As explained in Section 1, commercial paper is an essential part of the process of exchanging goods through credit. A person buys on time and sells on time and expects to pay for his purchases by the proceeds of his sales. So long, therefore, as the processes of commerce and industry proceed in a normal fashion, the paper discounted by a bank will be paid at maturity and the credit balance created by means of such discounts offset by corresponding debits. Ordinarily the credits created through discounts during a given period, say a day or a week, in favor of one set of customers will be balanced during this same period by the payment of notes previously discounted for other customers. Within a complete trading area this is certain to happen, since purchases and sales of goods are equal and what is credited to one man is debited to another.
The result is very different if a bank discounts investment paper, that is, credit documents which represent the unproductive consumption of individuals or of public and private corporations, or which represent the purchase on time of the instruments of production rather than the production of goods through the use of such instruments and their transfer from the producer to the consumer. The means of payment of such documents can only be created gradually by the application of the profits of the enterprises in which the investments were made, or by taxes spread over a series of years, or by a slow process of saving. If a bank issues its own demand obligations in exchange for such documents, it cannot make its books balance and it will be constantly exposed to the danger of forced liquidation. If it attempts to protect itself by requiring that the discounted paper shall mature in a short period, the necessity of liquidation will be forced upon customers who are responsible for the payment of the discounted paper; that is, such customers will be obliged to sell at such prices as they can command the property in which the investments were made, or some other property. Such liquidation always results in forced readjustments of prices and business depression, and sometimes in commercial crises.
4. The Issue of Notes
As an alternative for or a supplement to the conduct of checking accounts a commercial bank may issue its promissory notes payable to bearer on demand. By the issue of notes is meant their transfer to customers in exchange for cash, for checks left for collection or drawn against a credit balance in a checking account, or for discounted notes and bills.
By the use of these notes commercial banking can be carried on without checking accounts. In that case the notes are issued in exchange for cash and discounted bills, and notes are returned to the bank in exchange for cash or when discounted bills or notes mature and are paid. In the bookkeeping process which has been described bank notes thus issued and returned perform precisely the same function as checking accounts, and are related to the discount of commercial paper and the credit system of the country in precisely the same manner as such accounts.
Most banks of issue at the present time conduct checking accounts also, using the one instrumentality or the other as their customers desire. In this case notes are issued in exchange for checks drawn against credit balances on checking accounts or deposited for collection as well as in exchange for discounted notes and bills and cash.
By the use of both notes and checking accounts, a bank can supply most of the needs of its customers for a circulating medium, the notes serving as hand-to-hand money, and the checking accounts, practically all other purposes. Being the direct obligations of banks attested by the signatures of their responsible officers, and being payable to bearer on demand and capable of being issued in all necessary denominations, such notes can be transferred without indorsement, can be used for making change and payments of small and moderate size for which checks are not convenient, and they do not need to be presented at a bank for the test of their validity. If the bank or banks which issue them are properly conducted and supervised and properly safeguarded by law, such notes will circulate freely through the length and breadth of a country.
Checking accounts meet in the most satisfactory manner all currency needs for which hand-to-hand money is not well adapted, such as large payments and payments at a distance. With a few strokes of a pen payments of the greatest magnitude can be made through their agency. Checks can be sent through the mails at slight expense and without danger of loss of the amount involved. By the devices known as travelers' and commercial letters of credit, checking accounts supply the most convenient form of currency for travelers and for merchants engaged in foreign trade.
Besides bank notes and checking accounts the only forms of currency needed in any community are standard and subsidiary coins, the former for use as ultimate redemption material for all other forms of currency and for the payment of international and other balances, and the latter for small change. Even these forms of currency are supplied by commercial banks, but since they do not create them, ways and means of procuring them in the quantities needed constitute one of their peculiar problems.