The use of money does not remove the differences which exist between the various nonmonetary goods with regard to their marketability. In the money economy there is a very substantial difference between the marketability of money and that of the vendible goods. But there remain differences between the various specimens of this latter group. For some of them it is easier to find without delay a buyer ready to pay the highest price which, under the state of the market, can possibly be attained. With others it is more difficult. A first-class bond is more marketable than a house in a city's main street, and an old fur coat is more marketable than an autograph of an eighteenth-century statesman. One no longer compares the marketability of the various vendible goods with the perfect marketability of money. One merely compares the degree of marketability of the various commodities. One may speak of the secondary marketability of the vendible goods.
He who owns a stock of goods of a high degree of secondary marketability is in a position to restrict his cash holding. He can expect that when one day it is necessary for him to increase his cash holding [p. 463] he will be in a position to sell these goods of a high degree of secondary marketability without delay at the highest price attainable at the market. Thus the size of a man's or a firm's cash holding is influenced by whether or not he owns a stock of goods with a high degree of secondary marketability. The size of cash holding and the expense incurred in keeping it can be reduced if income-producing goods of a high degree of secondary marketability are available.
Consequently there emerges a specific demand for such goods on the part of people eager to keep them in order to reduce the costs of cash holding. The prices of these goods are partly determined by this specific demand; they would be lower in its absence. These goods are secondary media of exchange, as it were, and their exchange value is the resultant of two kinds of demand: the demand related to their services as secondary media of exchange, and the demand related to the other services they render.
The costs incurred by holding cash are equal to the amount of interest which the sum concerned would have borne when invested. The cost incurred by holding a stock of secondary media of exchange consists in the difference between the interest yield of the securities employed for this purpose and the higher yield of other securities which differ from the former only in regard to their lower marketability and are therefore not suited for the role of secondary media of exchange.
From time immemorial jewels have been used as secondary media of exchange. Today the secondary media of exchange commonly used are:
1. Claims against banks, bankers, and savings banks which--although not money-substitutes --are daily maturing or can withdrawn on short notice.
2. Bonds whose volume and popularity are so great that it is, as a rule, possible to sell moderate quantities of them without depressing the market.
3. Finally, sometimes even certain especially marketable stocks or even commodities.
Of course, the advantages to be expected from lowering the costs of holding cash must be confronted with certain hazards incurred. The sale of securities and still more that of commodities may only be feasible with a loss. This danger is not present with bank balances and the hazard of the bank's insolvency is usually negligible. Therefore interest-bearing claims against banks and bankers, which can be withdrawn at short notice, are the most popular secondary media of exchange. [p. 464]
One must not confuse secondary media of exchange with money-substitutes. Money-substitutes are in the settlement of payments given away and received like money. But the secondary media of exchange must first be exchanged against money or money-substitutes if one wants to use them--in a roundabout way--for paying or for increasing cash holdings.
Claims employed as secondary media of exchange have, because of this employment, a broader market and a higher price. The outcome of this is that they yield lower interest than claims of the same kind which are not fit to serve as secondary media of exchange. Government bonds and treasury bills which can be used as secondary media of exchange can be floated on conditions more favorable to the debtor than loans not suitable for this purpose. The debtors concerned are therefore eager to organize the market for their certificates of indebtedness in such a way as to make them attractive for those in search of secondary media of exchange. They are intent upon making it possible for every holder of such securities to sell them or to use them as collateral in borrowing under the most reasonable terms. In advertising their bond issues to the public they stress these opportunities as a special boon.
In the same way banks and bankers are intent upon attracting demand for secondary media of exchange. They offer convenient terms to their customers. They try to outdo one another by shortening the time allowed for notice. Sometimes they pay interest even for money maturing without notice. In this rivalry some banks have gone too far and endangered their solvency.
Political conditions of the last decades have given to bank balances which can be used as secondary media of exchange an increased importance. The governments of almost all countries are engaged in a campaign against the capitalists. They are intent upon expropriating them by means of taxation and monetary measures. The capitalists are eager to protect their property by keeping a part of their funds liquid in order to evade confiscatory measures in time. They keep balances with the banks of those countries in which the danger of confiscation or currency devaluation is for the moment less than in other countries. As soon as the prospects change, they transfer their balances into countries which temporarily seem to offer more security. It is these funds which people have in mind when speaking of "hot money."
The significance of hot money for the constellation of monetary affairs is the outcome of the one-reserve system. In order to make it easier for the central banks to embark upon credit expansion, the European governments aimed long ago at a concentration of their [p. 465] countries' gold reserves with the central banks. The other banks (the private banks, i.e., those not endowed with special privileges and not entitled to issue banknotes) restrict their cash holdings to the requirements of their daily transactions. They no longer keep a reserve against their daily maturing liabilities. They do not consider it necessary to balance the maturity dates of their liabilities and their assets in such a way as to be any day ready to comply unaided with their obligations to their creditors. They rely upon the central bank. When the creditors want to withdraw more than the "normal" amount, the private banks borrow the funds needed from the central bank. A private bank considers itself liquid if it owns a sufficient amount either of collateral against which the central bank will lend or of bills of exchange which the central bank will rediscount.
When the inflow of hot money began, the private banks of the countries in which it was temporarily deposited saw nothing wrong in treating these funds in the usual way. They employed the additional funds entrusted to them in increasing their loans to business. They did not worry about the consequences, although they knew that these funds would be withdrawn as soon as any doubts about their country's fiscal or monetary policy emerged. The illiquidity of the status of these banks was manifest: on the one hand large sums which the customers had the right to withdraw at short notice, and on the other hand loans to business which could be recovered only at a later date. The only cautious method of dealing with hot money would have been to keep a reserve of gold and foreign exchange big enough to pay back the whole amount in case of a sudden withdrawal. Of course, this method would have required the banks to charge the customers a commission for keeping their funds safe.
The showdown came for the Swiss banks on the day in September, 1936, on which France devalued the French franc. The depositors of hot money became frightened; they feared that Switzerland might follow the French example. It was to be expected that they would all try to transfer their funds immediately to London or New York, or even to Paris, which for the immediate coming weeks seemed to offer a smaller hazard of currency depreciation. But the Swiss commercial banks were not in a position to pay back these funds without the aid of the National Bank. They had lent them to business--a great part to business in countries which, by foreign exchange control, had blocked their balances. The only way out would have been for them to borrow from the National bank. Then they would have maintained their own solvency. But the depositors paid would have immediately [p. 466] asked the National Bank for the redemption, in gold or foreign exchange, of the banknotes received. If the National Bank were not to comply with this request, it would thereby have actually abandoned the gold standard and devalued the Swiss franc. If, on the other hand, the Bank had redeemed the notes, it would have lost the greater part of its reserve. A panic would have resulted. The Swiss themselves would have tried to procure as much gold and foreign exchange as possible. The whole monetary system of the country would have collapsed.
The only alternative for the Swiss National Bank would have been not to assist the private banks at all. But this would have been equivalent to the insolvency of the country's most important credit institutions.
Thus for the Swiss Government no choice was left. It had only one means to prevent an economic catastrophe: to follow suit forthwith and to devalue the Swiss franc. The matter did not brook delay.
By and large, Great Britain, at the outbreak of the war in September, 1939, had to face similar conditions. The City of London was once the world's banking center. It has long since lost this function. But foreigners and citizens of the Dominions still kept, on the eve of the war, considerable short-term balances in the British banks. Besides, there were the large deposits due to the central banks in the "sterling area." If the British Government had not frozen all these balances by means of foreign exchange restrictions, the insolvency of the British banks would have become manifest. Foreign exchange control was a disguised moratorium for the banks. It relieved them from the plight of having to confess publicly their inability to fulfill their obligations.
. For instance, demand deposits not subject to check.
. All this refers to European conditions. American conditions
differ only technically, but not economically.