The Theory of Money and Credit

It is usual to ascribe to the payment system elasticity that is said to be attained by means of the credit system and the continual improvements in banking organization and technique, the capacity of adjusting the available stock of money to the level of the demand for money at any time without exerting any influence on the exchange ratio between money and other economic goods. Between the volume of fiduciary media and the bank transactions or private arrangements that can take the place of a transfer of money, on the one hand, and the quantity of money, on the other hand, there is said to be no fixed relationship which could make the former rigidly dependent upon the latter. Instead of there being a fixed quantitative relationship between money and its substitutes, that is to say, between the stock of money and the various exchange and payment transactions, it is said that the organization of banking institutions and the credit system has made commerce in the highest degree independent of the quantity of money available. The present-day organization of the money, clearing, and credit system is said to have the tendency to balance out variations in the quantity of money and render them ineffective, and so to make prices as far as possible independent of the stock of money.5  By others, this adjusting capacity is ascribed only to fiduciary media, uncovered banknotes,6  or unbacked deposits.7

Before the soundness of these assertions can be tested, they must be brought out of the obscurity that is due to a confusion between the effects of the clearing system and those of the issue of fiduciary media. The two must be considered separately.

The reduction in the demand for money in the broader sense that results from the practice of settling counterclaims by balancing them against each other is limited in the first place by the number and amount of the claims and counterclaims falling due on the same date. No greater number or amount of claims can be reciprocally canceled between two parties than exist between them at the given moment. If, instead of payment in money, claims on third persons are transferred which are canceled by the transferee and the debtor by means of claims held by the latter against the former, the sphere of the offsetting process can be extended. The clearinghouses which nowadays exist in all important commercial centers are able to avoid the technical and legal difficulties in the way of such transfers, and have thus performed a quite extraordinary service in the extension of the system of reciprocal cancellation. Nevertheless, the clearing system is still capable of further improvement. Very many payments that could be settled by way of cancellation are still made by the actual transfer of money.

If we imagine the clearing system fully developed, so that all payments are first attempted to be settled by balancing, even those in everyday retail trade (which, for practical reasons, would not appear to be easy of accomplishment), then we are faced with a second limit to the extension of the clearing system, although this, unlike the first, is not surmountable. Even if the community were in a stable condition in which there were no variations in the relative incomes and wealth of individuals and in the sizes of their reserves, complete reciprocal cancellation of all the transfers of money that have to be made at a given moment would be possible, only if the money received by individuals was spent again immediately and nobody wanted to hold a sum of money in reserve against unforeseen and indefinite expenditure. But since these assumptions do not hold good, and in fact never could hold good, so long as money is in demand at all as a common medium of exchange, it follows that there is a rigid maximum limit to the transactions that can be settled through the clearing system. A community’s demand for money in the broader sense, even with the fullest possible development of the system of reciprocal cancellation, cannot be forced below a minimum which will be determined according to circumstances.

Now the degree in which a clearing system is actually developed within the limits which the circumstances of the time allow for it, is in no way dependent upon the ratio between the demand for money and the stock of money. A relative decline in the one or the other can of itself exercise neither a direct nor an indirect influence on the development of the clearing system. Such development is invariably due to special causes. It is no more justifiable to assume that progressive extension of settlement on the clearing principle reduces the demand for money precisely in the degree in which the increasing development of commerce augments it, than to suppose that the growth of the clearing system can never outstrip the increase in the demand for money. The truth is rather that the two lines of development are completely independent of one another. There is a connection between them only insofar as deliberate attempts to counteract an increase in the exchange value of money by reducing the demand of money through a better development of the clearing system may be made with greater vigor during a period of rising prices; assuming, of course, that the aim of currency policy is to prevent an increase in the purchasing power of money. But this is no longer a case of an automatic adjustment of the forces acting upon the objective exchange value of money, but one of political experiments in influencing it, and the extent to which these measures are accompanied by success remains a matter of doubt.

Thus it is easy to see what little justification there is for ascribing to the clearing system the property, without affecting the objective exchange value of money, of correcting the disparities that may arise between the stock of money and the demand for it, and which could otherwise be eliminated only by suitable automatic variations in the exchange ratio between money and other economic goods. The development of the clearing system is independent of the other factors that determine the ratio between the supply of money and the demand for it. The effect on the demand for money of an expansion or contraction of the system of reciprocal cancellation thus constitutes an independent phenomenon which is just as likely to strengthen as to weaken the tendencies which for other reasons have an influence in the market on the exchange ratio between money and commodities. It seems self-evident that an increase in the number and size of payments cannot be the sole determinant of the demand for money. Part of the new payments will be settled by the clearing system; for this, too, ceteris paribus, will be extended in such a way as thenceforward to be responsible for the settlement of the same proportion of all payments as before. The rest of the payments could only be settled by clearing processes if there was an extension of the clearing system beyond the customary degree; but such an extension can never be called forth automatically by an increase in the demand for money.

• 5See Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), pp. 263 f.
• 6See Helfferich, Studien über Geld-und Bankwesen (Berlin, 1900), pp. 151 f.; Schumacher, Weltwirtschaftliche Studien (Leipzig, 1911), pp. 5 ff.
• 7See White, An Elastic Currency (New York, 1893), p. 4.