits, and bills of exchange, were “credit.” (On the regulation of currencies, 2d ed., 1845, pp. 35 ff.)
J. S. Mill, review of Tooke and Torrens, Westminster review, XLI (1844), 590–91.
Edwin Hill, Principles of currency, 1856, pp. 105–06. R. H. Walsh later improved on this analysis by pointing out: (1) that credit instruments reduce the number of transactions for which “money” is needed only when they are exchanged for goods or services and increase the number when they are exchanged for money: (2) but that even when the use of credit instruments increases the number of transactions in which money must be used, as when to make a payment in another locality a person buys with money a bill of exchange which the recipient cashes for money, the amount of time during which money is employed to effect the transfer may be less than if no bills of exchange were used.—“Observations on the gold crisis,” Journal of the Dublin Statistical Society, I (1856), 186.
E. Hill, Principles of currency, 1856, p. 107 (italics in original).
“The currency: banking,” Westminster review, XXXV (1841), 99–100.
“Banking and currency, IV,” Dublin University magazine, XVI (1840), 613.
[J. W. Lubbock] On currency, 1840, pp. 29 ff.
Cf. Report from [Commons] Select Committee on banks of issue, 1840: evidence of Lord Overstone (Loyd), pp. 212, 281 ff.; Norman, p. 143; Sir Charles Wood, pp. 50 ff. On one point they were in agreement. The holder of a bank note was more entitled to protection against loss than the holder of a check. Bank notes were a common medium of hand-to-hand circulation, used by all classes, including persons who were in no position to inform themselves as to their quality or to bear a loss. Checks, on the other hand, were used mainly by businessmen and the well-to-do, who could better protect themselves against loss.
Even if the proportion of payments in specie and notes to payments by check remained constant, this would be valid only if the relative velocities of circulation of deposits and notes also remained constant.
Reply to the objections of the Westminster review, 1844, pp. 16–17. To this argument the banking school replied by citing statistical data purporting to show marked short-run divergencies between the fluctuations in deposits, in note circulation, and in volume of bills of exchange outstanding. Cf. Wm. Newmarch, “An attempt to ascertain the magnitude and fluctuations of the amount of bills of exchange ... in ... circulation,” Journal of Statistical Society of London, XIV (1851), 154 ff., and, for an attempt by an adherent of the currency school to meet this argument, cf. G. Arbuthnot, Sir Robert Peel's Act of 1844 ... vindicated, 1857, p. 30.
Remarks on the expediency of restricting the issue of promissory notes, 1844, pp. 14 ff.
“Notes, indeed, may be considered as ancillary to deposits, their functions commencing where those of deposits end; they are required only because banking is not universal, and will always diminish in quantity as the practice of banking is more widely diffused. The same considerations of economy and convenience, which have led to the substitution of notes for metallic money, tend evidently, although no doubt with inferior force, towards the further substitution of deposits transferable by cheques for a note circulation.” (Ibid., p. 19.)
Ibid., pp. 26–27.
Cf. his evidence, Report from Select Committee on banks of issue, 1840, p.205: The banking deposits of the United Kingdom may be estimated at the very least to exceed 100 millions sterling; and I confess, the notion that that amount of banking deposits would perform the same quantity of monetary functions as would be performed by an equal amount of bank notes and coin (which is the true test of these being really money), seems to me to be a supposition completely inadmissible; and if I was not convinced upon general grounds, would induce me to be persuaded that it is an incorrect hypothesis to consider banking deposits as so much money, and as performing an equal quantity of monetary functions, as the same amount of coin or bank notes.
Letter to Charles Wood, Esq., on money, and the means of economizing the use of it, 1841, pp. 42 ff., 82 ff.
Ibid., p. 74.
Overstone, Reflections suggested by a perusal of Mr....Palmer's pamphlet , Tracts, p.36.
Ibid., Second letter to J. B. Smith, Esq. , Tracts, p.201.
J. S. Mill claimed that the restriction of note issues would be nugatory, because to the ordinary man whether credit assumed the form of bank notes or not was a mere matter of convenience. “Is it supposed that having credit, and intending to buy goods by means of it, he will be disabled from doing so because a banker is prohibited from one particular mode of giving him credit?” This would make it appear that the restriction of note issues would have no important consequences. But he nevertheless predicted that it would cause the interest rate to fluctuate more, and during crises would accentuate the shortage of credit.—Review of Tooke and Torrens, Westminster review, XLI (1844), 591 ff.—It is not evident how these views can be reconciled. But the possibility that strict limitations on the volume of particular types of means of payment may fail to accomplish their purpose because of resort in greater degree to the use of the unrestricted types, the invention of new types, or more rapid rate of use of the restricted types, appears sufficiently real to warrant more consideration than is ordinarily given to it. Conversely, artificial stimuli to the use of one type of means of payment may result in offsetting declines in the use of other types.
Cf. J. M. Keynes, A treatise on money, 1930, II, 264: