FACTS ABOUT MONEY

Alexandra Herald and Central Otago Gazette, Issue 2094, 5 May 1937, Page 3

FACTS ABOUT MONEY

We intend to feature in tnis column a series of ten radio talks by Mr. W. K. McConnell, M.A., broadcast through Station 2TTW, Sydney. PIFTH TALK THE MYTH OF SOMETHING FOR NOTHING. Last week, in reply to a question, I explained that the trading banks do not get notes from the Commonwealth Bank without giving value in return. As an illustration, I said that a trading bank requiring more notes or cash may sell some of its securities, such as Government Bonds, to the Commonwealth Bank, and receive in return notes or, what amounts to the same thing, a credit in its deposit account at the Commonwealth Bank. The net result of such a transaction is: firstly, that the trading bank has more cash or, through the increase in its deposit account, a claim to more cash, and secondly, that the Commonwealth Bank has acquired the ownership of, and the right to receive the interest payable on, the Bonds so transferred. This is a plain and direct statement of what actually does take place. But another radio speaker has accused me of misleading my listeners. He said that I forgot to say that, "in the first place, the trading bank got the security or Bond for nothing by drawing (a cheque on itself." I did not forget to say this. I aid not say it because to have, said it would have been not only misleading, but ridiculous. Let us examine the statement. Banks do draw cheque- < on themselves, but they do not thereby get something for nothing. Let us suppose that a government loan is being floated, and that a certain trading bank applies for £IOO,OOO worth of Bonds. How does it pay for them? It may adopt one of two courses; and the fact that some of the trading banks adopt one of these courses and some the other is itself sufficient to show that, in effect, the two courses are identical. I told you in a previous talk that every trading bank is required by law to keep a deposit account at the Commonwealth Bank. Now the bank that we have supposed is applying for £IOO,OOO worth of Bonds may draw a cheque on its account.at the Commonwealth Bank, and forward it to the .Commonwealth Bank ias agent for the Government in the flotation of the loan. The' Commonwealth Bank then deducts the amount from this bank's account with it, and adds the amount to the Government's account with it. In due course, the bank will get the bonds which it applied for. Now what has happened? The bank in question has increased its holdings of Government Bonds by £IOO,OOO but it has now £IOO,OOO less in its account at the Commonwealth Bank than it would have had if it had not bought the Bonds. Where is the bank getting something for nothing? Exactly the same thing has happened as if you yourself had applied for Bonds. What would you do if you wanted to lake up £IOO worth of Bonds in a Government loan? Tou would apply for the Bonds and enclose a cheque for £IOO on your account at your bank. In return you would get the Bonds. But would you imagine that you had got the Bonds for nothing? Surely not! A trading bank builds up its deposit at the Commonwealth Bank just as you build up your deposit at your Bank. And a cheque by a trading bank on its account at the Commonwealth Bank has precisely the same effect on its aggregate funds as a cheque by you has on your funds at your bank. Now let us examine the second method a bank may adopt in paying for Bonds. Instead of drawing a cheque on its account at the Commonwealth Bank a bank may draw a cheque directly on itself (that is, a "bank cheque). In this ease, the bank will send along to the Commonwealth Bank as the Government's agent an application for £IOO,OO worth of Bonds and a cheque drawn on itself for £IOO,OOO. Now the Commonwealth Bank can, if it likes, send a clerk along to the bank that drew the cheque on itself to present it for payment and collect £IOO,OOO in notes. If this is done, it is quite evident that the Bank is parting with £IOO,OOO. But in practice, to suit its own convenience, the Commonwealth Bank does not do this. Tou can readily understand that if the Commonwealth Bank sent a clerk along to eacli individual'bank to collect all the cheques it receives, either drawn on banks by themselves or drawn on them by their depositors, it would need a huge army of messengers. To avoid pll this running about the Clearing House system has been devised. The Clearing House is a place where the clerks of all the banks meet to effect settlements of all the cheques drawn either by them or against them. Notice how simply it works. Suppose the Commonwealth Bank had a £IOO,OOO cheque drawn, say, by the Union Bank on itself, in payment for Bonds. And suppose it also had £30,000 worth of cheques drawn by depositors at the Union Bank on their accounts there. It would send a clerk down to the Clearing house with a total of £15Q,000 worth of cheques drawn on the Union Bank. Now it may be that the Union Bank's clerk would be there with £IOO,OOO worth of cheques drawn on the Commonwealth Bank (that is, by the Commonwealth Bank's own depositors or customers). This means that the Commonwealth Bank has to collect £150,000 from the Union Bank, and the Union Bank has to collect £IOO,OOO from the Commonwealth Bank In other words, the Union Bank has to give the Commonwealth Bank £50,000 to balance the two accounts.

The Union Bank will do this by banding a cheque to the Commonwealth Bank on its account at the Commonwealth Bank. In fact, the trading banks are compelled by the Commonwealth Bank to settle their balances in this way. So we arrive at exactly the same position as under the first method. The Union Bank's deposits at the Commonwealth bank are now £IOO,OOO less than they would

have been if it had not bought the £IOO,OOO worth of Bonds. A cheque drawn by a bank on itself is to all intents and purposes a promissory note. And a bank has no more chance of getting something for nothing by issuing promissory notes than you have. ■an —a y*»-^vy