Chapter Six: Banks and their Credit

Abstract: Fractional-reserve banking is a system where the banks lend some of their deposits and earn interest. This increases the amount of money in circulation compared to warehouse or 100% reserve banking. This utility of banking comes at the risk of being unable to withdraw your deposits. The amount that can be lent into circulation depends on the type of bank and the needs of the depositors. There are goldsmith-bankers, the typical banker who issues banknotes, and the national bank.

IF ONE HUNDRED THRIFTY GENTLEMEN or property owners who save money every year to occasionally buy land deposit 10,000 ounces of silver with a goldsmith or banker in London, they will receive in return notes payable on demand. They do this to avoid the trouble of keeping this money in their houses and to prevent thefts. They will often leave their money there for a long time, and when they make a purchase, they will notify the banker some time in advance to have their money ready when the formalities and legal documents are complete.

In these circumstances, the banker will often be able to lend throughout the year 90,000 ounces of the 100,000¹⁴⁹ he owes and will only need to keep on hand 10,000 ounces to meet all the withdrawals. He deals with wealthy and economical persons; so as fast as one thousand ounces is demanded of him from one hand, another thousand is brought to him from another hand. It is enough, as a rule, for him to keep on hand onetenth of his deposits. There have been examples and experiences of this in London. Instead of the individuals in question keeping on hand the greatest part of 100,000 ounces all year round, the custom of depositing it with a banker causes 90,000 ounces of the 100,000 to be put back into circulation. This is the primary idea one can derive regarding the utility of this sort of bank. The bankers or goldsmiths contribute to the acceleration of the circulation of money. They lend it out at interest at their own risk and peril, and yet they are, or ought to be, always ready to cash their notes on demand.

If an individual needs to pay 1,000 ounces to another, he will give him a banker’s note for that amount. This other person will perhaps not demand the money of the banker. He will keep the note and later give it to a third person in payment, and this note may pass through several hands for large payments and for a long time without any one demanding the money from the banker. It will be only someone who does not have complete confidence, or someone who has several small sums to pay, who will demand the money. In this first example, the cash reserve of a banker is only one-tenth of his business.

If 100 individuals or property owners deposit their income with a banker every six months as it is received, and then demand their money back when they have a need to spend it, the banker will be in a position to lend much more of the money that he owes and receives at the beginning of the half years, for a short term of some months, than he will be toward the end of these periods. And his experience with the conduct of his clients will teach him that he can hardly lend during the whole year more than about one half of the sums that he owes. Bankers of this kind will see their credit ruined if they fail for one instant to redeem the notes on their first presentation. When they are short of cash on hand, they will give anything to obtain money immediately. That is to say, they will pay a much higher interest than they receive on the sums they have lent. Hence, they make it a rule based on their experience to always keep enough money on hand to meet demands, and more rather than less. Many bankers of this kind (and they are the greatest in number) always keep on hand half the amounts deposited with them and lend the other half at interest and put it into circulation. In this second example, the banker causes his notes of 100,000 ounces or écus to circulate with 50,000 écus.¹⁵⁰

If he has a great flow of deposits and great credit, it increases confidence in his notes, and makes people less eager to cash them. However, it only delays his payments a few days or weeks or until the notes fall into the hands of persons who are not accustomed to dealing with him. He ought to always manage his business according to the practices of those who are accustomed to entrust their money to him. If his notes fall into the hands of those in his own business [i.e., banking], they will immediately want to withdraw the money from him.

If those who deposit money with the banker are entrepreneurs and merchants who regularly deposit large sums and soon thereafter draw them out, it will likely be the case that if the banker diverts more than one third of his cash he will find it difficult to meet these demands.

It is easy to understand by these examples that the sums of money which a goldsmith or a banker can lend at interest or divert from his cash are naturally proportional to the practices and conduct of his clients. While we have seen bankers who were safe with a cash reserve of one-tenth, others must keep nearly one-half or even two-thirds, though their credit might be as good as that of the first.

Some trust one banker, some another. The most fortunate is the banker whose clients are rich gentlemen looking for a safe place for their money without wishing to invest it at interest while they wait.

A general national bank has this advantage over the bank of a single goldsmith because there is always more confidence in it. The largest deposits are willingly brought to it, even from the most remote quarters of the city, and this generally leaves small bankers with only the deposits of petty sums from their neighborhood. Even the revenues of the State are deposited in it in countries where the prince is not absolute. And this, far from injuring credit and confidence in it, only serves to increase them.

If payments in a national bank are made by transfers or book credits, the advantage is that they are not subject to forgeries. But if the bank issues notes, false notes may be made and cause chaos. There will also be a disadvantage for those in the city who live far from the bank and who would rather pay and receive in money and not travel to the bank. This is especially so for those who live in the country. But if the bank notes are dispersed, they can be used near and far. In the national banks of Venice and Amsterdam, payment is only made in book credits, but in the one in London, it is made in credit, in notes, and in money, according to individual preferences. Today, London is the strongest bank.

Therefore, it should be understood that the advantage of all banks in a city, public or private, is to accelerate the circulation of money and to prevent so much of it from being hoarded, as it would naturally be for long time intervals.¹⁵¹

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¹⁴⁹ This is a preparation error. One hundred people depositing 10,000 ounces would result in 1,000,000 in deposits. This is probably a manuscript calculation error and it might be that they deposited 1,000 ounces, rather than 10,000.

¹⁵⁰ This banker causes 100,000 in notes and 50,000 in silver to circulate while keeping 50,000 in silver on reserve at the bank to redeem deposits. This is the first step in what is now know as the money multiplier process. If the 50,000 of silver put into circulation were actually redeposited in other banks and all these banks kept 50% reserves the money multiplier would be two and ultimately the money supply could be brought to a total of 200,000 from the original 100,000 deposited.

¹⁵¹ The final three chapters of the Essai are a thinly veiled attack on John Law and the Mississippi Company. Cantillon first shows that banks, including national banks, have some utility in accelerating the circulation of money. The mercantilists often thought that banks decreased circulation and that banks hurt the economy. Ultimately, Cantillon concludes that national banks, such as Law’s, were of little utility in a large country like France and would ultimately be very harmful.