The Theory of Money and Credit

Thus fiduciary media are claims to the payment of a given sum on demand, which are not covered by a fund of money and whose legal and technical characteristics make them suitable for tender and acceptance instead of money in fulfillment of obligations that are in terms of money. As has already been suggested, it is not the dead letter of the law so much as actual business practice that counts, so that some things function as fiduciary media, although they cannot be regarded as promises to pay money from the juristic point of view, because they nevertheless are in fact honored as such by somebody or other. We were able to show that, so far as they are not money certificates, even modern token coins and such kinds of money as the German thaler during the period from the establishment of the gold standard until its abolition, constitute fiduciary media and not money.

Fiduciary media may be issued in two ways: by banks, and otherwise. Bank fiduciary media are characterized by being dealt with as constituting a debt of the issuing body. They are entered as liabilities, and the issuing body does not regard the sum issued as an increase of its income or capital, but as an increase on the debit side of its account, which must be balanced by a corresponding increase on the credit side if the whole transaction is not to figure as a loss. This way of dealing with fiduciary media makes it necessary for the issuing body to regard them as part of its trading capital and never to spend them on consumption but always to invest them in business. These investments need not always be loans; the issuer may himself carry on a productive enterprise with the working capital that is put into his hands by the issue of fiduciary media. It is known that some deposit banks sometimes open deposit accounts without a money cover not only for the purpose of granting loans, but also for the purpose of directly procuring resources for production on their own behalf. More than one of the modern credit and commercial banks has invested a part of its capital in this manner, and the question of the right attitude in this case of the holders of the money substitutes, and of the state legislature that feels itself called upon to protect them, remains an open one. In earlier times there was a similar problem concerning banks issuing notes1  until banking practice or the law prescribed short-term loans as “cover.”

The issuer of fiduciary media may, however, regard the value of the fiduciary media put into circulation as an addition to his income or capital. If he does this, he will not take the trouble to cover the increase in his obligations due to the issue by setting aside a special credit fund out of his capital. He will pocket the profits of the issue, which in the case of token coinage is called seigniorage, as composedly as any other sort of income.

The only difference between the two ways of putting fiduciary media into circulation lies in the attitude of the issuer. Naturally, this cannot have any significance for the determination of the value of the fiduciary media. The difference between the methods of issue is a result of historical factors. Fiduciary media have sprung from two different roots: from the activities of the deposit and giro banks on the one hand, and from the state prerogative of minting on the other hand. The former is the source of notes and current accounts; the latter, that of convertible Treasury notes, token coins, and that current money of which the coinage is restricted, but which can be regarded neither as credit money nor as fiat money because it is actually convertible into money on demand to its full amount. Today the difference between the two methods of issuing is gradually disappearing, all the more as the state endeavors to act in the same way as the banks in issuing fiduciary media. Some states are already in the habit of devoting the profits of their coinage to special purposes and of refusing to treat them in any way as an increase of wealth.2

Of the two types of money substitutes issued by the banks, the current account is the older. The banknote, in fact, is only a development of it. It is true that the two are different in the eyes of the law and the banker, but they do not differ at all in the eyes of the economist. The only distinctions between them are in those legal or banking or commercial peculiarities of the banknote which give it a special capacity of circulation. It is easily transferable and very like money in the way in which it is transferred. Banknotes were therefore able to outstrip the older money substitute, the current account, and penetrate into commerce with extraordinary rapidity. For medium and small payments they offer such great advantages that the current account was hardly able to maintain its ground beside them. It was not until the second half of the nineteenth century that the current account once more became important along with the banknote. In large transactions, check and clearing payments are often superior to notes. But the chief reason why the current account was able in part to expel the banknote must by no means be sought in any inherent requirements of business. The current account is not, as it is sometimes the fashion to assert without any reason or proof, a “higher” form of money substitute than the banknote. The banknote has been supplanted by the current account in many countries because its development was artificially hindered and that of the current account artificially encouraged, the reason for this being that acceptance of the doctrines of the Currency principle led people to see danger for the stability of the exchange ratio between money and other economic goods only in the overissue of notes, and not in the excessive increase of bank deposits.

For the study of the credit system from the economic point of view, the contrast between notes and deposits is of minor importance. There are payments for which one or other form is the more suitable, and payments for which both forms are suitable. If their development had been allowed to take its own course, this fact would undoubtedly have been more evident than it is today when the attempt is sometimes made to bring about the employment of one or other kind of fiduciary medium by artificial means in circumstances where it appears the less appropriate technically.

• 1See Lotz, Geschichte und Kritik des deutschen Bankgesetzes vom 14. März 1875 (Leipzig, 1888), pp. 72 f.
• 2See for example on the Swiss currency reserve fund established by article 8 of the Currency Act of January 31, 1860, Altherr, Eine Betrachtung über neue Wege der schweizerischen Münzpolitik (Bern, 1908), pp. 61 ff.