Implications for Banking Operations
There are three possible solutions to these financial panics:
1. Convince the public that there is more gold in the vaults than there really is.
2. Prevent more receipts from circulating than there is gold on hand.
3. Do away with a metallic reserve altogether.
We will consider these points in terms of goldsmiths acting as bankers.
Maintaining public health. It is of course possible to fool some of the people all of the time, to paraphrase Abraham Lincoln. But it is extraordinary difficult to convince a population that there money is backed by gold when it is not. Suppose paper money (receipts) is issued in excess of the gold available. The slightest doubt in the public’s mind can be easily resolved to the banker’s (goldsmith’s) confusion by presenting the money for gold. If the gold is not there, its absence will be soon apparent. Furthermore, the first in line to get gold will be successful while later ones will not. There is tremendous incentive not to be too trusting of a bank’s ability to pay on demand.
Limiting paper money. If banks were forced to limit the issue of paper money to the gold in their vaults, the problem will disappear. There would be a 100 percent reserve against all paper money, and anybody could exchange paper money for gold at any time. As a result they probably wouldn’t bother.
But this solution means that the quantity of money is tied directly to the supply of gold and has no relation to current economic conditions. In a period when the economy is expanding any expansion of the money supply would await increased mining activity or new gold discovery. Alternatively, a new gold discovery might mean an increase in the money supply when there was no economic need for such an expansion. There can be serious economic effects from differential rates of growth between the money supply and the economy.
Abolishing metallic reserve. Doing away with a metallic reserve altogether is the final rationalization of the position that it is not the metallic backing that determines the value of money. The value of money is determined by what it can buy, not by the character of the reserves.
However, if paper unsupported by metal is to circulate somebody in whom the people have confidence has to assert that the paper is, in fact, money. The government takes over the printing of paper money and coins as a monopoly and calls all else counterfeiting. The government calls what it produces “legal tender for all debts public and private,” and thus creates money.
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Sometime in the future we may have what is called “cashless” society. Money becomes a number stored in a computer, and our cheques are plastic cards inserted in a terminal. By then, the goldsmiths will have faded into the past. Money will be strictly an abstract concept- a pure unit of account and store of value.
What Should a Banking System Do?
Banks accept deposits into savings and checking accounts from depositors such as you. For a fee they will protect your deposits and handle the paperwork of clearing checks and accounting for your withdrawals and deposits. This fee may take the form of service charge, or the bank may pay less than the market rate of interest on your deposits.
At the same time banks buy earning assets such as government bonds and loan or IOU money to depositors. The banks receive interest from such transactions. The difference between interest and charges received, and interest and expenses paid, becomes the banks’ profit.
A banking system can be judged to be a good one if it satisfies the reasonable desires of the public for security, service, and the efficient provision of loan funds for withdrawal funds for worthwhile purposes. However, there are legitimate national economic targets in which the banking system should pay a contributing role. Such targets as full employment and price stability may require actions that are at variance with the concerns of the banks as private businesses.
Through many decades of experience we have learned that government regulation of the banking industry is a necessary and legitimate government activity; the government must stand ready to serve as the ultimate guarantor of the money supply. And the money supply is such an important economic variable that its control simply cannot be left in the hands of the private banking system.
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