Chapter VII Simplified Mechanics of Reserve Banking

clearing of cheques drawn against these bank deposits. First, The Reserve authorities create bank reserves. Second, Reserve Bank credits are convertible into commercial bank credit. Third, Commercial bank credit is convertible into bank deposits to the credit of borrowers from the banks, or sellers who sell to the banks investment obligations. Those are the three steps in the creation of "bank deposits transferable by cheque wherewith business men and other persons make the bulk of their monetary payments.". On page 55, Federal Reserve System booklet, we find: "Loans and purchases of securities by the Federal Reserve authorities are one of the important sources of member bank reserves." These securities may be U.S. Bonds, corporation stock, notes, mortgages, debentures, any investment obligation. When the Reserve authorities buy corporation stock, they give a cheque against no funds in payment for the stock, and the corporation deposits this cheque with its home bank. This creates bank deposits; then when the cheque reaches the bank's Reserve Bank, the Reserve Bank gives the member bank credit in its reserve fund the face of the cheque, dollar for dollar. One cheque created two funds: bank deposits, and bank credit. In depositing the Reserve authorities' cheque in a member bank it reversed the order of creation of credits. First the cheque created bank deposits; then it created an equal amount of bank reserves; then the next step is with the commercial member bank — it multiplies its reserves by 5. It makes loans, or buys investment obligations, giving the borrowers and the sellers deposit credits on their books, new bank deposits. And that's the whole picture. Of course there are many different purchases the Reserve authorities may make, but it matters not what they may buy, when they give the seller a cheque, when it is deposited, it creates both new bank deposits and new bank reserves. And this is true: every time a Government cheque is deposited, it creates bank deposits; but only when the cheque is given by the government against new deposit credits it got on the books of the Reserve Banks when selling anew issue of bonds, does the cheque create new deposit credits. Cheques given by the