money warehouse receipts. The first, the most obvious, is the
written receipt, a piece of paper on which the deposit bank promises
to pay to the bearer a certain amount of cash in gold or silver
(or in government paper money). This written form of warehouse
receipt is called the bank note. Thus, in the United States before
the Civil War, hundreds if not thousands of banks issued their
own notes, some in response to gold deposited, others in the
course of extending fractional reserve loans. At any rate, if someone
comes into the possession (either by depositing gold or by
selling a product in exchange) of, say, a $100 note from the Bank
of New Haven, it will function as part of the money supply so
long as people accept the $100 note as a substitute, a surrogate,
for the gold. If someone uses the $100 note of the Bank of New
Haven to buy a product sold by another person who is a customer
of the Bank of Hartford, the latter will go to his bank and
exchange the $100 New Haven note for a similar note from the
Bank of Hartford.
The bank note has always been the basic form of warehouse
receipt used by the mass of the public. Later, however, there
emerged another form of warehouse receipt used by large merchants
and other sophisticated depositors. Instead of a tangible
receipt, the bank simply opened a deposit account on its books.
Thus, if Jones deposited $10,000 in a bank, he received, if he
wished, not tangible bank notes, but an open book account or
deposit account for $10,000 on the bank’s books. The bank’s
demand debt to Jones was not in the form of a piece of paper but
of an intangible book account which could be redeemed at any
time in cash. Confusingly, these open book accounts came to be
called demand deposits, even though the tangible bank note was
just as much a demand deposit from an economic or a legal point
of view. When used in exchange, instead of being transferred
physically as in the case of a bank note, the depositor, Jones,
would write out an order, directing the bank to transfer his book
104 The Mystery of Banking
account to, say, Brown. Thus, suppose that Jones has a deposit
account of $10,000 at the Rothbard Bank.
Suppose now that Jones buys a hi-fi set from Brown for
$3,000. Jones writes out an order to the bank, directing it to
transfer $3,000 from his open book account to that of Brown.
The order will appear somewhat as follows:
Rothbard Bank
Pay to the order of John Brown $3,000
Three thousand and 00/000
(signed)
Robert Jones
This written instrument is, of course, called a check. Note that
the check itself is not functioning as a money surrogate here. The
check is simply a written order transferring the demand deposit
from one person to another. The demand deposit, not the check,
functions as money, for the former is a warehouse receipt (albeit
unwritten) for money or cash.
The Rothbard Bank’s balance sheet is now as follows:
The Rothbard Bank
Assets Equity & Liabilities
Gold $10,000 Demand deposits
to Jones $7,000
to Brown $3,000
Total Assets $10,000 Total Liabilities $10,000
FIGURE 7.5 — TRANSFERRING DEMAND DEPOSITS
Note that from this purchase of a hi-fi set, nothing has changed in
the total money supply in the country. The bank was and still is
pursuing a 100 percent reserve policy; all of its demand liabilities
Deposit Banking 105
are still covered or backed 100 percent by cash in its vaults. There
is no fraud and no inflation.
Economically, then, the demand deposit and the tangible bank
note are simply different technological forms of the same thing: a
demand receipt for cash at the money warehouse. Their economic
consequences are the same and there is no reason for the legal system
to treat them differently. Each form will tend to have its own
technological advantages and disadvantages on the market. The
bank note is simpler and more tangible, and doesn’t require quite
the same degree of sophistication or trust by the holders of the
receipt. It also involves less work for the bank, since it doesn’t
have to change the names on its books; all it needs to know is that
a certain quantity of bank notes is out in circulation. If Jones buys
a hi-fi set from Brown, the bank note changes hands without anyone
having to report the change at the bank, since the bank is
liable to the note-holder in any case. For small transactions—purchase
of a newspaper or ham sandwich—it is difficult to visualize
having to write out a check in payment. On the other hand,
demand deposits have the advantage of allowing one to write out
checks for exact amounts. If, for example, the hi-fi set costs some
nonrounded amount, such as $3,168.57, it may well be easier to
simply write out the check than trying to find notes and coins for
the exact amount—since notes will generally be in fixed denominations
($1, $5, $10, etc.).15 Also, it will often be more convenient
to use demand deposits for large transactions, when amassing
cash can be cumbersome and inconvenient. Moreover, there
is far greater danger of loss from theft or accident when carrying
cash than when having a certain known amount on a bank’s
books.
106 The Mystery of Banking
15Bank
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