I. An Approximate Formula

For the purpose of tracing the circulation of money, and measuring it by bank records, we may classify the persons who use money in purchase of goods into three groups:—

The three groups necessarily include all in the community who circulate money. By circulating money is meant expending it in exchange, not for some other circulating medium, as checks, but for goods.

The nature of these three groups of people must now occupy our attention. In countries advanced in the art of banking, "Commercial depositors" include practically all business establishments, and little else; "Other depositors" include most persons in the professional and salaried classes and proprietors, and little else; while the class of "Nondepositors" is almost coterminous with wage earners.

It is true that these characterizations of the three classes are not quite complete. "Commercial depositors," for instance, do not include some small business dealers, like street vendors, for these usually have no bank accounts. But the number of such is comparatively small in comparison with the number of business men or corporations who do have accounts, and, what is more to the point, the business they do is still smaller. It follows that the money they handle is negligible. In the United States, at least, excepting those rural parts of the South and a few other places where the money expenditures are very small, the custom of having bank accounts is practically universal among business men, firms, and corporations.

To keep a bank account is, in fact, a practical necessity of business. Without such an account a business man practically deprives himself of three of the most essential aids in modern business: the use of circulating credit; the use of remittance by mail; and the use of time credit.

Unless a dealer is obliged to pay "spot cash" or prefers to do so—and such cases are both few in number and insignificant in the amounts of money involved—he will almost invariably find it easier to make payment by check. Moreover, the very fact that most other business men use banking facilities creates in his mind the desire to have an account himself, both because he dislikes to appear "different," and because, when others pay him by checks, he finds it necessary to cash these checks,—a procedure which is always more trouble than to deposit them.

Cash payments are especially inconvenient when business is done at a distance. Remitting money by post, express, or personal delivery is troublesome, risky, and expensive as compared with posting a letter containing a check. Even a post-office money order is a clumsy and expensive substitute, and its use proclaims the user an insignificant financial factor.

Again, a business man without a bank account cannot usually obtain time credit, either from dealers or from banks. In the United States a bank likes to lend only to its own depositors. A business man who asks for a bank loan usually meets with the request to open an account. If he should seek a loan from another dealer, as for instance, his supply house, the absence of a bank account would arouse suspicions as to his business standing, and might lead to a refusal.

These facts, confirmed by observation and inquiry, have led to the belief that practically all business transactions in the United States, certainly over 99 per cent (measured, not by their number, but by their aggregate size), make some use of bank accounts. Even in localities where there are no banks, traders usually like to have a bank account in the nearest town, in order to facilitate their dealings as purchasers. We conclude, therefore, that the category of "Commercial depositors" coincides for all practical purposes with the category of business establishments.

"Other depositors" include most proprietors, professional, and salaried persons. Almost no wage earners are included, and almost no business establishments or business men in a business capacity. When a single individual conducts a business, he usually separates carefully his business self from his personal self. John Smith, the individual, and the John Smith Shop are distinct. The pocket money of the one and the till money of the other are not often confused. Where payments of money are made from one to the other, the transaction is regarded as of the same nature as the payments between the shop and any other person. Originally, and under primitive conditions, it is of course true that no such distinction was observed, and even to-day the differentiation is sometimes unmarked, e.g. in the case of hucksters, peddlers, fruit-stand dealers, and small country shopkeepers. But, as we have seen, these persons are not usually depositors anyway. Moreover, their number is small; and since by the nature of the case the money they handle is also small, their classification is, for practical purposes, a matter of indifference. It is true that occasional cases exist of ordinary business men who have the exclusive ownership of a business and do not take care to separate clearly their business and their personal accounts. Yet we may, in such cases, perform the separation in thought. When such a person withdraws money from his till and puts it in his pocket, we may say his business self has paid his personal self some dividends of the business. Likewise, his checks drawn are usually distinguishable as between his business or his personal expenses, even though he himself fails to keep two separate bank accounts. But such cases are rare and unimportant, because modern business of size is usually conducted by partnerships and corporations, where a strict separation of accounts is necessary to safeguard conflicting interests.

So much for the line of demarcation between "Other depositors" and "Commercial depositors." As to the line separating "Other depositors" and "Nondepositors," it should be observed that, although "Other depositors" include most proprietors and professional and salaried persons, yet some proprietors and professional men, especially in rural communities, and some salaried persons, chiefly small clerks, are "Nondepositors."

Finally, "Nondepositors" consist chiefly of those who are classed in statistics as wage earners. While there are some wage earners who are depositors,they are rare; and while there are some "Nondepositors" who are not wage earners, especially (as just indicated) the agricultural proprietors (farmers) and small clerks, the amount of money circulated by them is small in comparison with the total circulation. While the line separating wages and salaries is not definitely marked in theory, it is usually easily recognized in practice.

Children under, say, twelve years need not be included in any of the three categories, as they are not handlers of money; at least, not to a sufficient degree to have any appreciable influence on the total circulation.

We may now picture concretely the main currents of the monetary flow, including the circulation of money in exchange for goods. Figure 18 illustrates the three principal types.

The corners of the triangle, C, O and N, represent the three groups of "Commercial depositors," "Other depositors," and "Nondepositors," and the B's represent banks. The arrows represent the flow of money from each of these four categories to the others. Thus Bo represents the annual withdrawals from banks by "Other depositors," Oc the spending of this withdrawn money by "Other depositors" among "Commercial depositors," and Cb the return of the money from the "Commercial depositors" to the banks. This circuit (BoOcCb) of three links is very common. A second type of circuit is represented by a chain of four arrows (BoOcNcCb. It is illustrated by private depositors drawing money (Bo), and paying wages (On) to servants who in turn spend the money (Nc) among tradesmen who finally deposit it (Cb). A third type of circuit, also fourfold, is represented by the arrows BcCnNcCb. It is illustrated by commercial firms cashing their checks at banks (Bc) for pay rolls, with the cash so obtained paying wages (Cn) to workmen who spend it (Nc) among other tradesmen who redeposit it in banks (Cb). These three types are not the only ones, but they are so much more important than any others that they merit our undivided attention before a completer study is undertaken. Figure 18 has been constructed for the purpose of exhibiting them uncomplicated by other details.

It will be noted that not all of the flows described are examples of the circulation of money. As already indicated, money may be said to circulate only when it passes in exchange for goods. Its entrance into and exit from banks is a flow, but not a circulation against goods. In the diagram the horizontal arrows represent such mere banking operations, not true circulation. On the other hand, the arrows along the sides of the triangle represent actual circulation. The diagram shows four such arrows, representing the four chief types of circulation: Oc payments of money from "Other depositors" to "Commercial depositors" in the purchase of goods; On payments from "Other depositors" to "Nondepositors," as when a housewife pays wages; Cn payments from "Commercial depositors" to "Nondepositors," as when a firm pays wages; and Nc payments from "Nondepositors" to "Commercial depositors," as when a wage earner buys goods of a merchant.

These four types of circulation of money occur in the three circuits already described, being sandwiched between the flows from and to the banks. The first, Oc, is contained within the circuit BoOcCb, and since no "Nondepositors" intervene, represents money changing hands once between its withdrawal from bank and its re-deposit there. The remaining types (On,Cn, and Nc) are contained within the two other circuits (BoOnNcCb and BcCnNcCb), and, owing to the fact that "Nondepositors" intervene, represent money circulating twice between withdrawal and re-deposit.

In short, one of the three circuits (BoOcCb) shows money circulating once out of bank. Both the others pass through N, and show money circulating twice out of bank. The diagram, then, represents all circulating money as springing from and returning to the banks; all of it as circulating at least once in the interim; and that portion handled by "Nondepositors" as circulating once in addition. Therefore, the total circulation exceeds the total flow from and to banks by the amount flowing through "Nondepositors." In other words, the total circulation in the diagram is simply the sum of the annual money flowing from and to banks and the money handled by "Nondepositors." The quotient of this sum divided by the amount of money in circulation will give approximately the velocity of circulation of money.