The Mystery of Banking

FEDERAL RESERVE BANK OF NEW YORK 
Pay to the Order of Murray N. Rothbard 
$100.00 
(Signed) 
Mr. Blank 
Officer 
Federal Reserve Bank of New York 
There is only one thing I can do with this check. I cannot
deposit or cash it at the Fed, because the Fed takes only deposit
accounts of banks, not individuals. The only thing I can do is
deposit it at a commercial bank. Suppose I deposit it in my
account at Citibank. In that case, I now have an increase of $100
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in my demand deposit account at Citibank; the bank, in turn, has
a $100 check on the Fed. The bank greets the check with enthu-
siasm, for it now can rush down to the Fed and deposit the check,
thereby obtaining an increase in its reserves at the Fed of $100. 
Figure 10.7 shows what has happened as a result of the Fed’s
purchase of my desk. The key monetary part of the transaction
was not the desk, which goes to grace the increased furniture asset
column of the Fed’s ledger, but that the Fed has written a check
upon itself. I can use the check only by depositing it in a bank,
and as soon as I do so, my own money supply in the form of
demand deposits goes up by $100. More important, my bank 
now deposits the check on the Fed at that institution, and its total
reserves also go up by $100. The money supply has gone up by
$100, but the key point is that reserves have gone up by the same
amount, so that the banking system will, over a few months, pyra-
mid more loans and demand deposits on top of the new reserves,
depending on the required reserve ratio and hence the money
multiplier. 
Citibank
Assets
Equity & Liabilities
Demand deposits
to Rothbard
+ $100
Reserves at Fed
+ $100
Total assets
+ $100
Total demand deposits
+ $100
Federal Reserve Bank
Assets
Equity & Liabilities
Desk
+ $100
Demand deposits to
banks
+ $100
F
IGURE
10.7 — O
PEN
M
ARKET
P
URCHASE
Central Banking: Determining Total Reserves
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Note that bank reserves have increased by the same amount
(in this case, $100) as the Fed’s open market purchase of the desk;
open market purchases are a
factor of increase 
of bank reserves,
and in practice by far the most important such factor. 
An
open market sale
has precisely the reverse effect. Suppose
that the Fed decides to auction off some old furniture and I buy
one of its desks for $100. Suppose too, that I pay for the sale with
a check to the Fed on my bank, say, Citibank. In this case, as we
see in Figure 10.8, my own money stock of demand deposits is
decreased by $100, in return for which I receive a desk. More
important, Citibank has to pay the Fed $100 as it presents the
check; Citibank pays for it by seeing its reserve account at the Fed
drawn down by $100. 
Citibank
Assets
Equity & Liabilities
Demand deposits
to Rothbard
– $100
Reserves at Fed
– $100
Total assets
– $100
Total demand deposits
– $100
Federal Reserve Bank
Assets
Equity & Liabilities
Desk
– $100
Demand deposits to
banks
– $100
F
IGURE
10.8 — O
PEN
M
ARKET
S
ALE
Total money supply has initially gone down by $100. But the
important thing is that total bank reserves have gone down by
$100, which will force a contraction of that times the money