banks
and
warehouse receipts for gold as part of the money sup-
ply. Warehouse receipts are surrogates for reserves, even when
they are pyramided on top of them, so that reserves cannot
also
be included in an account of the supply of money.
Under central banking, then, the total supply of money, M,
equals cash in the hands of the public plus demand deposits
owned by the public. Cash, in turn, consists
of gold coin or bul-
lion among the public, plus Central Bank notes. Or, putting this
in equation form,
M = gold in public + Central Bank notes in public +
Demand deposits of the commercial banks
When a nation is taken off
the gold standard, gold dollars or
francs are no longer part of the money supply, and so the money
supply equation becomes (as it is in the
United States and all other
countries now):
M = Central Bank notes + Demand deposits
It is clear that, even under central banking, if the public is or
becomes unwilling to hold any money in bank deposits or notes
and insists on using only gold, the inflationary potential of the
banking system will be severely limited. Even if the public insists
on holding bank
notes rather than deposits, fractional reserve
bank expansion will be highly limited. The more the public is
willing to hold checking accounts rather than cash, the greater the
inflationary potential of the central banking system.
But what of the other limits on bank inflation that existed
under free banking? True, the Central Bank—at least under the
gold standard—can still go bankrupt if the public insists on cash-
ing in their deposits
and
Central Bank paper for gold. But, given
the prestige of the Central
Bank conferred by government, and
with government using the Central Bank for its own deposits and
conferring the monopoly privilege of note issue, such bankruptcy
will be most unlikely. Certainly the parameters of bank inflation
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Chapter Nine.qxp 8/4/2008 11:38 AM Page 132
have been greatly widened. Furthermore, in most cases govern-
ment has conferred another crucial privilege on the Central Bank:
making its notes legal tender for all debts in money. Then, if A has
contracted with B for a debt of $10,000
in money, B
has
to accept
payment in Central Bank notes; he cannot insist, for example, on
gold. All this is important in propping up the Central Bank and
its associated commercial banks.
What of the dread bank run? Cannot a bank still be subjected
to drastic loss of confidence by its clients, and hence demands for
redemption, either in gold or in Central Bank notes? Yes, it can,
under the gold standard, and bank runs often swept through the
American banking system until 1933. But under central banking
as contrasted to free banking, the Central Bank stands ready at all
times to lend its vast prestige and resources—to be, as the Eng-
lishman Walter Bagehot called it in the mid-nineteenth century—
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