Relative inflation may result from inadequate redemption

The return of bank checks and bank notes - which are the instruments by means of which bank credit is brought into actual service - may be effected in several ways. They may be redeemed in cash, they may be used to liquidate an obligation owing to the bank itself, or they may simply be deposited for credit. Whichever of these expedients may be employed the fact remains that the bank credit represented by the instruments involved has been withdrawn from use, or, broadly speaking, has been "redeemed."

On any given level of prices the use of credit beyond the need for it as an addition to the available media of exchange carries with it the impounding in reserves of the money which the excessive credit displaces. But money will not remain so impounded. Where there is not a sufficient demand for credit to permit bankers profitably to use their funds in the home market, they will, through operations in the foreign exchange market subsequently to be explained, transfer such funds to the markets where higher rates are obtainable. If the influence is strong enough the result is an exportation of gold.

Such a loss of gold is, however, a serious matter. Assuming that the country had only its normal proportion to begin with, the displacement of gold by credit carries with it a weakening of the ultimate reserves for all credit. Moreover, it is a weakening that is more hazardous than that which results from positive expansion because in the latter case reserves can be strengthened by a simple contraction of liabilities whereas, where gold has been exported, reserves can be restored to normal only through reimpor tation.

Gold may be exported

Forcing out gold is a precarious matter

After a certain point has been reached a weakening of reserves necessitates a halt in the further extension of credit by the banks. This might appear to be desirable but should an increase in demand be felt, necessitous bor rowers would find it difficult to obtain accommodation Holders of bank liabilities might also become apprehensive about the continued convertibility of their claims, and might therefore demand that they be redeemed in cash thus further weakening reserves. Contraction and liqui dation may be forced in this way, but it is not a norma] contraction. Industry is interfered with, and, should general loss of confidence develòp, the effect is likely to be cumulative and a situation bordering on panic may result.

There are thus two kinds of overexpansion. The most virulent is that which grows out of a rapid multiplication of credit facilities and which carries with it the over valuation of goods in terms of money. The other is pas sive and grows out of the failure of credit to contrad when demand falls off. This carries with it an undervaluation of money in terms of goods. The difference be tween them is that in the first case the price level will necessarily be high while in the second case an unduly higt price level is not a necessary consequence. But there are the other consequences which in both cases are positive and serious. Hence, just as active overexpansion is to be guarded against by restraining credit, provision must be made against passive overexpansion through facilities per mitting rapid redemption.

A careful examination of the nature of the deposit and of the check which is based upon it, will show that speedy redemption may, in this form of bank credit, be expected as a matter of course.

In the first place it may be pointed out that there is a strong incentive to the owner of a check either to present it for payment to the bank on which it is drawn or to deposit it in his own bank. The reason for this is that until the check is so presented the holder can never be sure of its validity. The drawer may not have an account; or, if h ' has, he may have overdrawn it and other of his checks presented first may get an unwarranted preference. Then too there may be some doubt about the bank itself, although this is not likely in normal times to exercise any considerable influence. But certainly a check for an uneven amount, transferable only by indorsement is not, as was previously explained, nearly so convenient a medium for further payment as is the easily divided deposit-balance which the deposited check serves to strengthen. Finally, it may be pointed out that the law requires the presentation of the check for payment within a reasonably short time after it has been received, and the owner jeopardizes his legal claim against the maker if he holds the check too long. Experience proves that all these things taken together act as a strong stimulus to the individual holder of a check to get it back for collection as soon as he can. In the second place it may be mentioned that there is an equally strong incentive for banks receiving as deposits checks on other banks to present such checks for collection within the shortest possible period. Here again the impelling reasons are not unlike those operative in the case of the individual. The receiving bank knows in the first place that a good many checks drawn by its own depositors will be presented for collection by other banks. The more checks that the receiving bank can itself present on such other banks the more completely can it offset their claims. Here too the law requires reasonably rapid collection and the depositor may hold his bank responsible if it fails with reasonable promptness to collect the checks deposited with it. Furthermore, the failure to present checks may injure the receiving bank's position as a creditor. Each bank knows, whatever be the circumstances in a particular case, that all other banks will present all their claims against a given bank as soon as possible. Any withholding of claims, irrespective of the motives involved, would constitute a sacrifice not in favor of the bank liable for the claims withheld but rather in favor of the other creditor banks. The bank withholding some of its claims would thus strengthen other creditor banks at its own expense. All things considered, therefore, there is a powerful incentive to banks to present all checks for collection at the earliest possible moment.