Readings in Money and Banking - Selected and Adapted

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Title: Readings in Money and Banking - Selected and Adapted
Author: Phillips, Chester Arthur, 1882-1976
Language: English
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READINGS IN MONEY AND BANKING

* * * * *

THE MACMILLAN COMPANY

NEW YORK · BOSTON · CHICAGO · DALLAS

ATLANTA · SAN FRANCISCO

MACMILLAN & CO. LIMITED

LONDON · BOMBAY · CALCUTTA

MELBOURNE

THE MACMILLAN CO. OF CANADA. LTD.

TORONTO

* * * * *

READINGS IN MONEY AND BANKING

Selected And Adapted

CHESTER ARTHUR PHILLIPS

Assistant Professor of Economics in Dartmouth College
and Assistant Professor of Banking in the Amos
Tuck School of Administration and Finance

New York
The Macmillan Company
1921
All rights reserved

Printed in the United States of America

Set up and electrotyped. Published September, 1916.

Ferris Printing Company
New York City

PREFACE

Designed mainly for class room use in connection with one of the
introductory manuals on the subject of Money and Banking or of Money and
Currency, this volume, _in itself_, lays no claim to completeness. Where
its use is contemplated the problems of emphasis and proportion are,
accordingly, to be solved by the selection of one or another of the
available texts, or by the choice of supplementary lecture topics and
materials. The contents of the introductory manuals are so divergent in
character as to render possible combinations of text and readings that
will include, it is hoped, matter of such range and variety as may be
desired.

Fullness of treatment has been attempted, however, in the chapters
dealing with the important recent developments in the "mechanism of
exchange," and my aim has been throughout to select and, in many
instances, to adapt with a view to meeting the wants of those who are
interested chiefly in the modern phases of the subject.

For valuable suggestions in the preparation of the volume I am greatly
indebted to Professors F. H. Dixon and G. R. Wicker and Mr. J. M.
Shortliffe of Dartmouth, Professor Hastings Lyon of Columbia, Professor
E. E. Day of Harvard, and to my former teacher, Professor F. R.
Fairchild of Yale. I desire also to mention my great obligation to
authors and publishers who alike have generously permitted the
reproduction of copyrighted material.

CHESTER ARTHUR PHILLIPS.

Dartmouth College,
Hanover, N. H., July, 1916.

TABLE OF CONTENTS

CHAPTER PAGE

I THE ORIGIN AND FUNCTIONS OF MONEY 1

II THE EARLY HISTORY OF MONEY 10

III QUALITIES OF THE MATERIAL OF MONEY 18

IV LEGAL TENDER 26

V THE GREENBACK ISSUES 33

VI INTERNATIONAL BIMETALLISM 71

VII THE SILVER QUESTION IN THE UNITED STATES 82

VIII INDEX NUMBERS 115

IX BANKING OPERATIONS AND ACCOUNTS 121

X THE USE OF CREDIT INSTRUMENTS IN PAYMENTS
IN THE UNITED STATES 150

XI A SYMPOSIUM ON THE RELATION BETWEEN MONEY
AND GENERAL PRICES 159

XII THE GOLD EXCHANGE STANDARD 213

XIII A PLAN FOR A COMPENSATED DOLLAR 229

XIV MONETARY SYSTEMS OF FOREIGN COUNTRIES 246

XV THE NATURE AND FUNCTIONS OF TRUST COMPANIES 256

XVI SAVINGS BANKS 270

XVII DOMESTIC EXCHANGE 290

XVIII FOREIGN EXCHANGE 305

XIX CLEARING HOUSES 355

XX STATE BANKS AND TRUST COMPANIES SINCE THE PASSAGE
OF THE NATIONAL BANK ACT 381

XXI THE CANADIAN BANKING SYSTEM 406

XXII THE ENGLISH BANKING SYSTEM 435

XXIII THE SCOTCH BANKS 474

XXIV THE FRENCH BANKING SYSTEM 488

XXV THE GERMAN BANKING SYSTEM 526

XXVI BANKING IN SOUTH AMERICA 559

XXVII AGRICULTURAL CREDIT IN THE UNITED STATES 575

XXVIII THE CONCENTRATION OF CONTROL OF MONEY AND CREDIT 606

XXIX CRISES 627

XXX THE WEAKNESSES OF OUR BANKING SYSTEM PRIOR TO
THE ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 672

XXXI THE FEDERAL RESERVE SYSTEM 723

XXXII THE EUROPEAN WAR IN RELATION TO MONEY,
BANKING AND FINANCE 797

APPENDICES 830

READINGS IN MONEY AND BANKING

CHAPTER I

THE ORIGIN AND FUNCTIONS OF MONEY

[1]In order to understand the manifold functions of a Circulating
Medium, there is no better way than to consider what are the principal
inconveniences which we should experience if we had not such a medium.
The first and most obvious would be the want of a common measure for
values of different sorts. If a tailor had only coats, and wanted to buy
bread or a horse, it would be very troublesome to ascertain how much
bread he ought to obtain for a coat, or how many coats he should give
for a horse. The calculation must be recommenced on different data,
every time he bartered his coats for a different kind of article; and
there could be no current price, or regular quotations of value. Whereas
now each thing has a current price in money, and he gets over all
difficulties by reckoning his coat at £4 or £5, and a four-pound loaf at
6_d._ or 7_d_. As it is much easier to compare different lengths by
expressing them in a common language of feet and inches, so it is much
easier to compare values by means of a common language of pounds,
shillings, and pence. In no other way can values be arranged one above
another in a scale: in no other can a person conveniently calculate the
sum of his possessions; and it is easier to ascertain and remember the
relations of many things to one thing, than their innumerable cross
relations with one another. This advantage of having a common language
in which values may be expressed, is, even by itself, so important, that
some such mode of expressing and computing them would probably be used
even if a pound or a shilling did not express any real thing, but a mere
unit of calculation. It is said that there are African tribes in which
this somewhat artificial contrivance actually prevails. They calculate
the value of things in a sort of money of account, called macutes. They
say, one thing is worth ten macutes, another fifteen, another twenty.
There is no real thing called a macute: it is a conventional unit, for
the more convenient comparison of things with one another.

This advantage, however, forms but an inconsiderable part of the
economical benefits derived from the use of money. The inconveniences of
barter are so great, that without some more commodious means of
effecting exchanges, the division of employments could hardly have been
carried to any considerable extent. A tailor, who had nothing but coats,
might starve before he could find any person having bread to sell who
wanted a coat: besides, he would not want as much bread at a time as
would be worth a coat, and the coat could not be divided. Every person,
therefore, would at all times hasten to dispose of his commodity in
exchange for anything which, though it might not be fitted to his own
immediate wants, was in great and general demand, and easily divisible,
so that he might be sure of being able to purchase with it, whatever was
offered for sale. The primary necessaries of life possess these
properties in a high degree. Bread is extremely divisible, and an object
of universal desire. Still, this is not the sort of thing required: for,
of food, unless in expectation of a scarcity, no one wishes to possess
more at once than is wanted for immediate consumption; so that a person
is never sure of finding an immediate purchaser for articles of food;
and unless soon disposed of, most of them perish. The thing which people
would select to keep by them for making purchases, must be one which,
besides being divisible, and generally desired, does not deteriorate by
keeping. This reduces the choice to a small number of articles.

By a tacit concurrence, almost all nations, at a very early period,
fixed upon certain metals, and especially gold and silver, to serve this
purpose. No other substances unite the necessary qualities in so great a
degree, with so many subordinate advantages. Next to food and clothing,
and in some climates even before clothing, the strongest inclination in
a rude state of society is for personal ornament, and for the kind of
distinction which is obtained by rarity or costliness in such ornaments.
After the immediate necessities of life were satisfied, every one was
eager to accumulate as great a store as possible of things at once
costly and ornamental; which were chiefly gold, silver, and jewels.
These were the things which it most pleased every one to possess, and
which there was most certainty of finding others willing to receive in
exchange for any kind of produce. They were among the most imperishable
of all substances. They were also portable, and containing great value
in small bulk, were easily hid; a consideration of much importance in an
age of insecurity. Jewels are inferior to gold and silver in the quality
of divisibility; and are of very various qualities, not to be accurately
discriminated without great trouble. Gold and silver are eminently
divisible, and when pure, always of the same quality; and their purity
may be ascertained and certified by a public authority.

Accordingly, though furs have been employed as money in some countries,
cattle in others, in Chinese Tartary cubes of tea closely pressed
together, the shells called cowries on the coast of Western Africa, and
in Abyssinia at this day blocks of rock salt; though even of metals, the
less costly have sometimes been chosen, as iron in Lacedæmon from
ascetic policy, copper in the early Roman republic from the poverty of
the people; gold and silver have been generally preferred by nations
which were able to obtain them, either by industry, commerce, or
conquest. To the qualities which originally recommended them, another
came to be added, the importance of which only unfolded itself by
degrees. Of all commodities, they are among the least influenced by any
of the causes which produce fluctuations of value. They fluctuate less
than almost any other things in their cost of production. And from their
durability, the total quantity in existence is at all times so great in
proportion to the annual supply, that the effect on value even of a
change in the cost of production is not sudden: a very long time being
required to diminish materially the quantity in existence, and even to
increase it very greatly not being a rapid process. Gold and silver,
therefore, are more fit than any other commodity to be the subject of
engagements for receiving or paying a given quantity at some distant
period. If the engagement were made in corn, a failure of crops might
increase the burthen of the payment in one year to fourfold what was
intended, or an exuberant harvest sink it in another to one-fourth. If
stipulated in cloth, some manufacturing invention might permanently
reduce the payment to a tenth of its original value. Such things have
occurred even in the case of payments stipulated in gold and silver; but
the great fall of their value after the discovery of America, is, as
yet, the only authenticated instance; and in this case the change was
extremely gradual, being spread over a period of many years.

When gold and silver had become virtually a medium of exchange, by
becoming the things for which people generally sold, and with which they
generally bought, whatever they had to sell or to buy; the contrivance
of coining obviously suggested itself. By this process the metal was
divided into convenient portions, of any degree of smallness, and
bearing a recognized proportion to one another; and the trouble was
saved of weighing and assaying at every change of possessors, an
inconvenience which on the occasion of small purchases would soon have
become insupportable. Governments found it their interest to take the
operation into their own hands, and to interdict all coining by private
persons; indeed, their guarantee was often the only one which would have
been relied on, a reliance however which very often it ill deserved;
profligate governments having until a very modern period seldom
scrupled, for the sake of robbing their creditors, to confer on all
other debtors a licence to rob theirs, by the shallow and impudent
artifice of lowering the standard; that least covert of all modes of
knavery, which consists in calling a shilling a pound, that a debt of a
hundred pounds may be cancelled by the payment of a hundred shillings.
It would have been as simple a plan, and would have answered the purpose
as well, to have enacted that "a hundred" should always be interpreted
to mean five, which would have effected the same reduction in all
pecuniary contracts, and would not have been at all more shameless. Such
strokes of policy have not wholly ceased to be recommended, but they
have ceased to be practised; except occasionally through the medium of
paper money, in which case the character of the transaction, from the
greater obscurity of the subject, is a little less barefaced.

Money, when its use has grown habitual, is the medium through which the
incomes of the different members of the community are distributed to
them, and the measure by which they estimate their possessions. As it is
always by means of money that people provide for their different
necessities, there grows up in their minds a powerful association
leading them to regard money as wealth in a more peculiar sense than any
other article; and even those who pass their lives in the production of
the most useful objects, acquire the habit of regarding those objects as
chiefly important by their capacity of being exchanged for money. A
person who parts with money to obtain commodities, unless he intends to
sell them, appears to the imagination to be making a worse bargain than
a person who parts with commodities to get money; the one seems to be
spending his means, the other adding to them. Illusions which, though
now in some measure dispelled, were long powerful enough to overmaster
the mind of every politician, both speculative and practical, in Europe.

It must be evident, however, that the mere introduction of a particular
mode of exchanging things for one another, by first exchanging a thing
for money, and then exchanging the money for something else, makes no
difference in the essential character of transactions. It is not with
money that things are really purchased. Nobody's income (except that of
the gold or silver miner) is derived from the precious metals. The
pounds or shillings which a person receives weekly or yearly, are not
what constitutes his income; they are a sort of tickets or orders which
he can present for payment at any shop he pleases, and which entitle him
to receive a certain value of any commodity that he makes choice of. The
farmer pays his laborers and his landlord in these tickets, as the most
convenient plan for himself and them; but their real income is their
share of his corn, cattle, and hay, and it makes no essential difference
whether he distributes it to them directly or sells it for them and
gives them the price; but as they would have to sell it for money if he
did not, and he is a seller at any rate, it best suits the purposes of
all, that he should sell their share along with his own, and leave the
laborers more leisure for work and the landlord for being idle. The
capitalists, except those who are producers of the precious metals,
derive no part of their income from those metals, since they only get
them by buying them with their own produce: while all other persons have
their incomes paid to them by the capitalists, or by those who have
received payment from the capitalists, and as the capitalists have
nothing, from the first, except their produce, it is that and nothing
else which supplies all incomes furnished by them. There cannot, in
short, be intrinsically a more insignificant thing, in the economy of
society, than money; except in the character of a contrivance for
sparing time and labor. It is a machine for doing quickly and
commodiously, what would be done, though less quickly and commodiously,
without it: and like many other kinds of machinery, it only exerts a
distinct and independent influence of its own when it gets out of order.

The introduction of money does not interfere with the operation of any
of the Laws of Value.... The reasons which make the temporary or market
value of things depend on the demand and supply, and their average and
permanent values upon their cost of production, are as applicable to a
money system as to a system of barter. Things which by barter would
exchange for one another, will, if sold for money, sell for an equal
amount of it, and so will exchange for one another still, though the
process of exchanging them will consist of two operations instead of
only one. The relations of commodities to one another remain unaltered
by money: the only new relation introduced, is their relation to money
itself; how much or how little money they will exchange for; in other
words, how the Exchange Value of money itself is determined. And this is
not a question of any difficulty, when the illusion is dispelled, which
caused money to be looked upon as a peculiar thing, not governed by the
same laws as other things. Money is a commodity, and its value is
determined like that of other commodities, temporarily by demand and
supply, permanently and on the average by cost of production.

In the foregoing,[2] attention has been directed mainly to the two
functions of money known (1) as the Standard or Common Denominator of
Value, and (2) as the Medium of Exchange. Concerning transactions begun
and ended on the spot nothing more need be said; but the fact of
contracts over a period of time introduces an important element--the
time element. Whenever a contract is made covering a period of time,
within which serious changes in the economic world may take place, then
difficulties may arise as to what is a just standard of payments.
Various articles might serve equally well as a standard for exchanges
performed on the spot, but it is not so when any one article is chosen
as a standard for deferred payments. Without much regard to theory, the
world has in fact used the same standard for transactions whether
settled on the spot, or whether extending over a period of time.

In order to work with perfection as a standard for deferred payments,
the article chosen as that standard should place both debtors and
creditors in exactly the same absolute, and the same relative, position
to each other at the end of a contract that they occupied at its
beginning; this implies that the chosen article should maintain the same
exchange value in relation to goods, rents, and the wages of labour at
the end as at the beginning of the contract, and it implies that the
borrower and lender should preserve the same relative position as
regards their fellow producers and consumers at the later as at the
earlier point of time, and that they have not changed this relation, one
at the loss of the other. This makes demands which any article that can
be suggested as a standard cannot satisfy. And yet it is a practical
necessity of society that some one article should in fact be selected as
the standard. The business world has thus been forced to find some
commodity which--while admittedly never capable of perfection--provides
more nearly than anything else all the essentials of a desirable
standard.

The causes which may bring about changes in the relations between goods
and labor, on the one side, and the standard, on the other, are
various. We may, for instance, compare wheat with the existing gold
standard. The quantity of gold for which the wheat will exchange is its
price. As wheat falls in value relatively to gold, it exchanges for less
gold, that is, its price falls; or, _vice versa_, gold exchanges for
more wheat, and relatively to wheat gold has risen. As one goes up, the
other term in the ratio necessarily goes down; just as certainly as a
rise in one end of a plank balanced on a log necessitates a fall in the
other end of the plank. Therefore, changes in prices can be caused by
forces affecting either the gold side or the wheat side of the ratio; by
forces affecting either the money standard or the goods compared with
that standard. Consequences of importance follow from this explanation.
First suppose that commodities and labor remain unchanged in their
production and reward, respectively; then, anything affecting the supply
of and demand for gold will affect in general the value of gold in
comparison with goods and labor. Or, second, if we suppose an
equilibrium between the demand for and supply of gold, then, prices and
wages can be affected also by anything affecting the cost of obtaining
goods or labor. It is one-sided to look for changes in prices solely
from causes touching gold, or one term of the price ratio. If, however,
it should be desired that prices should remain stationary, then this can
be brought about only by finding for the standard an article that would
automatically move in extent, and in the proper compensating direction,
so as to meet any changes in value arising not only from causes
affecting itself, but also from causes affecting labor and the vast
number of goods that may be quoted in price. No commodity ever existed
which could thus move in value.

During long periods of time--within which gains in mechanical skill and
invention, revolutions in political and social habits, changes in taste
or fashion, settlement of new countries, opening of new markets, may
take place--great alterations in the value of the standard may occur
wholly from natural causes affecting the commodity side of the price
ratio. And yet, in default of a perfect standard, persons who borrow and
lend create debts and obligations expressed in terms of that article
which has been adopted as the standard by the concurring habits of the
commercial community of which they form a part. It should be understood,
whenever men enter into obligations reaching over a period of time, that
a necessary part of the risks involved in this undertaking is the
possibility of an alteration in the exchange values of goods, on the one
hand, and in the standard metal on the other, due to industrial changes
and natural causes. This is one of the risks which belong to individual
enterprise, differing in no way from other possibilities of gain and
loss. For instance, prices rose, as indicated by an index number of 100
in 1860 to an index number of 216 in 1865. Therefore, in the United
States, in this period of rising prices the creditor lost and the debtor
gained. On the other hand, from 1865 to 1878, prices fell from 216 to
101, and in this period of falling prices the creditor gained and the
debtor lost. It is to be observed, however, that these figures refer to
actual quotations of prices during the fluctuations of our paper money.
But it is evident in such movements as these, that parties to a
time-contract must take their own chances of changes; and indeed it is
much more wholesome that they should do so.

It should be kept well in mind that it is not a proper function of
government to step in and save men from the ordinary risks of trade and
industry. It goes without saying that if changes in the value of the
standard due to natural causes take place during the continuance of a
contract, it is not the business of government to indemnify either party
to the contract. This is a matter on which every individual who enters
into time obligations must bear his own responsibility.

FOOTNOTES:

[1] John Stuart Mill, _Principles of Political Economy_, Vol. II, pp.
17-23.

[2] Adapted from _The Report of the Commission of the Indianapolis
Convention_, pp. 92, 93, 103, 104. The University of Chicago Press,
1898.

CHAPTER II

THE EARLY HISTORY OF MONEY

[3]Living in civilized communities, and accustomed to the use of coined
metallic money, we learn to identify money with gold and silver; hence
spring hurtful and insidious fallacies. It is always useful, therefore,
to be reminded of the truth, so well stated by Turgot, that every kind
of merchandise has the two properties of measuring value and
transferring value. It is entirely a question of degree what commodities
will in any given state of society form the most convenient currency,
and this truth will be best impressed upon us by a brief consideration
of the very numerous things which have at one time or other been
employed as money. Though there are many numismatists and many political
economists, the natural history of money is almost a virgin subject,
upon which I should like to dilate; but the narrow limits of my space
forbid me from attempting more than a brief sketch of the many
interesting facts which may be collected.

CURRENCY IN THE HUNTING STATE

Perhaps the most rudimentary state of industry is that in which
subsistence is gained by hunting wild animals. The proceeds of the chase
would, in such a state, be the property of most generally recognized
value. The meat of the animals captured would, indeed, be too perishable
in nature to be hoarded or often exchanged; but it is otherwise with the
skins, which, being preserved and valued for clothing, became one of the
earliest materials of currency. Accordingly, there is abundant evidence
that furs or skins were employed as money in many ancient nations. They
serve this purpose to the present day in some parts of the world.

In the book of Job (ii, 4) we read, "Skin for skin, yea, all that a man
hath will he give for his life"; a statement clearly implying that skins
were taken as the representative of value among the ancient Oriental
nations. Etymological research shows that the same may be said of the
northern nations from the earliest times. In the Esthonian language the
word _râha_ generally signifies money, but its equivalent in the kindred
Lappish tongue has not yet altogether lost the original meaning of skin
or fur. Leather money is said to have circulated in Russia as late as
the reign of Peter the Great, and it is worthy of notice, that classical
writers have recorded traditions to the effect that the earliest
currency used at Rome, Lacedæmon, and Carthage, was formed of leather.

We need not go back, however, to such early times to study the use of
rude currencies. In the traffic of the Hudson's Bay Company with the
North American Indians, furs, in spite of their differences of quality
and size, long formed the medium of exchange. It is very instructive,
and corroborative of the previous evidence to find that even after the
use of coin had become common among the Indians the skin was still
commonly used as the money of account. Thus Whymper says, "a gun,
nominally worth about forty shillings, bought twenty 'skins.' This term
is the old one employed by the company. One skin (beaver) is supposed to
be worth two shillings, and it represents two marten, and so on. You
heard a great deal about 'skins' at Fort Yukon, as the workmen were also
charged for clothing, etc., in this way."

CURRENCY IN THE PASTORAL STATE

In the next higher stage of civilization, the pastoral state, sheep and
cattle naturally form the most valuable and negotiable kind of property.
They are easily transferable, convey themselves about, and can be kept
for many years, so that they readily perform some of the functions of
money.

We have abundance of evidence, traditional, written, and etymological,
to show this. In the Homeric poems oxen are distinctly and repeatedly
mentioned as the commodity in terms of which other objects are valued.
The arms of Diomed are stated to be worth nine oxen, and are compared
with those of Glaucos, worth one hundred. The tripod, the first prize
for wrestlers in the 23rd Iliad, was valued at twelve oxen, and a woman
captive, skilled in industry, at four. It is peculiarly interesting to
find oxen thus used as the common measure of value, because from other
passages it is probable, as already mentioned, that the precious metals,
though as yet uncoined, were used as a store of value, and occasionally
as a medium of exchange. The several functions of money were thus
clearly performed by different commodities at this early period.

In several languages the name for money is identical with that of some
kind of cattle or domesticated animal. It is generally allowed that
_pecunia_, the Latin word for money, is derived from _pecus_, cattle.
From the Agamemnon of Æschylus we learn that the figure of an ox was the
sign first impressed upon coins, and the same is said to have been the
case with the earliest issues of the Roman _As_. Numismatic researches
fail to bear out these traditions, which were probably invented to
explain the connection between the name of the coin and the animal. A
corresponding connection between these notions may be detected in much
more modern languages. Our common expression for the payment of a sum of
money is _fee_, which is nothing but the Anglo-Saxon _feoh_, meaning
alike money and cattle, a word cognate with the German _vieh_, which
still bears only the original meaning of cattle.

In the ancient German codes of law, fines and penalties are actually
defined in terms of live-stock. In the Zend Avesta, as Professor
Theodores ... informs me, the scale of rewards to be paid to physicians
is carefully stated, and in every case the fee consists in some sort of
cattle. The fifth and sixth lectures in Sir H. S. Maine's most
interesting work on _The Early History of Institutions_, which has just
been published, are full of curious information showing the importance
of live-stock in a primitive state of society. Being counted by the
head, the kine was called capitale, whence the economical term capital,
the law term chattel, and our common name cattle.

In countries where slaves form one of the most common and valuable
possessions, it is quite natural that they should serve as the medium
of exchange like cattle. Pausanias mentions their use in this way, and
in Central Africa and some other places where slavery still flourishes,
they are the medium of exchange along with cattle and ivory tusks.
According to Earl's account of New Guinea, there is in that island a
large traffic in slaves, and a slave forms the unit of value. Even in
England slaves are believed to have been exchanged at one time in the
manner of money.

ARTICLES OF ORNAMENT AS CURRENCY

A passion for personal adornment is one of the most primitive and
powerful instincts of the human race, and as articles used for such
purposes would be durable, universally esteemed, and easily
transferable, it is natural that they should be circulated as money. The
_wampumpeag_ of the North American Indians is a case in point, as it
certainly served as jewellery. It consisted of beads made of the ends of
black and white shells, rubbed down and polished, and then strung into
belts or necklaces, which were valued according to their length, and
also according to their color and luster, a foot of black _peag_ being
worth two feet of white _peag_. It was so well established as currency
among the natives that the Court of Massachusetts ordered in 1649, that
it should be received in the payment of debts among settlers to the
amount of forty shillings. It is curious to learn, too, that just as
European misers hoard up gold and silver coins, the richer Indian chiefs
secrete piles of wampum beads, having no better means of investing their
superfluous wealth.

Exactly analogous to this North American currency, is that of the cowry
shells, which, under one name or another--_chamgos_, _zimbis_, _bouges_,
_porcelanes_, etc.--have long been used in the East Indies as small
money. In British India, Siam, the West Coast of Africa, and elsewhere
on the tropical coasts, they are still used as small change, being
collected on the shores of the Maldive and Laccadive Islands, and
exported for the purpose. Their value varies somewhat, according to the
abundance of the yield, but in India the current rate used to be about
five thousand shells for one rupee, at which rate each shell is worth
about the two-hundredth part of a penny. Among our interesting
fellow-subjects, the Fijians, whale's teeth served in the place of
cowries, and white teeth were exchanged for red teeth somewhat in the
ratio of shillings to sovereigns.

Among other articles of ornament or of special value used as currency,
may be mentioned yellow amber, engraved stones, such as the Egyptian
scarabæi, and tusks of ivory.

CURRENCY IN THE AGRICULTURAL STATE

Many vegetable productions are at least as well suited for circulation
as some of the articles which have been mentioned. It is not surprising
to find, then, that among a people supporting themselves by agriculture,
the more durable products were thus used. Corn has been the medium of
exchange in remote parts of Europe from the time of the ancient Greeks
to the present day. In Norway corn is even deposited in banks, and lent
and borrowed. What wheat, barley, and oats are to Europe, such is maize
in parts of Central America, especially Mexico, where it formerly
circulated. In many of the countries surrounding the Mediterranean,
olive oil is one of the commonest articles of produce and consumption;
being, moreover, pretty uniform in quality, durable, and easily
divisible, it has long served as currency in the Ionian Islands,
Mytilene, some towns of Asia Minor, and elsewhere in the Levant.

Just as cowries circulate in the East Indies, so cacao nuts, in Central
America and Yucatan, form a perfectly recognized and probably an ancient
fractional money. Travellers have published many distinct statements as
to their value, but it is impossible to reconcile these statements
without supposing great changes of value either in the nuts or in the
coins with which they are compared. In 1521, at Caracas, about thirty
cacao nuts were worth one penny English, whereas recently ten beans
would go to a penny, according to Squier's statements. In the European
countries, where almonds are commonly grown, they have circulated to
some extent like the cacao nuts, but are variable in value, according to
the success of the harvest.

It is not only, however, as a minor currency that vegetable products
have been used in modern times. In the American settlements and the West
India Islands, in former days, specie used to become inconveniently
scarce, and the legislators fell back upon the device of obliging
creditors to receive payment in produce at stated rates. In 1618, the
Governor of the Plantations of Virginia ordered that tobacco should be
received at the rate of three shillings for the pound weight, under the
penalty of three years' hard labor. We are told that, when the Virginia
Company imported young women as wives for the settlers, the price per
head was one hundred pounds of tobacco, subsequently raised to one
hundred and fifty. As late as 1732, the legislature of Maryland made
tobacco and Indian corn legal tenders; and in 1641 there were similar
laws concerning corn in Massachusetts. The governments of some of the
West India Islands seem to have made attempts to imitate these peculiar
currency laws, and it was provided that the successful plaintiff in a
lawsuit should be obliged to accept various kinds of raw produce, such
as sugar, rum, molasses, ginger, indigo, or tobacco....

The perishable nature of most kinds of animal food prevents them from
being much used as money; but eggs are said to have circulated in the
Alpine villages of Switzerland, and dried codfish have certainly acted
as currency in the colony of Newfoundland.

MANUFACTURED AND MISCELLANEOUS ARTICLES AS CURRENCY

The enumeration of articles which have served as money may already seem
long enough for the purposes in view. I will, therefore, only add
briefly that a great number of manufactured commodities have been used
as a medium of exchange in various times and places. Such are the pieces
of cotton cloth, called _Guinea pieces_, used for traffic upon the banks
of the Senegal, or the somewhat similar pieces circulated in Abyssinia,
the Soulou Archipelago, Sumatra, Mexico, Peru, Siberia, and among the
Veddahs. It is less easy to understand the origin of the curious straw
money which circulated until 1694 in the Portuguese possessions in
Angola, and which consisted of small mats, called _libongos_, woven out
of rice straw, and worth about 1-1/2_d._ each. These mats must have had,
at least originally, some purpose apart from their use as currency, and
were perhaps analogous to the fine woven mats so much valued by the
Samoans, and also treated by them as a medium of exchange.

Salt has been circulated not only in Abyssinia, but in Sumatra, Mexico,
and elsewhere. Cubes of benzoin gum or beeswax in Sumatra, red feathers
in the Islands of the Pacific Ocean, cubes of tea in Tartary, iron
shovels or hoes among the Malagasy, are other peculiar forms of
currency. The remarks of Adam Smith concerning the use of hand-made
nails as money in some Scotch villages will be remembered by many
readers, and need not be repeated. M. Chevalier has adduced an exactly
corresponding case from one of the French coalfields.

Were space available it would be interesting to discuss the not
improbable suggestion of Boucher de Perthes, that, perhaps, after all,
the finely worked stone implements now so frequently discovered were
among the earliest mediums of exchange. Some of them are certainly made
of jade, nephrite, or other hard stones, only found in distant
countries, so that an active traffic in such implements must have
existed in times of which we have no records whatever.

There are some obscure allusions in classical authors to a wooden money
circulating among the Byzantines, and to a wooden talent used at Antioch
and Alexandria, but in the absence of fuller information as to their
nature, it is impossible to do more than mention them....

THE INVENTION OF COINING

The date of the invention of coining can be assigned with some degree of
probability. Coined money was clearly unknown in the Homeric times, and
it was known in the time of Lycurgus. We might therefore assume, with
various authorities, that it was invented in the mean time, or about 900
B. C. There is tradition, moreover, that Pheidon, King of Argos, first
struck silver money in the island of Ægina about 895 B. C., and the
tradition is supported by the existence of small stamped ingots of
silver, which have been found in Ægina. Later inquiries, however, lead
to the conclusion that Pheidon lived in the middle of the eighth century
B. C., and Grote has shown good reasons for believing that what he did
accomplish was done in Argos, and not in Ægina.

The mode in which the invention happened is sufficiently evident. Seals
were familiarly employed in very early times, as we learn from the
Egyptian paintings or the stamped bricks of Nineveh. Being employed to
signify possession, or to ratify contracts, they came to indicate
authority. When a ruler first undertook to certify the weights of pieces
of metal, he naturally employed his seal to make the fact known, just
as, at Goldsmiths' Hall, a small punch is used to certify the fineness
of plate. In the earliest forms of coinage there were no attempts at so
fashioning the metal that its weight could not be altered without
destroying the stamp or design. The earliest coins struck, both in Lydia
and in the Peloponnesus, were stamped on one side only....

FOOTNOTES:

[3] W. Stanley Jevons, _Money and the Mechanism of Exchange_, D.
Appleton and Company, New York, 1902, pp. 19-28, 54, 55.

CHAPTER III

QUALITIES OF THE MATERIAL OF MONEY

[4]Many recent writers, such as Huskisson, MacCulloch, James Mill,
Garnier, Chevalier, and Walras, have satisfactorily described the
qualities which should be possessed by the material of money. Earlier
writers seem, however, to have understood the subject almost as well....
Of all writers, M. Chevalier ... probably gives the most accurate and
full account of the properties which money should possess, and I shall
in many points follow his views.

The prevailing defect in the treatment of the subject is the failure to
observe that money requires different properties as regards different
functions. To decide upon the best material for money is thus a problem
of great complexity, because we must take into account at once the
relative importance of the several functions of money, the degree in
which money is employed for each function, and the importance of each of
the physical qualities of the substance with respect to each function.
In a simple state of industry money is chiefly required to pass about
between buyers and sellers. It should, then, be conveniently portable,
divisible into pieces of various size, so that any sum may readily be
made up, and easily distinguishable by its appearance, or by the design
impressed upon it. When money, however, comes to serve, as it will at
some future time, almost exclusively as a measure and standard of value,
the system of exchange, being one of perfected barter, such properties
become a matter of comparative indifference, and stability of value,
joined perhaps to portability, is the most important quality. Before
venturing, however, to discuss such complex questions, we must proceed
to a preliminary discussion of the properties in question, which may
thus perhaps be enumerated in the order of their importance:

1. Utility and value.
2. Portability.
3. Indestructibility.
4. Homogeneity.
5. Divisibility.
6. Stability of value.
7. Cognisability.

1. UTILITY AND VALUE

Since money has to be exchanged for valuable goods, it should itself
possess value and it must therefore have utility as the basis of value.
Money, when once in full currency, is only received in order to be
passed on, so that if all people could be induced to take worthless bits
of material at a fixed rate of valuation, it might seem that money does
not really require to have substantial value. Something like this does
frequently happen in the history of currencies, and apparently valueless
shells, bits of leather, or scraps of paper are actually received in
exchange for costly commodities. This strange phenomenon is, however, in
most cases capable of easy explanation, and if we were acquainted with
the history of every kind of money the like explanation would no doubt
be possible in other cases. The essential point is that people should be
induced to receive money, and pass it on freely at steady ratios of
exchange for other objects; but there must always be some sufficient
reason first inducing people to accept the money. The force of habit,
convention, or legal enactment may do much to maintain money in
circulation when once it is afloat, but it is doubtful whether the most
powerful government could oblige its subjects to accept and circulate as
money a worthless substance which they had no other motive for
receiving.

Certainly, in the early stages of society, the use of money was not
based on legal regulations, so that the utility of the substance for
other purposes must have been the prior condition of its employment as
money. Thus the singular _peag_ currency, or _wampumpeag_, which was
found in circulation among the North American Indians by the early
explorers, was esteemed for the purpose of adornment, as already
mentioned.... The cowry shells, so widely used as a small currency in
the East, are valued for ornamental purposes on the West Coast of
Africa, and were in all probability employed as ornaments before they
were employed as money. All the other articles [previously] mentioned
... such as oxen, corn, skins, tobacco, salt, cacao nuts, tea, olive
oil, etc., which have performed the functions of money in one place or
another, possessed independent utility and value. If there are any
apparent exceptions at all to this rule, they would doubtless admit of
explanation by fuller knowledge. We may, therefore, agree with Storch
when he says: "It is impossible that a substance which has no direct
value should be introduced as money, however suitable it may be in other
respects for this use."

When once a substance is widely employed as money, it is conceivable
that its utility will come to depend mainly upon the services which it
thus confers upon the community. Gold, for instance, is far more
important as the material of money than in the production of plate,
jewellery, watches, gold-leaf, etc. A substance originally used for many
purposes may eventually serve only as money, and yet, by the demand for
currency and the force of habit, may maintain its value. The cowry
circulation of the Indian coasts is probably a case in point. The
importance of habit, personal or hereditary, is at least as great in
monetary science as it is, according to Mr. Herbert Spencer, in morals
and sociological phenomena generally.

There is, however, no reason to suppose that the value of gold and
silver is at present due solely to their conventional use as money.
These metals are endowed with such singularly useful properties that, if
we could only get them in sufficient abundance, they would supplant all
the other metals in the manufacture of household utensils, ornaments,
fittings of all kinds, and an infinite multitude of small articles,
which are now made of brass, copper, bronze, pewter, German silver, or
other inferior metals and alloys.

In order that money may perform some of its functions efficiently,
especially those of a medium of exchange and a store of value, to be
carried about, it is important that it should be made of a substance
valued highly in all parts of the world, and, if possible, almost
equally esteemed by all peoples. There is reason to think that gold and
silver have been admired and valued by all tribes which have been lucky
enough to procure them. The beautiful lustre of these metals must have
drawn attention and excited admiration as much in the earliest as in the
present times.

2. PORTABILITY

The material of money must not only be valuable, but the value must be
so related to the weight and bulk of the material, that the money shall
not be inconveniently heavy on the one hand, nor inconveniently minute
on the other. There was a tradition in Greece that Lycurgus obliged the
Lacedæmonians to use iron money, in order that its weight might deter
them from overmuch trading. However this may be, it is certain that iron
money could not be used in cash payments at the present day, since a
penny would weigh about a pound, and instead of a five-pound note, we
should have to deliver a ton of iron. During the last century copper was
actually used as the chief medium of exchange in Sweden; and merchants
had to take a wheelbarrow with them when they went to receive payments
in copper _dalers_. Many of the substances used as currency in former
times must have been sadly wanting in portability. Oxen and sheep,
indeed, would transport themselves on their own legs; but corn, skins,
oil, nuts, almonds, etc., though in several respects forming fair
currency, would be intolerably bulky and troublesome to transfer.

The portability of money is an important quality not merely because it
enables the owner to carry small sums in the pocket without trouble, but
because large sums can be transferred from place to place, or from
continent to continent, at little cost. The result is to secure an
approximate uniformity in the value of money in all parts of the world.
A substance which is very heavy and bulky in proportion to value, like
corn or coal, may be very scarce in one place and over-abundant in
another; yet the supply and demand cannot be equalised without great
expense in carriage. The cost of conveying gold or silver from London to
Paris, including insurance, is only about four-tenths of one per cent.;
and between the most distant parts of the world it does not exceed from
2 to 3 per cent.

Substances may be too valuable as well as too cheap, so that for
ordinary transactions it would be necessary to call in the aid of the
microscope and the chemical balance. Diamonds, apart from other
objections, would be far too valuable for small transactions. The value
of such stones is said to vary as the square of the weight, so that we
cannot institute any exact comparison with metals of which the value is
simply proportional to the weight. But taking a one-carat diamond (four
grains) as worth £15, we find it is, weight for weight, 460 times as
valuable as gold. There are several rare metals, such as iridium and
osmium, which would likewise be far too valuable to circulate. Even gold
and silver are too costly for small currency. A silver penny now weighs
7-1/4 grains, and a gold penny would weigh only half a grain. The pretty
octagonal quarter-dollar tokens circulated in California are the
smallest gold coins I have seen, weighing less than four grains each,
and are so thin that they can almost be blown away.

3. INDESTRUCTIBILITY

If it is to be passed about in trade, and kept in reserve, money must
not be subject to easy deterioration or loss. It must not evaporate like
alcohol, nor putrefy like animal substances, nor decay like wood, nor
rust like iron. Destructible articles, such as eggs, dried codfish,
cattle, or oil, have certainly been used as currency; but what is
treated as money one day must soon afterwards be eaten up. Thus a large
stock of such perishable commodities cannot be kept on hand, and their
value must be very variable. The several kinds of corn are less subject
to this objection, since, when well dried at first, they suffer no
appreciable deterioration for several years.

4. HOMOGENEITY

All portions of specimens of the substance used as money should be
homogeneous, that is, of the same quality, so that equal weights will
have exactly the same value. In order that we may correctly count in
terms of any unit, the units must be equal and similar, so that twice
two will always make four. If we were to count in precious stones, it
would seldom happen that four stones would be just twice as valuable as
two stones. Even the precious metals, as found in the native state, are
not perfectly homogeneous, being mixed together in almost all
proportions; but this produces little inconvenience, because the assayer
readily determines the quantity of each pure metal present in any ingot.
In the processes of refining and coining, the metals are afterwards
reduced to almost exactly uniform degrees of fineness, so that equal
weights are then of exactly equal value.

5. DIVISIBILITY

Closely connected with the last property is that of divisibility. Every
material is, indeed, mechanically divisible, almost without limit. The
hardest gems can be broken, and steel can be cut by harder steel. But
the material of money should be not merely capable of division, but the
aggregate value of the mass after division should be almost exactly the
same as before division. If we cut up a skin or fur the pieces will, as
a general rule, be far less valuable than the whole skin or fur, except
for a special intended purpose; and the same is the case with timber,
stone, and most other materials in which reunion is impossible. But
portions of metal can be melted together again whenever it is desirable,
and the cost of doing this, including the metal lost, is in the case of
precious metals very inconsiderable, varying from 1/4_d._ to 1/2_d._ per
ounce. Thus, approximately speaking, the value of any piece of gold or
silver is simply proportional to the weight of fine metal which it
contains.

6. STABILITY OF VALUE

It is evidently desirable that the currency should not be subject to
fluctuations of value. The ratios in which money exchanges for other
commodities should be maintained as nearly as possible invariable on the
average. This would be a matter of comparatively minor importance were
money used only as a measure of values at any one moment, and as a
medium of exchange. If all prices were altered in like proportion as
soon as money varied in value, no one would lose or gain, except as
regards the coin which he happened to have in his pocket, safe, or bank
balance. But, practically speaking, as we have seen, people do employ
money as a standard of value for long contracts, and they often maintain
payments at the same variable rate, by custom or law, even when the real
value of the payment is much altered. Hence every change in the value of
money does some injury to society.

It might be plausibly said, indeed, that the debtor gains as much as the
creditor loses, or vice versa, so that on the whole the community is as
rich as before; but this is not really true. A mathematical analysis of
the subject shows that to take any sum of money from one and give it to
another will, on the average of cases, injure the loser more than it
benefits the receiver. A person with an income of one hundred pounds a
year would suffer more by losing ten pounds than he would gain by an
addition of ten pounds, because the degree of utility of money to him is
considerably higher at ninety pounds than it is at one hundred and ten.
On the same principle, all gaming, betting, pure speculation, or other
accidental modes of transferring property involve, on the average, a
dead loss of utility. The whole incitement to industry and commerce and
the accumulation of capital depends upon the expectation of enjoyment
thence arising, and every variation of the currency tends in some degree
to frustrate such expectation and to lessen the motives for exertion.

7. COGNISABILITY

By this name we may denote the capability of a substance for being
easily recognised and distinguished from all other substances. As a
medium of exchange, money has to be continually handed about, and it
will occasion great trouble if every person receiving currency has to
scrutinize, weigh, and test it. If it requires any skill to discriminate
good money from bad, poor ignorant people are sure to be imposed upon.
Hence the medium of exchange should have certain distinct marks which
nobody can mistake. Precious stones, even if in other respects good as
money, could not be so used, because only a skilled lapidary can surely
distinguish between true and imitation gems.

Under cognisability we may properly include what has been aptly called
_impressibility_, namely, the capability of a substance to receive such
an impression, seal, or design, as shall establish its character as
current money of certain value. We might more simply say, that the
material of money should be coinable, so that a portion, being once
issued according to proper regulations with the impress of the state,
may be known to all as good and legal currency, equal in weight, size,
and value to all similarly marked currency....

FOOTNOTES:

[4] W. Stanley Jevons, _Money and the Mechanism of Exchange_, pp. 29-39.
D. Appleton & Company, New York, 1902.

CHAPTER IV

LEGAL TENDER[5]

The essential idea of "legal tender" is that quality given to money by
law which obliges the creditor to receive it in full satisfaction of a
past debt when expressed in general terms of the money of a country. A
debt is a sum of money due by contract, express or implied. When our
laws, for instance, declare that United States notes are legal
tender--and this is the only complete designation of a legal-tender
money--for "all debts public and private," it must be understood that
this provision does not cover any operations not arising from contract.
Current buying and selling do not make a situation calling for legal
tender; a purchaser cannot compel the delivery of goods over a counter
by offering legal-tender money for them, because, as yet, no debt has
been created.[6]

Contracts made in general terms of the money units of the country must
necessarily often be interpreted by the courts. The existence of
contracts calling for a given sum of dollars and the necessity of
adjudicating and enforcing such contracts, require that there should be
an accurate legal interpretation of what a dollar is. As every one
knows, the name, or unit of account, is affixed to a given number of
grains of a specified fineness of a certain metal. This being the
standard, and this having been chosen by the concurring habits of the
business world, it is fit that the law should designate that, when only
dollars are mentioned in a contract, it should be satisfied only by the
payment of that which is the standard money of the community.

Since prices and contracts are expressed in terms of the standard
article, it is clear that the legal-tender quality should not be equally
affixed to different articles having different values, but called by the
same name. This method would be sure to bring confusion, uncertainty,
and injustice into trade and industry. No one who had made a contract
would know in what he was to be paid. The legal-tender quality, then,
should be confined to that which is the sole standard. And it is also
obvious that when a standard is satisfactorily determined upon, and when
various effective media of exchange, like bank notes, checks, or bills
of exchange, have sprung up, the legal-tender quality should not be
given to these instruments of convenience. They are themselves expressed
in, and are resolvable into, the standard metal; so the power to satisfy
debts should be given not to the shadow, but to the substance, not to
the devices drawn in terms of the standard, but only to the standard
itself, even though, as a matter of fact, nine-tenths of the debts and
contracts are actually settled by means of these devices. So long as
these instruments are convertible into, and thus made fully equal to,
the standard in terms of which they are drawn, they will be used by the
business community for the settlement of debts without being made a
legal tender. And whenever they are worth less than the standard they
certainly should not be made a legal tender, because of the injustice
which in such a case they would work.

Having shown that the legal-tender quality is only a necessary legal
complement of the choice of a standard, it will not be difficult to see
that the state properly chooses an article fit to have the legal-tender
attribute for exactly the reasons that governed the selection of the
same article as a standard. The whole history of money shows that the
standard article was the one which had utility to the community using
it. As the evolution of the money commodity went on from cattle to
silver and gold, so the legal-tender provisions naturally followed this
course.

A state may select a valueless commodity as a standard, but that will
not make it of value to those who would already give nothing for it; and
so, it may give the legal-tender quality to a thing which has become
valueless, but that will not of itself insure the maintenance of its
former value. This proposition may, at first, appear to be opposed to a
widely-spread belief; but its soundness can be fully supported. It
should be learned that a commodity, or a standard, holds its value for
reasons quite independent of the fact that it is given legal
recognition. It has happened that legal recognition has been given to it
because it possessed qualities that gave it value to the commercial
world, and not that it came to have these qualities and this value
because it was made a legal tender.

A good illustration of this truth is to be found in international trade.
Money which is not dependent on artificial influences for its value, and
which is not redeemable in something else, is good the world over at its
actual commercial value, not at its value as fixed by any legal-tender
laws. It is not the legal-tender stamp that gives a coin its value in
international payments. A sovereign, an eagle, a napoleon, is constantly
given and received in international trade not because of the stamp it
bears, but because of the number of grains of a given fineness of gold
which it contains--the value of which is determined in the markets of
the world. And an enormous trade among the great commercial countries
goes on easily and effectively without regard to the legal-tender laws
of the particular country whose coins are used.

By imposing the attribute of legal tender, however, upon a given metal
or money, it may be believed that thereby a new demand is created for
that metal, and that its value is thus controlled. And in theory there
is some basis for this belief. It is, of course, true that, in so far as
giving to money a legal-tender power creates a new demand for it (which
without that power would not have existed) an effect upon its value can
be produced. But this effect is undoubtedly much less than is usually
supposed. It must be remembered that the value of gold, for instance, is
affected by world influences; that its value is determined by the demand
of the whole world as compared with the whole existing supply in the
world. In order to affect the value of gold in any one country, a demand
created by a legal-tender enactment must be sufficient to affect the
world-value of gold. Evidently the effect will be only in the proportion
that the new demand bears to the whole stock in the world. It is like
the addition of a barrel of water to a pond; theoretically the surface
level is raised, but not to any appreciable extent.

It may now be permissible to examine into the extent to which a demand
is created by legal-tender laws. If the article endowed with a
legal-tender power is already used as the standard and as a medium of
exchange, it is given no value which it did not have before. The customs
and business habits of a country alone determine how much of the
standard coin will be carried about and used in hand-to-hand purchases,
and how much of the business will be performed by other media of
exchange, such as checks or drafts. The decision of a country to adopt
gold--when it had only paper before, as was the case in Italy--would
create a demand for gold to an extent determined by the monetary habits
of that country; and this demand has an effect, as was said, only in the
proportion of this amount to the total supply in the world. This
operation arises from choosing gold as the standard of prices and as the
medium of exchange. To give this standard a legal-tender power in
addition does not increase the demand for it, because the stamp on the
coin does not in any way alter the existing habits of the community as
to the quantity of money it will use.

But in case an equal power to pay debts is given to fixed quantities of
two metals, while each quantity so fixed has a different metallic value
but the same denomination in the coinage, Gresham's law is set in
operation with the result that the cheaper metal becomes the standard.
After this change has been accomplished, the legal tender has no
value-giving force. When the cheaper metal has become the standard, its
legal-tender quality does not raise the value of the coin beyond the
value of its content. This cheaper standard, in international trade,
would be worth no more in the purchase of goods because it bore the
stamp of any one country. Prices must necessarily be adjusted between
the relative values of goods and the standard with which they are
compared. If the standard is cheaper, prices will be higher,
irrespective of legal-tender acts. Where two metals are concerned, then,
the only effect of a legal-tender clause is an injurious one, in that
the metal which is overvalued drives out that which is under-valued.

The example of an inconvertible paper, such as our United States notes
(greenbacks) in 1862-1879, is still more conclusive. Although a full
legal tender for all debts public and private, their value steadily sank
until they were at one time worth only 35 cents in gold. In California,
moreover, these notes, although legal-tender, were even kept out of
circulation by public opinion. In short, the value of inconvertible
paper can be but little affected by legal-tender powers. Its value is
more directly governed, as in the case of token coins, by the
probabilities of redemption.[7] As bearing on the point that the value
of the paper was more influenced by the chances of redemption than by
legal-tender laws, we may cite the sudden fluctuations in the value of
our United States notes during the Civil War. With no change in the
legal-tender quality and no change in the indebtedness which might be
paid with such notes, their value frequently rose or fell many per cent.
in a single day owing to reports of Federal successes or defeats in
battle, which had a tendency to affect one way or the other the public
estimate of the probabilities of an early resumption of specie payments.
The fact that they were legal tender evidently had no effect whatever in
maintaining their value.

In view of the evident fact that legal-tender acts do not preserve the
value of money, it is clear that the demand created by such legislation
must be insignificant. And this must be so in principle as well as in
fact.

There is but one thing which the legal-tender quality enables money to
do which it could not equally well do without being a legal tender; that
is, to pay past debts. An examination, however, shows that this use of
money is very small compared with its other uses. The amount of past
debts coming due and which might be paid in any year, month or day is
insignificant when compared with the total transactions of that year,
month or day--so very small as to lose all measurable value-giving
power. In other words, the one thing which legal-tender money can surely
do in spite of the habits, wishes or prejudices of the business
community in which it exists, namely, cancel past debt, is
infinitesimally small when compared with those other things which man
wishes money to do for him. It is for this reason that it ceases to give
value, and this is why history has shown so many instances where money
endowed with legal-tender power has become utterly valueless. The
legal-tender money is no longer money if it will not secure for man the
things which are most important for his welfare, if it will not buy
food, clothes and shelter; for it performs none of the functions of
money except the subsidiary one of cancelling past debts.

Moreover, the obligatory uses of legal-tender money are in fact very
inconsiderable. A law requiring a past debt to be satisfied with money
of a certain kind has for its essence only the payment of something of a
definite value, or its equivalent; in practice, it does not even bring
about the actual use of a legal money, since the monetary habits of the
community will not necessarily require the debt to be paid in such
money. Take the extreme case of a judgment by a court against a
defendant for fulfilment of a contract; in such an example, of all
others, it would be supposed that legal money would be exacted. But even
here, the judgment would most probably be satisfied by the attorney's
check, or at most by a certified check. If such media of exchange are of
common usage in the community they will be resorted to in practice even
for legal-tender payments.

The necessity of paying that which would be mutually satisfactory to
payer and payee also makes clear why the existence of a legal-tender
money does not necessarily cause its actual use in payments. The
business habits of the community are stronger than legislative powers.
Business men will not as a rule take advantage of a legal-tender act to
pay debts in a cheaper money, if they look forward to remaining in
business. For, if, by taking advantage of legal devices they defraud the
creditor, they cannot expect credit again from the same source; and
since loans are a necessity of legitimate modern trade, such action
would ruin their credit and cut them off from business activity in the
future. Gold was not driven out of circulation by paper money during the
years 1862-1879 in California, because the sentiment of the business
public was against the use of our depreciated greenback currency; and a
discrimination was made against merchants who resorted to the use of
paper.

Explanation has been given of the principles according to which
legal-tender laws should be applied, if at all. It is not wholly clear
that there is any reason for their existence. It may now be well to
indicate briefly the origin of legal-tender provisions. It can scarcely
be doubted that their use arose from the desire of defaulting monarchs
to ease their indebtedness by forcing upon creditors a debased coinage.
Having possession of the mints, the right of coinage vesting in the
lord, the rulers of previous centuries have covered the pages of history
with the records of successive debasements of the money of account. The
legal-tender enactment was the instrument by which the full payment of
debts was evaded. There would have been no reason for debasing coins, if
they could not be forced upon unwilling creditors. It is, therefore,
strange indeed that, in imitation of monarchical morals of a past day,
republican countries should have thought it a wise policy to clothe
depreciated money with a nominal value for paying debts. Although the
people are now sovereign, they should not embrace the vices of mediæval
sovereignty for their own dishonest gain in scaling debts.

FOOTNOTES:

[5] _Report of the Monetary Commission of the Indianapolis Convention_,
pp. 131-7. The Hollenbeck Press, Indianapolis, 1900.

[6] "A contract payable in money generally is, undoubtedly, payable in
any kind of money made by law legal tender, at the option of the debtor
at the time of payment. He contracts simply to pay so much money, and
creates a debt pure and simple; and by paying what the law says is money
his contract is performed. But, if he agrees to pay in gold coin, it is
not an agreement to pay money simply, but to pay or deliver a specific
kind of money and nothing else; and the payment in any other is not a
fulfilment of the contract according to its terms or the intention of
the parties." 25 California 564, Carpenter _vs._ Atherton.

[7] For a contrary view, see Joseph French Johnson, _Money and
Currency_, Chapter 13.--EDITOR.

CHAPTER V

THE GREENBACKS

THE GREENBACK ISSUES

[8]The greenbacks were an outgrowth of the Civil War. Soon after the
opening of the struggle the Secretary of the Treasury negotiated a loan
of $150,000,000 with Eastern banks. Partly because of Confederate
successes and partly because of the failure of Secretary Chase to adopt
a firm policy of loans supported by taxation, public credit greatly
declined, and Government bonds became almost unsaleable. The outlook
became alarming and depositors withdrew gold from the New York banks in
such large amounts that specie payments were suspended, December 30,
1861. In February, 1862, Congress provided for the issue of $150,000,000
in United States notes or greenbacks. Bond sales proceeded slowly and a
second issue of $150,000,000 of notes was authorised in July of the same
year. As a result of "military necessity" a third issue of $100,000,000
was authorised January 17, 1863, and temporarily increased March 3 to
$150,000,000. Provision was made for the reissue of the greenbacks and
$400,000,000 were outstanding at the close of the war.

THE FLUCTUATING PREMIUM ON GOLD

Depreciation of the greenbacks occurred at once and the value of gold as
expressed in greenbacks was subject to almost constant change. During
the year 1862 the premium varied from 2 to 32; in 1863 from 25 to 60;
and in 1864 from 55 to 185. Among the most important political and
economic factors which caused these fluctuations may be mentioned:

(1) The increase in the amount of the greenbacks. Each new issue was
reflected in a rise in the premium.

(2) The condition of the treasury. The annual reports of the Secretary
of the Treasury were anxiously awaited and their appearance caused a
rise or fall of the premium according as the condition of the finances
seemed gloomy or hopeful.

(3) Ability of the Government to borrow. The fate of a loan indicated
public confidence or distrust.

(4) Changes in the officials of the treasury department. Secretary
Chase's resignation, July 1, 1864, depressed the currency decidedly.

(5) War news. Every victory raised the price of currency and every
defeat depressed it.

From 1862 to 1865 the premium on gold and the median of relative prices
correspond so well that one cannot resist the conclusion that these
changes were mainly due to a common cause, which can hardly be other
than the varying esteem in which the notes of the Government that
constituted the standard money of the country were held. If this
conclusion be accepted, it follows that the suspension of specie
payments and the legal-tender acts must be held almost entirely
responsible for all the far-reaching economic disturbances following
from the price upheaval which it is our task now to trace in detail.

THE EFFECTS OF GREENBACKS UPON WAGES

Statistical evidence supports unequivocally the common theory that
persons whose incomes are derived from wages suffer seriously from a
depreciation of the currency. The confirmation seems particularly
striking when the conditions other than monetary affecting the labour
market are taken into consideration. American workingmen are intelligent
and keenly alive to their interests. There are probably few districts
where custom plays a smaller and competition a larger rôle in
determining wages than in the Northern States. While labor organisations
had not yet attained their present power, manual laborers did not fail
to avail themselves of the help of concerted action in the attempt to
secure more pay. Strikes were frequent. All these facts favored a speedy
readjustment of money wages to correspond with changed prices. But more
than all else, a very considerable part of the labor supply was
withdrawn from the market into the army and navy. In 1864 and 1865 about
one million of men seem to have been enrolled. About one-seventh of the
labor supply withdrew from the market. But despite all these favoring
circumstances, the men who stayed at home did not succeed in obtaining
an advance in pay at all commensurate with the increase in living
expenses. Women on the whole succeeded less well than men in the
struggle to readjust money wages to the increased cost of living.

It is sometimes argued that the withdrawal of laborers from industrial
life was the chief cause of the price disturbances of the war period.
This withdrawal, it is said, caused the advance of wages, and greater
cost of labor led to the rise of prices. The baselessness of this view
is shown by two well established facts--first, that the advance of wages
was later than the advance of prices, and second, that wages continued
to rise in 1866 after the volunteer armies had been disbanded and the
men gone back to work.

Wage-earners, however, seem to have been more fully employed during the
war than in common times of prosperity. Of course, the enlistment of so
many thousands of the most efficient workers made places for many who
might otherwise have found it difficult to secure work. Moreover, the
paper currency itself tended to obtain full employment for the laborer,
for the very reason that it diminished his real income. In the
distribution of what Marshall has termed the "national dividend" a
diminution of the proportion received by the laborer must have been
accompanied by an increase in the share of some one else. Nor is it
difficult to determine who this person was. The beneficiary was the
active employer, who found that the money wages, interest, and rent he
had to pay increased less rapidly than the money prices of his products.
The difference between the increase of receipts and the increase of
expenses swelled his profits. Of course, the possibility of making high
profits provided an incentive for employing as many hands as possible.

After an examination of the change in the condition of the great mass of
wage-earners, it may seem surprising that few complaints were heard
from them of unusual privations. This silence may be due in part to the
fact that a considerable increase of money income produces in the minds
of many a fatuous feeling of prosperity, even though it be more than
offset by an increase of prices. But doubtless the chief reason is to be
found in the absorption of public interest in the events of the war. The
people both of the South and North were so vitally concerned with the
struggle that they bore without murmuring the hardships it entailed of
whatever kind. Government taxation that under other circumstances might
have been felt to be intolerable was submitted to with cheerfulness. The
paper currency imposed upon wage-earners a heavier tax--amounting to
confiscation of perhaps a fifth or a sixth of real incomes. But the
workingmen of the North were receiving considerably more than a bare
subsistence minimum before the war, and reduction of consumption was
possible without producing serious want. Accordingly the currency tax,
like the tariff and the internal revenue duties, was accepted as a
necessary sacrifice to the common cause and paid without protest by
severe retrenchment.

RENT

URBAN RENTS

In studying the influence of depreciation upon rent, it is necessary to
use that term in its popular rather than in its scientific sense. This
fact is less to be lamented, because the theorist himself admits that
the distinction becomes sadly blurred when he attempts to deal with
short intervals of time. Capital once invested in improvements can
seldom be withdrawn rapidly. In "the short run," therefore, it is
practically a part of the land, and the return to it follows the analogy
of rent rather than of interest.

The renting landlord found that the degree in which he was affected by
the fluctuations in the value of the paper money depended largely upon
the terms of the contract into which he had entered. It is clear from a
careful examination that the landlord who before suspension had leased
his property for a considerable period without opportunity for
revaluation must have suffered severely if paid in greenbacks. The
number of "dollars" received as rental might be the same in 1865 as in
1860, but their purchasing power was less than one-half as great.
Somewhat less hard was the situation of the landlord who had let his
property for but one or two years. At the expiration of the leases he
had opportunities to make new contracts with the tenants.

In his capacity as special commissioner of the revenue, Mr. David A.
Wells devoted some attention to the rise of rent. His report for
December, 1866, says:

The average advance in the rents of houses occupied by
mechanics and laborers in the great manufacturing centres of
the country is estimated to have been about 90 per cent.; in
some sections, however, a much greater advance has been
experienced, as for example, at Pittsburgh, where 200 per
cent. and upward is reported. In many of the rural
districts, on the other hand, the advance has been much
less. Mr. Wells later modified this estimate somewhat.

The advance in rents was greater in cities than in minor towns. In some
cities--_e. g._, Cincinnati and Louisville--owners of workingmen's
tenements appear to have been able to increase their money incomes
rather more rapidly than prices advanced, but in Boston, Philadelphia,
St. Louis, and in smaller towns, their money incomes appear to have
increased more slowly than living expenses. These conclusions rest,
however, on a narrow statistical basis.

FARM RENTS

The rural landowner suffered serious injury from the paper currency when
he let his land for a money rent. But renting farms for a fixed sum of
money has always been less common in the United States than renting for
a definite share of the products. It is probable that at the time of the
Civil War more than three-quarters of the rented farms were let "on
shares." Inasmuch as no money payments entered into such arrangements,
the pecuniary relations of landlord and tenant were not directly
affected by the change in the monetary standard. Farm owners who had let
their places on these conditions escaped the direct losses that weighed
so heavily on the recipients of money rents. But even they did not avoid
all loss. For the price of agricultural products for the greater part
of the war period lagged considerably behind the price of other goods.
This difference, of course, meant loss to men whose incomes were paid in
bushels of grain.

INTEREST AND LOAN CAPITAL

THE PROBLEM OF LENDERS AND BORROWERS OF CAPITAL

The task of ascertaining the effect of the greenback issues upon the
situation of lenders and borrowers of capital is in one respect more
simple and in another respect more complex than the task of dealing with
wage-earners. It is simpler in that there are not different grades of
capital to be considered like the different grades of labor. But it is
more complex in that the capitalist must be considered not only as the
recipient of a money income, as is the laborer, but also as the
possessor of certain property that may be affected by changes in the
standard money.

The problem is further complicated by the fact that the relative
importance of these two items--rate of interest and value of
principal--is not the same in all cases. Whether a lender is affected
more by the one item or the other depends upon what he intends to do
with his property at the expiration of existing contracts. A widow left
in 1860 with an estate of say $10,000, who expected to keep this sum
constantly at interest and to find new borrowers as soon as the old
loans were paid, could neglect everything but the net rate of interest
received. On the other hand, if this estate had been left to a youth of
twenty who intended to invest his property in some business after a few
years, the rate of interest would be of relatively less importance to
him than the purchasing power of the principal when the time came to set
up for himself.

Of course, the same difference exists in the case of different
borrowers. Those borrowers who expected to renew old loans on maturity
would have to consider little beyond the interest demanded by lenders,
while borrowers who expected to pay off the loans out of the proceeds of
their ventures would be interested primarily in the amount of goods that
would sell for sufficient money to make up the principal.

Although these two classes of cases are by no means independent of each
other, the following discussion will be rendered clearer by observing
the broad difference between them. Accordingly, attention will first be
directed to the effect of the price fluctuations upon the purchasing
power of the principal of loans, and afterward to changes in the rate of
interest.

PURCHASING POWER OF THE PRINCIPAL OF LOANS

Most persons who made loans in the earlier part of the Civil War and
were repaid in greenbacks must have suffered heavy losses from the
smaller purchasing power of the principal when it was returned to them.
But while this general fact is clear, it is difficult to make a
quantitative statement of the degree of the loss that will be even
tolerably satisfactory.

In the case of almost all loans made before the middle of 1864 and
repaid prior to 1866, the creditor found that the sum returned to him
had a purchasing power much less than the purchasing power that had been
transferred to the borrower when the loan was made. This decline varied
from 1 to more than 50 per cent. On loans made in the middle of 1864 or
later, on the contrary, the creditor gained as a rule. In the case of
loans made in January, 1865, and repaid six months later, the increase
in purchasing power was over 40 per cent.

THE RATE OF INTEREST

In turning to study the fortunes of men who have no thought of employing
their capital for themselves, but expect to seek new borrowers as
rapidly as old loans are repaid, one finds it necessary to distinguish
between cases where loans have been made for short and for long terms;
between the cases, that is, where there is and where there is not an
opportunity to make a new contract regarding the rate of interest. The
latter cases may be dismissed with a word. The capitalist who lent
$10,000 for five years in April, 1862, at 6 per cent. interest, would be
in relatively the same position as the workingman who received no
advance in money wages; while his money income remained the same, the
rise of prices would decrease his real income in 1864 and 1865 by about
one-half. Of course, this loss to the creditor is a gain to the debtor;
for to the business man using borrowed capital the advance of prices
means that he can raise his interest money by selling a smaller
proportion of his output.

More interesting is the case of loans maturing and made afresh during
the period under examination. The important question is: How far did the
lender secure compensation for the diminished purchasing power of the
money in which he was paid by contracting for a higher rate of interest?

The advance in the rate of interest was comparatively small--much too
small to compensate for the increased cost of living. While prices rose
approximately 85 per cent. and money wages somewhat less than 60 per
cent. during the years 1860-65, rates of interest on call and time loans
increased less than 15 per cent. during the same period.

The conclusion is not only that persons who derived their income from
capital lent at interest for short terms were injured by the issues of
the greenbacks, but also that their injuries were more serious than
those suffered by wage-earners.

To explain this state of affairs is not easy. The first reason that
suggests itself to the mind considering the problem is that both lenders
and borrowers failed to foresee the changes that would take place in the
purchasing power of money between the dates when loans were made and
repaid. No doubt there is much force in this explanation. If, for
instance, men arranging for loans in April, 1862, to be repaid a year
later, had known that in the meantime the purchasing power of money
would decline 30 per cent., they would have agreed upon a very high rate
of interest. Men able to discern the future course of prices would not
have lent money at the ordinary rates, and if the rates prevailing in
the New York market throughout all 1862 and 1863 were less than 7 per
cent., it must have been because the extraordinary rise of prices was
not foreseen by borrowers and lenders.

Nor is it surprising that business men failed to see what was coming;
for the course of prices depended chiefly upon the valuation set upon
the greenbacks, and this valuation, in turn, depended chiefly upon the
state of the finances and the fortunes of war--matters that no one could
foresee with certainty. Indeed, there was much of the time a very
general disposition to take an unwarrantedly optimistic view of the
military situation and the chances of an early peace. Many members of
the business community seem to have felt that the premium on gold was
artificial and must soon drop, that prices were inflated and must
collapse. To the extent that such views prevailed borrowers would be
cautious about making engagements to repay money in a future that might
well present a lower range of prices, and lenders would expect a gain
instead of a loss from the changes in the purchasing power of money.

But the full explanation of the slight advance in interest cannot be
found in this inability to foresee the future--at least not without
further analysis of what consequences such inability entailed.
Workingmen are commonly credited with less foresight than capitalists,
and nevertheless they seem, according to the figures, to have succeeded
better in making bargains with employers of labour than did lenders with
employers of capital. The explanation of this less success seems to be
found in the difference between the way in which depreciation affected
what the capitalist and the laborer had to offer in return for interest
and wages. There is no reason for assuming that an artisan who changed
employers during the war would render less efficient service in his new
than in his old position, or that a landlord who changed tenants had
less advantages to put at the disposal of the incoming lessee. In both
these cases the good offered to the active business man remained
substantially the same, and it may safely be assumed that, other things
being equal, this business man could afford to give quite as much for
the labor and the land after as before suspension. From the business
man's point of view, therefore, there seems to have been room for a
doubling of money wages and rent when the purchasing power of money had
fallen one-half. But in the case of the borrower of capital the like was
not true. The thousand dollars which Mr. A offered him in 1865 was not,
like the labour of John Smith or the farm of Mr. B, as efficient for his
purposes as it would have been five years before. For, with the thousand
dollars he could not purchase anything like the same amount of
machinery, material, or labor. And since the same nominal amount of
capital was of less efficiency in the hands of the borrower, he could
not without loss to himself increase the interest which he paid for new
loans in proportion to the decline in the purchasing power of money, as
he could increase the wages of laborers or the rent for land.

It should also be pointed out that on one important class of loans
capitalists suffered comparatively little even during the war. Interest
on many forms of Government bonds was paid in gold. Capitalists who
invested their means in these securities consequently received an income
of almost unvarying specie value. If the person who made these
investments were an American, he would be able to sell his gold-interest
money at a high premium, but he would also have to pay correspondingly
high prices for commodities, so that upon the whole his position would
not be greatly different from that of the foreign investor. That such
opportunities for investment as these securities offered should exist
when men were most of the time loaning money for short terms at 7 per
cent. or less, is perhaps the most emphatic proof that could be offered
of the inability of the public to foresee what the future had in store.

PROFITS

Laborers, landlords, and lending capitalists are all alike in that the
amount of remuneration received by them for the aid which they render to
production is commonly fixed in advance by agreement, and is not
immediately affected by the profitableness or unprofitableness of the
undertaking. It remains to examine the economic fortunes of those men
whose money incomes are made up by the sums left over in any business
after all the stipulated expenses have been met.

A very important part of the solution of the problem of profits has
already been contributed by the preceding studies of wages, rent, and
interest. The evidence has been found to support the conclusion that in
almost all cases the sums of money wages, rent, and interest received by
laborers, landlords, and capitalists increased much less rapidly than
did the general price level. If the wording of this conclusion be
reversed--the prices of products rose more rapidly than wages, rent, or
interest--we come at once to the proposition that as a rule profits
must have increased more rapidly than prices. For, if the sums paid to
all the other co-operating parties were increased in just the same ratio
as the prices of the articles sold, it would follow that, other things
remaining the same, money profits also would increase in the same ratio.
But if, while prices doubled, the payments to labourers, landlords, and
capitalists increased in any ratio less than 100 per cent., the sums of
money left for the residual claimants must have more than doubled. In
other words, the effect of the depreciation of the paper currency upon
the distribution of wealth may be summed up in the proposition: The
shares of wage-earners, landowners, and lenders in the national dividend
were diminished and the share of residual claimants was increased.

Two other general propositions respecting profits are suggested. First,
other things being equal, profits varied inversely as the average wage
per day paid to employees. This conclusion follows directly from the
fact that the money wages of men earning $1-$1.49 per day before the
perturbation of prices increased in higher ratio than those of men
earning $1.50-$1.99; that the wages of the latter class increased more
than the wages of men in the next higher wage class, etc. Second, other
things being equal, profits varied directly as the complexity of the
business organization. By this proposition is meant, for example, that a
farmer who paid money rent, used borrowed capital, and employed hired
labourers, made a higher percentage of profits than a farmer of whom any
one of these suppositions did not hold true. If, as has been argued, the
increase of profits was made at the expense of laborers, landlords, and
capitalists, it follows that that _entrepreneur_ fared best whose
contracts enabled him to exploit the largest number of these other
persons.

PROFITS IN AGRICULTURE

The farmers of the loyal states were among the unfortunate producers
whose products rose in price less than the majority of other articles,
and from this standpoint they were losers rather than gainers by the
paper currency. Of course, it is possible that the farmer's loss from
this inequality of price fluctuations might be more than offset by his
gains at the expense of labourers, landlord, and lending capitalist.
But there is good reason for believing that the increase of the
_entrepreneur's_ profits in the latter fashion was less in farming than
in any other important industry. This conclusion seems to follow from
the proposition that, other things being equal, profits varied directly
as the complexity of business organization. The American farmers of the
Civil War were in a large proportion of cases their own landlords,
capitalists, and laborers. So far as this was true, they had few
important pecuniary contracts with other persons of which they could
take advantage by paying in depreciated dollars. Of those farmers who
hired labor very many paid wages partly in board and lodging--an
arrangement which threw a considerable part of the increased cost of
living upon them instead of upon their employees. Finally, the renting
farmer probably gained less on the average from the contract with his
landlord than tenants of any other class, because in a majority of cases
the rent was not a sum of money, but a share of the produce. While,
then, the general effect of the paper standard was in the direction of
increasing profits, it seems very doubtful whether farmers as a whole
did not lose more than they gained because of the price disturbances.

STATISTICAL EVIDENCE REGARDING PROFITS

It would be highly desirable to test our general conclusions by means of
direct information regarding profits made in various branches of trade,
but the data available for such a purpose are very meager. What scraps
of information are available, however, support the view that profits
were uncommonly large. Mr. David A. Wells, for example, in his reports
as special commissioner of the revenue, has stories of "most anomalous
and extraordinary" profits that were realized in the paper, woolen,
pig-iron, and salt industries. A more general indication of the
profitableness of business is afforded by the remark in the annual
circular of Dun's Mercantile Agency for 1864, that "it is generally
conceded that the average profits on trade range from 12 to 15 per
cent."

But the most important piece of evidence is found in the statistics of
failures compiled by the same agency. The following table shows Dun's
report of the number of bankruptcies and the amount of liabilities in
the loyal States from the panic year 1857 to the end of the war:

_Year_ _Number_ _Liabilities_

1857 4,257 $265,500,000
1858 3,113 73,600,000
1859 2,959 51,300,000
1860 2,733 61,700,000
1861 5,935 $178,600,000
1862 1,652 23,000,000
1863 495 7,900,000
1864 510 8,600,000
1865 500 17,600,000

The very great decrease both in the number and the liabilities of firms
that failed is the best proof that almost all business enterprises were
"making money."

From one point of view the small number of failures is surprising. An
unstable currency is generally held to make business unsafe, and seldom
has the standard money of a mercantile community proven so unstable,
undergone such violent fluctuations in so short a time, as in the United
States during the Civil War. Yet, instead of being extremely hazardous,
business seems from the statistics of failures to have been more than
usually safe.

The explanation of the anomaly seems to be that the very extremity of
the danger proved a safeguard. Business men realized that the inflation
of prices was due to the depreciation of the currency, and that when the
war was over gold would fall and prices follow. They realized very
clearly the necessity of taking precautions against being caught in a
position where a sudden decline of prices would ruin them. They did this
by curtailing credits. So long as prices continued to rise such
precautions were really not needed by the man in active business except,
in so far as he was a creditor of other men; but when prices commenced
to fall prudence had its reward. Such a sudden and violent drop of
prices as occurred between January and July, 1865, would have brought a
financial revulsion of a most serious character upon a business
community under ordinary circumstances. But so well had the change been
prepared for, that the number of failures was actually less than it had
been in the preceding year of rapidly rising prices.

The whole situation can hardly be explained better than it was by a New
York business man writing in _Harper's Monthly Magazine_: "When the war
ended," he said, "we all knew we should have a panic. Some of us, like
Mr. Hoar, expected that greenbacks and volunteers would be disbanded
together. Others expected gold to fall to 101 or 102 in a few days.
Others saw a collapse of manufacturing industry, owing to the cessation
of Government purchases. But we all knew a 'crisis' was coming, and
having set our houses in order accordingly, the 'crisis' of course never
came."

THE PRODUCTION AND CONSUMPTION OF WEALTH

PRODUCTION

What influence did the greenback currency have as one of the many
factors that affected the production of wealth? In the first place, the
paper standard was responsible in large measure for the feeling of
"prosperity" that seems from all the evidence to have characterized the
public's frame of mind. Almost every owner of property found that the
price of his possessions had increased, and almost every wage-earner
found that his pay was advanced. Strive as people may to emancipate
themselves from the feeling that a dollar represents a fixed quantity of
desirable things, it is very difficult for them to resist a pleasurable
sensation when the money value of their property rises or their incomes
increase. They are almost certain to feel cheerful over the larger sums
that they can spend, even though the amount of commodities the larger
sums will buy is decreased. Habit is too strong for arithmetic.

But, more than this, "business" in the common meaning of the word was
unusually profitable during the war. The "residual claimant" is in most
enterprises the active business man, and, as has been shown, his money
income did as a rule rise more rapidly than the cost of living. In other
words, "business" was, in reality as well as in appearance, rendered
more profitable by the greenbacks. There is therefore no error in saying
that the business of the country enjoyed unwonted prosperity during the
war. And it may be added that the active business man is probably a more
potent factor in determining the community's feeling about "good times"
and "bad times" than is the workingman, the landlord, or the lending
capitalist.

The effect of high profits, however, is not limited to producing a
cheerful frame of mind among business men. Under ordinary circumstances
one would say that when the great majority of men already in business
are "making money" with more than usual rapidity they will be inclined
to enlarge their operations, that others will be inclined to enter the
field, and that thus the production of wealth will be stimulated. But
the circumstances of the war period were not ordinary and this
conclusion cannot be accepted without serious modifications.

1. It has been shown that business men realised the precariousness of
all operations that depended for their success upon the future course of
prices--and nearly all operations that involved any considerable time
for their consummation were thus dependent. So far did this disposition
prevail that it produced a marked curtailment in the use of credit. The
prudent man might be willing to push his business as far as possible
with the means at his own disposal, but he showed a disinclination to
borrow for the purpose. Thus the uncertainty which all men felt about
the future in a large measure counteracted the influence of high profits
in increasing production.

2. The foregoing consideration of course weighed most heavily in the
minds of cautious men. But not all business men are cautious. Among many
the chance of winning large profits in case of success is sufficient to
induce them to undertake heavy risks of loss. On the whole, Americans
seem to display a decided propensity toward speculative ventures and are
not easily deterred by having to take chances. To men of this type it
seems that the business opportunities offered by the fluctuating
currency would make a strong appeal. But, while the force of this
observation may be admitted, it does not necessitate a reconsideration
of the conclusion that the instability of prices tended to diminish the
production of wealth. For in a time of great price fluctuations the
possibilities of making fortunes rapidly are much greater in trade than
in agriculture, mining, or manufactures. Every rise and fall in
quotations holds out an alluring promise of quick gain to the man who
believes in his shrewdness and good fortune, and who does not hesitate
to take chances. The probable profits of productive industry in the
narrower sense might be larger than common, but this would not attract
investors in large numbers if the probable profits of trading were
larger yet; and such seems clearly to have been the case during the war
when the paper currency offered such brilliant possibilities to
fortunate speculators in gold, in stocks, or in commodities. Instead,
then, of the greenbacks being credited with stimulating the production
of wealth, they must be charged with offering inducements to abandon
agriculture and manufactures for the more speculative forms of trade.

This tendency of the times did not escape observation. On the contrary,
it was often remarked and lamented in terms that seem exaggerated. Hugh
McCulloch, for instance, in his report as Secretary of the Treasury for
1865, said:

There are no indications of real and permanent prosperity
... in the splendid fortunes reported to be made by skilful
manipulations at the gold room or the stock board; no
evidences of increasing wealth in the facts that railroads
and steamboats are crowded with passengers, and hotels with
guests; that cities are full to overflowing, and rents and
the necessities of life, as well as luxuries, are daily
advancing. All these things prove rather ... that the number
of non-producers is increasing, and that productive industry
is being diminished.

In one of his reports as special commissioner of the revenue, Mr. Wells
said:

During the last few years large numbers of our population,
under the influence and example of high profits realized in
trading during the period of monetary expansion, have
abandoned employments directly productive of national
wealth, and sought employments connected with commerce,
trading, or speculation. As a consequence we everywhere find
large additions to the population of our commercial cities,
an increase in the number and cost of the buildings devoted
to banking, brokerage, insurance, commission business, and
agencies of all kinds, the spirit of trading and speculating
pervading the whole community, as distinguished from the
spirit of production.

Within the period under review, then, it seems very doubtful whether the
high profits had their usual effect of leading to a larger production
of raw materials or to an increase in manufactures. The prudent man
hesitated to expand his undertakings because of the instability of the
inflated level of prices; the man with a turn for speculative ventures
found more alluring opportunities in trade.

CONSUMPTION

No one can read contemporary comments on American social life of the
later years of the war without being impressed by the charges of
extravagance made against the people of the North. Newspapers and
pulpits were at one in denouncing the sinful waste that, they declared,
was increasing at a most alarming rate. The "shoddy aristocracy" with
its ostentatious display of wealth became a stock subject for
cartoonists at home, and earned a well-merited reputation for vulgarity
abroad.

In trying to account for this unpleasant phase of social development,
men usually laid the blame upon the paper standard. High prices were
said to make every one feel suddenly richer and so to tempt every one to
adopt a more lavish style of living than his former wont. Thus the view
gained general credence that the greenbacks were ultimately responsible
for a great increase in the consumption of wealth.

However, such a view regarding the consumption of wealth can be but
partially true. The enormous profits of _entrepreneurs_ made possible
the rapid accumulation of an unusual number of fortunes, and the
families thus lifted into sudden affluence enjoyed spending their money
in the ostentatious fashion characteristic of the newly rich. It is
therefore true that the monetary situation was largely responsible for
the appearance of a considerable class of persons--of whom the fortunate
speculator and the army contractor are typical--who plunged into the
recklessly extravagant habits that called down upon their heads the
condemnation of the popular moralist.

But if the greenbacks were in the last resort a chief cause of the
increased consumption of articles of luxury by families whom they had
aided in enriching, they were not less truly a cause of restricted
consumption by a much larger class of humbler folk. The laboring man
whose money wages increased but one-half, while the cost of living
doubled, could not continue to provide for his family's wants so fully
as before. He was forced to practise economies--to wear his old clothing
longer, to use less coffee and less sugar, to substitute cheaper for
better qualities in every line of expenditure where possible. Similar
retrenchment of living expenses must have been practised by the families
of many owners of land and lenders of capital. In other words, the war
time fortunes resulted in a very large measure from the mere transfer of
wealth from a wide circle of persons to the relatively small number of
residual claimants to the proceeds of business enterprises. The enlarged
consumption of wealth which the paper currency made possible for the
fortunate few was therefore contrasted with a diminished consumption on
the part of the unfortunate many on whose slender means the greenbacks
levied contributions for the benefit of their employers.

That the diminished consumption of wealth by large numbers of poor
people escaped general notice, while the extravagance of the newly rich
attracted so much attention, need not shake one's confidence in the
validity of these conclusions. The purchase of a fast trotting-horse by
a Government contractor, and the elaborateness of his wife's gowns and
jewelry, are much more conspicuous facts than the petty economies
practised by his employees. The same trait that leads fortunate people
to flaunt their material prosperity in the eyes of the world leads the
unfortunate to conceal their small privations. Even an attentive
observer may fail to notice that the wives of workingmen are still
wearing their last year's dresses and that the children are running
barefoot longer than usual.

But though the newspapers were not full of comments on the enforced
economies of the mass of the population, wholesale dealers in staple
articles of food and clothing noticed a decrease in sales. In reviewing
the trade situation in September, 1864. when real wages were near their
lowest ebb, Hunt's _Merchants' Magazine_ remarked that "the rise in the
prices of commodities has ... outrun the power of consumption and the
fall trade has been almost at a stand. Those articles such as coffee,
sugar, low grade goods, which form the staple products of the great mass
of the people in moderate circumstances, have reached such high rates
that the decline in consumption is very marked, amounting almost to a
stagnation of the fall trade." The consumption of many articles of
luxury increased very greatly, while the consumption of many staple
articles declined.

THE GREENBACKS AND THE COST OF THE CIVIL WAR

The reader who goes back to the debates upon the legal-tender bills will
find that most of the unfortunate consequences that followed their
enactment were foretold in Congress--the decline of real wages, the
injury done creditors, the uncertainty of prices that hampered
legitimate business and fostered speculation. But a majority of this
Congress were ready to subject the community to such ills because they
believed that the relief of the treasury from its embarrassments was of
more importance than the maintenance of a relatively stable monetary
standard.

GREENBACKS AND EXPENDITURES

What effect had the greenbacks upon the amount of expenditures incurred?
Few questions raised by the legal-tender acts have attracted more
attention than this. Even while the first legal-tender bill was being
considered its critics declared that if made a law it would increase the
cost of waging the war by causing an advance in the prices of articles
that the Government had to buy. As the war went on the soundness of this
view became apparent.

When the war was over and the divers reasons that had deterred many men
from criticizing the financial policy of the government were removed,
competent writers began to express similar views with freedom. For
example, Mr. C. P. Williams put the increase of debt at one-third to
two-fifths; S. T. Spear, at a billion dollars; L. H. Courtney, an
English critic, at nearly $900,000,000. Of later discussions that of H.
C. Adams has attracted the most attention. He estimated that of the
gross receipts from debts created between January 1, 1862, and
September 30, 1865, amounting to $2,565,000,000 the gold value was but
$1,695,000,000--a difference of $870,000,000 between value received and
obligations incurred.

A detailed consideration of the elements that enter the problem would
seem to warrant a reduction of the estimates given to $791,000,000. It
is hardly necessary to insist strenuously that this is but a very rough
estimate.

THE GREENBACKS AND RECEIPTS

The total increase of receipts was approximately $174,000,000, as shown
in the following table:

(In millions of dollars)

_1862_ _Fiscal Year_ _1866_
_(Six Months) 1863 1864 1865 (Two Months)_

Current receipts:
From customs 33.5 69.1 102.3 84.9 31.3
From sales of public lands .1 .2 .6 1.0 .1
From direct tax 1.8 1.5 .5 1.2 .0
From miscellaneous sources .5 3.0 47.5 33.0 12.3
From internal revenue ... 37.6 109.7 209.5 64.4
---- ----- ----- ----- -----
35.9 111.4 260.6 329.6 108.1
Estimated actual increase 0 10 39 106 19

The caution is hardly necessary that the above results are to be
accepted subject also to a wide margin of error.

There were other financial consequences of the shift from the specie to
the paper standard, however, that were not unimportant, though they were
indirect and difficult to gauge. Two of the most prominent must be
indicated.

1. It is probable that not a little of the lavishness with which public
funds were appropriated by Congress during the war can be traced to the
paper-money policy.

2. If the paper currency tempted the Government to reckless
expenditures, it also predisposed the people to submit more willingly to
heavy taxation. It has been remarked several times that the advance of
money wages and of money prices made most people feel wealthier, and,
feeling wealthier, they were less inclined to grumble over the taxes.

While these indirect effects of the paper currency on expenditures and
receipts could not by any system of bookkeeping be brought to definite
quantitative statement, it is probable that their net result was
unfavorable to the treasury.

CONTRACTION AND INFLATION OF THE LEGAL TENDERS[9]

The policy of a permanent currency of government legal-tender paper at
the close of the Civil War was unknown. Upwards of four hundred million
notes of the United States were, it is true, in circulation at the
return of peace. There were doubtless many individuals who approved the
continuance of exactly this form of currency. But no such proposition
had been advanced by any public man of influence or by any political
organization. That the resort to legal-tender powers was an evil
justified only by extreme emergency, and that the circulation of
government notes in any form was a purely temporary measure, were the
unanimous convictions of the statesmen who contrived the system. The
logical inference that these Government notes would be paid off and
cancelled, as soon as the war deficiency had ended, was publicly
accepted.

Such was the theory and purpose of the public men through whom the
Legal-Tender Act was constructed and applied. Nor is the general
position of our statesmen, at the close of the Civil War, any more
obscure than their original position. The first financial resolution
adopted by Congress, in December, 1865, was an explicit promise to
retire the legal tenders. The first legislation of that Congress gave
discretionary powers to the Secretary of the Treasury for continuous
contraction. Very few legislative victories are won without at least a
temporary popular endorsement, and the votes of December, 1865, and of
March, 1866, were no exceptions. But the popular approval of contraction
in that year, exception as it was to all our subsequent legislation, is
readily enough explained. Public opinion, when the war ended, was
governed by impatience with inflated prices; inflation far beyond the
European level, and properly ascribed to the condition of the currency.
The cost of living reached during 1865 the highest point recorded in
this country's history. From 1860 to 1865, inclusive, the average of
European prices rose only 4 to 6 per cent.; average prices in the
United States advanced, in the same period, no less than 116 per cent.
With flour at $16 a barrel, butter at 55 cents a pound, coal at $10 a
ton, and wages and salaries advanced since 1860 hardly one-third as far
as prices, the demand for currency reform obtained ready endorsement
from the people.

This popular sentiment was further strengthened by the Administration's
attitude at the opening of Lincoln's second term. Mr. McCulloch's first
official Treasury report, dated December 4, 1865, took positive ground
for the reduction of the legal-tender debt. He asked authority to issue
bonds in his discretion, at 6 per cent. or less, "for the purpose of
retiring not only the compound interest notes, but the United States
notes."

Two weeks after the publication of this report, on December 18, 1865,
the House of Representatives resolved, by a vote of 144 to 6,

that this house cordially concurs in the view of the
Secretary of the Treasury in relation to the necessity of a
contraction of the currency, with a view to as early a
resumption of specie payments as the business interests of
this country will permit; and we hereby pledge co-operative
action to this end as speedily as practicable.

This resolution of 1865, however, marked the climax of the movement.
Never thereafter did the policy of retiring the legal-tender notes even
approach success. The truth is, that the inflated prices had begun
already, during the three months after the resolution of December, to
recede. This was inevitable, from the very nature of the previous
expansion; and it was a welcome movement to consumers. But it
necessarily caused some derangement in the plans of trade, and
politicians began to ask, when they had to face the fulfilment of their
pledge through a formal act of Congress, how the contraction policy
would be greeted by producers. The bill, as originally introduced,
granted full powers to the Secretary of the Treasury to issue new bonds
for the retirement both of interest-bearing and of noninterest-bearing
debt. In the spring of 1866 this measure was defeated in the House of
Representatives by a vote of 70 to 64. Reconsidered and amended so as to
restrict contraction of the legal tenders to $10,000,000 in the first
six months and to $4,000,000 per month thereafter, the compromise
measure did indeed pass the House by 83 to 53, and the Senate by 32 to
7. But a victory thus won was ominous. Mr. McCulloch himself declared
the amended act to be awkward and ineffective. Still more significant
was the character of opposition developed in the course of the debate.
It had a dozen varying grounds of argument, most of them pretty certain
to appeal to popular prejudice later on. Some Congressmen objected to
the discretionary powers as revolutionary, and, while conceding Mr.
McCulloch's ability and conservatism, pointed out that a very different
Treasury Secretary might succeed him. Others pronounced the notion of
immediate resumption of specie payments to be "Utopian in the extreme."
Much was heard of the comfortable theory that if Congress would "allow
things to go on without active interference," the "natural development
of events" would automatically bring about resumption. More than one
legislator could not understand, "when we have $450,000,000 [debt]
bearing no interest, and which need bear no interest, why it is to be
taken up and put into bonds." The excellence of a circulating medium
"that rests on the property of the whole country, and has for its
security the faith and patriotism of the greatest and freest country on
the face of the globe," played its usual part in the discussion; so did
the argument that "the amount of legal tenders now outstanding is not
too much for the present condition of the country." In short, all the
arguments which have been made familiar by the twenty subsequent years
of controversy, cut a figure in this opening discussion.

As a matter of fact, even the restricted powers of note retirement
granted under the law of March, 1866, were revoked within two years.
Little or no progress had meantime been made towards resumption of
specie payments. The Secretary himself had officially pointed out that
two commercial influences must be removed before resumption would be
possible; the excessively high prices in the United States and the heavy
balance of foreign trade against us. But prices continued above the
European level, and, as a consequence, export of merchandise was checked
and imports greatly stimulated. The entire gold product of each year in
the United States was sent abroad.

Contraction of the inflated currency, even if pursued under the
limitations of the Act of 1866, would in time have brought about
conditions under which resumption might have been planned. But events
outside of the United States now moved in such a way as to turn the
entire financial community against the Secretary's policy. Hardly two
months after the vote of March came a wholly unexpected crisis in the
foreign money markets. The London collapse, precipitated by the
Overend-Gurney failure of May, 1866, was in some respects as complete as
any in the history of England. It affected every nation with which Great
Britain had commercial dealings; not least of all the United States, of
whose securities it was estimated that European investors even then held
$600,000,000. During three months the Bank of England kept its minimum
discount rate at the panic figure of 10 per cent.; the consequent sudden
recall of foreign capital put a heavy strain on the American markets.

With the familiar disposition of the trade community to lay the blame
for disordered markets on some move of public policy, the Treasury's
operations to reduce outstanding notes were made the scapegoat.
Politicians with an eye to popularity were quick to catch this drift of
public sentiment. Some of them honestly believed that McCulloch's action
in the currency was the cause of the trade distress; others, better
informed but equally politic, avoided personal declaration of opinion,
but characteristically announced that whether the theory was correct or
not, the public believed it, and that in deference to the public,
currency contraction ought to cease. The usual result ensued. Under the
previous question, and without debate, a measure revoking absolutely the
Secretary's power of contraction passed the House of Representatives in
December, 1867, by a vote of 127 to 32. In the Senate there was an able
show of opposition, but it was plainly put on the defensive, and on
January 22, 1868, the resolution passed both chambers in its original
and final shape.

This was the end of the McCulloch plan. It was the end of all serious
debate upon resumption, for at least six years. It was also, and very
logically, the beginning of the fiat-money party. The Republicans were
forced into open defence of sound financial principles by the very
recklessness of their opponents. Helped by the great personal prestige
of its candidate, General Grant, the Republican party won a sweeping
victory. President Johnson, who was then at open odds with his party,
had produced in his Annual Message of December 7, 1868, the
extraordinary suggestion that "the 6 per cent. interest now paid by the
Government" on its debt "should be applied to the reduction of the
principal in semi-annual instalments"; in other words, that the plan of
repudiating interest obligations--since adopted, with no agreeable
results, by Turkey and Greece--should be formally approved by the United
States. This remarkable utterance was first condemned by an overwhelming
vote in both House and Senate; next, by an almost equally decisive vote,
on March 3, 1869, Congress adopted the Public Credit Act, promising coin
redemption of both notes and bonds, solemnly pledging its faith "to make
provision, at the earliest practicable period, for the redemption of the
United States notes in coin."

The promise was as easily made as the similar pledge of December, 1865;
was still more easily broken. No such arrangement was made, nor any
serious attempt in that direction, until the matter was forced on the
party by the exigency of politics. Not only was no effort made to reduce
outstanding legal tenders, but the supply in circulation was heavily
increased; rising from $314,704,000 in the middle of 1869 to
$346,168,000 in 1872, and two years later, as a result of the Treasury's
weak experiments in the panic, to $371,421,000.

This period was congenial to such juggling with public credit and
legislative pledges. Socially, financially, and politically, it stands
out quite apart from any other decade of the century. Moral sense for a
time seemed to have deteriorated in the whole community; it was a sorry
audience, at Washington or elsewhere, to which to address appeals for
economy, retrenchment, and rigid preservation of the public faith. The
Government's financial recklessness was readily imitated by the
community at large; debt was the order of the day in the affairs of
both. As the period approached its culmination, foreign trade reflected
the nature of the situation. Merchandise imports in the fiscal year 1871
rose $84,000,000 over 1870; in 1872 they increased $106,000,000 over
1871. This movement was the familiar warning of an approaching crash;
but the warning fell on deaf ears, as it usually does. In 1873 the house
of cards collapsed.

The panic of 1873 left the country's financial and commercial structure
almost a ruin. It had, however, several ulterior results so valuable
that it is not wholly unreasonable to describe the wreck of credit as a
blessing in disguise. American prices, long out of joint with the
markets of the world, and thoroughly artificial in themselves, were
certain to be eventually brought down. This very liquidating process
served a useful double purpose; it disclosed the nation's true
resources, and it placed the United States on equal footing with the
commercial world at large. With the bursting of the bubble of inflated
debt and inflated prices, the excessive importations ceased.
Simultaneously the export trade, which had halted during 1872, in spite
of the continued agricultural expansion, rose to proportions never
before approached in our commercial history. In 1874, the balance of
foreign trade turned permanently in our favor. By 1876, even the
continuous outflow of gold was checked. In short, the two conditions
fixed by Hugh McCulloch, ten years before, as indispensable to
resumption of specie payments, had now been realized.

Congress was not by any means disposed, however, to seize the
opportunity. The first result of the money market crisis in 1873, as in
all similar years, was urgent public clamor for more currency. The
Supreme Court had decided finally, in 1871, for the constitutionality of
the legal tenders; the Secretary of the Treasury, in 1873, had so far
yielded to the prevalent excitement as to reissue legal-tender notes
already formally retired. The first response of Congress, therefore, was
an inflation measure. By a vote of 140 to 102 in the House of
Representatives, and of 29 to 24 in the Senate, a law was passed for the
permanent increase of the legal-tender currency, by $18,000,000. The
Republican party controlled Congress by unusually large majorities; but
60 per cent. of the party's vote in each chamber was cast in favor of
the bill. Only the interposition of Grant's Presidential veto prevented
this first positive backward step in the direction of fiat money.

It is reasonable to suppose that this curious vote of the Administration
party, which occurred in April, 1874, measured the party's political
desperation. They were about to receive, in the Congressional elections,
the usual chastisement experienced by a dominant party when the people
vote in a period of hard times; the inflation act was an anchor thrown
desperately to windward. The experiment was in all respects a failure.
Even the party's own State conventions failed to say a good word for the
inflation bill, and it gained no mitigation of sentence in the November
vote.

PASSAGE OF THE RESUMPTION ACT[10]

The Forty-third Congress had three months of existence left to it after
the vote of November, 1874. Already defeated overwhelmingly at the
polls, it had nothing to risk by a move in sound-money legislation, and
possibly much to gain. It used this three-months' period to enact a law
of the first importance, not only to the nation, but to the Republican
party's future history--a law which must fairly be described, however,
under the circumstances of the time, as an expression of death-bed
repentance. This was the Specie-Resumption Act, drawn up by a party
committee, and submitted to Congress, in December, 1874, by Senator John
Sherman. It fixed the date for resumption of specie payments at January
1, 1879, provided for the reduction of legal-tender notes from
$382,000,000 to $300,000,000, but made no provision for any further
retirement of the notes. It went through Congress on January 7, 1875. It
was contended by some that under the Resumption Act of 1875 there could
be no reissue of the greenbacks once received into the Treasury.
Inflationist successes of 1877-1878 settled this uncertainty, as
Congress, May 31, 1878, ordered that there be no further destruction of
greenbacks. The amount then outstanding was $346,681,000--the volume of
legal tenders still current.

THE STRUGGLE FOR RESUMPTION[11]

The Resumption Act is one of the most curious laws in financial history.
It was plain in its requirement that on and after January 1, 1879, the
Treasury should "redeem in coin the United States legal-tender notes
then outstanding, on their presentation for redemption"; but it left the
Treasury to make whatever arrangements it might choose. The law, it is
true, conferred ample powers. In order "to prepare and provide for the
redemption in this Act authorized or required," it empowered the
Secretary of the Treasury "to use any surplus revenues, from time to
time, in the Treasury not otherwise appropriated, and to issue, sell,
and dispose of bonds of the United States at not less than par in coin."
This power was perpetual.

The Law of 1875 involved the double problem of providing for resumption
at the stipulated date, and of maintaining it afterward. It is the first
of these undertakings, which we shall now sketch. There were, as we have
already seen, two influences at work in 1875, which made possible the
achievement as it would not have been in 1866. These influences--the
shifting of the foreign trade balance in favor of the United States and
the subsequent check to gold exports--were factors on which no finance
minister could have reckoned. Both in fact developed after the passage
of the Resumption Law. But even after allowing for these accidental
commercial advantages, the credit for the return to specie payments on
January 1, 1879, belongs individually and without dispute to John
Sherman.

As one of the authors of the Resumption Act, Mr. Sherman was responsible
both for its virtues and its vices. His appointment to the Treasury,
therefore, in the Administration under which resumption must by law be
carried out, was entirely logical. Yet the practical efficiency of Mr.
Sherman, in an administrative office, could not then have been foretold.
The Secretary's previous career, though useful and industrious, had been
marred by weaknesses which did not promise well. As a legislator, he
belonged to the school of compromisers who have indirectly been
responsible, in a score of critical emergencies, for the gravest
mischief in our history.

But Mr. Sherman was not the first of public men to show that the faults
or weakness of a legislator, whose purpose is to obtain enactment of a
policy, will sometimes disappear in the administrator, who presses
settled policies into execution. As Secretary he was unwavering in
pursuit of the resumption goal; practical, resolute, and adroit in the
means employed. It was in the face of the repudiation clamor that he
declared officially for payment of the Government bonds in gold. Equally
distinct was the Secretary's public declaration that the Act of 1875
conferred the power to issue bonds after, as well as before, resumption;
another precedent which did invaluable service sixteen years afterward.

To say that Secretary Sherman's management of the Treasury achieved
during his time precisely the results proposed, and achieved them
promptly, is to concede his administration's practical success. Nor were
these results attained through extravagance or waste. In his refunding
and resumption operations, Mr. Sherman placed the bonds of the United
States on better terms than any of his predecessors.

ARRANGEMENTS FOR RESUMPTION[12]

The Secretary of the Treasury now put the final touches on his
arrangements for resumption. Partly by accident and partly through
stress of circumstances, the Treasury gold reserve was defined, in later
years, at a fixed and arbitrary minimum. The theory adopted by Mr.
Sherman, however, in his early operations, was different and undoubtedly
better. Following probably the practice of the Bank of England, he fixed
his reserve at 40 per cent. of outstanding notes--"the smallest
reserve," he wrote to Congress, "upon which resumption could be
prudently commenced and successfully maintained." On this basis he held
in the Treasury, on December 31, 1878, $114,193,000 gold in excess of
outstanding gold certificates, which was a trifle over 40 per cent. of
the Government notes then circulating outside the Treasury. Of this gold
reserve, $95,500,000 had been obtained through sale of bonds, part of
the coin being procured in Europe.

There remained now to be settled only the formal machinery of exchange
between the Treasury and outside institutions. If the Treasury had left
the banks to pursue unchanged their policy of keeping special gold
deposits, the Government reserve would have been at once imperilled. If
the banks had continued to present their individual drafts for
redemption across the counter of the Sub-Treasury, any timid or
blundering banker might have started a general drain of gold. Against
these possibilities Mr. Sherman now took measures. He secured the
admission of the New York Sub-Treasury as a member of the
clearing-house. At New York and Boston the clearing-houses modified
their rules, agreed to abolish "gold deposits" after January 1st, and to
accept the legal tenders freely in discharge of balances against one
another and against the Government. At the same time, the requirement of
coin payment of customs duties was revoked, and public officers were
directed to receive coin or legal tenders at the payer's option--a move
of obvious propriety, since refusal to take notes in payment would
merely send the importer to the Treasury's redemption office to convert
them into coin. All these preliminaries had been formally and positively
settled before the close of 1878. On December 17th, the premium on gold
disappeared, for the first time since 1861; on January 1st, specie
payments were quietly resumed.

SHOULD THE GREENBACKS BE RETIRED?

[13]Let us now consider for a moment an issue which twenty years ago was
urgently pertinent, was in fact the very crux of so-called "currency
reform," and which still persists as a live issue in the minds of some
of the veteran "reformers" of those days, although the conditions which
then gave it point have long since disappeared.

In the middle nineties, when it was estimated that the total gold stock
of the entire country was only about 600 million dollars and less than
200 millions of this was in the vaults of the treasury, the
Government's fiduciary currency, consisting of 346 millions of
greenbacks and 400 millions or more of overvalued silver, presented
beyond question a serious menace to the country's monetary standard. It
meant that the treasury had outstanding currency obligations payable in
gold to the extent of three or four times its own gold holdings, and
amounting to far more than all of the gold in the country, including the
holdings of the treasury, the banks, and the general public. At that
time fluctuations in the trade balance of a single year sometimes almost
equalled the treasury's gold holdings in amount, and it was quite
conceivable, in fact not improbable, that a sudden unfavorable change in
that balance might drain the treasury of all of its gold, and leave the
country with a currency standard of depreciated silver or paper. This
was the situation which continually menaced Mr. Cleveland's second
administration, causing great financial anxiety and forcing the treasury
during those years of peace and normal expenditures to borrow 262
million dollars in gold in order to replenish its continually dwindling
reserve. Such a situation inevitably led the advocates of monetary
legislation in the nineties to place first and foremost among their
proposals the necessity of getting rid of the precarious greenback, and
most of the plans proposed by bankers' associations, chambers of
commerce, and financial experts generally at that time emphasized the
urgency of this measure.

WHY RETIREMENT IS NOT IMPORTANT

It sometimes happens that, with the lapse of time and with changed
conditions, infirmities, long left untreated, cure themselves, and so it
has been with the one-time bothersome greenback. Twenty years ago, when
the outstanding greenbacks amounted to twice the gold holdings of the
treasury and to much more than half of the country's entire gold stock,
there was abundant reason for anxiety on account of their continued
circulation. The situation is utterly different to-day. Gold has
accumulated in the treasury beyond the wildest "dreams of avarice" of
the nineties. From less than 200 millions in the middle nineties the
treasury's gold holdings have grown to approximately 1,250 millions
to-day, and the estimated gold stock of the country has increased from
600 to more than 1,800 millions, despite the fact that the Director of
the Mint in 1907 reduced the estimate for gold in circulation by 135
millions as compared with the basis of previous years.

The greenback has thus become each year a relatively less important
element in our currency system, an element of ever less and less potency
for harm. Doubtless the absolute amount of outstanding greenbacks has
diminished considerably through loss and destruction during fifty years,
and is to-day far less than the $346,000,000 issued during the Civil
War, which are still carried as an obligation on the Government
books....

The greenbacks are less menacing to-day for the further reason that they
are being rapidly transformed into small denominations which are
absorbed in the general circulation, and which could only with great
difficulty be collected in sufficiently large amounts to cause a serious
drain upon the treasury through presentation for redemption.... So great
and continuous is the demand for notes of small denominations that one
may safely predict that in another decade practically all of the
greenbacks still in existence will be in small denominations in the
pockets of the people.

The "endless chain" with its ineffectual bond issues, the imminence of
specie suspension, and the fear of treasury bankruptcy will never again
result from the outstanding greenbacks. Their dangers, lurid and
nerve-racking though they were twenty years ago, are now only memories.

THE CONFEDERATE CURRENCY[14]

The financial system adopted by the Confederate Government was
singularly simple and free from technicalities. It consisted chiefly in
the issue of treasury notes enough to meet all the expenses of the
Government, and in the present advanced state of the art of printing
there was but one difficulty incident to this process; namely, the
impossibility of having the notes signed in the Treasury Department, as
fast as they were needed. There happened, however, to be several
thousand young ladies in Richmond willing to accept light and
remunerative employment at their homes, and as it was really a matter
of small moment whose name the notes bore, they were given out in sheets
to these young ladies, who signed and returned them for a consideration.
I shall not undertake to guess how many Confederate treasury notes were
issued. Indeed, I am credibly informed by a gentleman who was high in
office in the Treasury Department, that even the Secretary himself did
not certainly know. It was clearly out of the power of the Government
ever to redeem the notes, and whatever may have been the state of
affairs within the treasury, nobody outside its precincts ever cared to
muddle his head in an attempt to get at exact figures.

We knew only that money was astonishingly abundant. Provisions fell
short sometimes, and the supply of clothing was not always as large as
we should have liked, but nobody found it difficult to get money enough.
It was to be had almost for the asking. And to some extent the abundance
of the currency really seemed to atone for its extreme badness. Money
was so easily got, and its value was so utterly uncertain, that we were
never able to determine what was a fair price for anything. We fell into
the habit of paying whatever was asked, knowing that to-morrow we should
have to pay more.

Speculation became the easiest and surest thing imaginable. The
speculator saw no risks of loss. Every article of merchandise rose in
value every day, and to buy anything this week and sell it next was to
make an enormous profit quite as a matter of course. So uncertain were
prices, or rather so constantly did they tend upward, that when a cargo
of cadet gray cloths was brought into Charleston once, an officer in my
battery, attending the sale, was able to secure enough of the cloth to
make two suits of clothes, without any expense whatever, merely by
speculating upon an immediate advance. Naturally enough, speculation
soon fell into very bad repute, and the epithet "speculator" came to be
considered the most opprobrious in the whole vocabulary of invective.
The feeling was universal that the speculators were fattening upon the
necessities of the country and the sufferings of the people. Nearly all
mercantile business was regarded at least with suspicion, and much of it
fell into the hands of people with no reputations to lose, a fact which
certainly did not tend to relieve the community in the matter of high
prices.

The prices which obtained were almost fabulous, and singularly enough
there seemed to be no sort of ratio existing between the values of
different articles. I bought coffee at forty dollars and tea at thirty
dollars a pound on the same day. My dinner at a hotel cost me twenty
dollars, while five dollars gained me a seat in the dress circle of the
theatre. I paid one dollar the next morning for a copy of the
_Examiner_, but I might have got the _Whig_, _Dispatch_, _Enquirer_, or
_Sentinel_, for half that sum. For some wretched tallow candles I paid
ten dollars a pound. The utter absence of proportion between these
several prices is apparent, and I know of no way of explaining it except
upon the theory that the unstable character of the money had
superinduced a reckless disregard of all value on the part of both
buyers and sellers. A facetious friend used to say prices were so high
that nobody could see them, and that they "got mixed for want of
supervision." He held, however, that the difference between the old and
the new order of things was a trifling one. "Before the war," he said,
"I went to market with the money in my pocket, and brought back my
purchases in a basket; now I take the money in the basket, and bring the
things home in my pocket."

As I was returning to my home after the surrender at Appomattox Court
House, a party of us stopped at the residence of a planter for supper,
and as the country was full of marauders and horse thieves, deserters
from both armies, bent upon indiscriminate plunder, our host set a
little black boy to watch our horses while we ate, with instructions to
give the alarm if anybody should approach. After supper we dealt
liberally with little Sam. Silver and gold we had none, of course, but
Confederate money was ours in great abundance, and we bestowed the crisp
notes upon the guardian of our horses, to the extent of several hundreds
of dollars. A richer person than that little negro I have never seen.
Money, even at par, never carried more of happiness with it than did
those promises of a dead government to pay. We frankly told Sam that he
could buy nothing with the notes, but the information brought no sadness
to his simple heart.

"I don' want to buy nothin', master," he replied. "I's gwine to keep dis
always."

I fancy his regard for the worthless paper, merely because it was called
money, was closely akin to the feeling which had made it circulate among
better-informed people than he. Everybody knew, long before the
surrender, that these notes never could be redeemed. There was little
reason to hope, during the last two years of the war, that the
"ratification of a treaty of peace between the Confederate States and
the United States," on which the payment was conditioned, would ever
come. We knew the paper was worthless, and yet it continued to
circulate. It professed to be money, and on the strength of that
profession people continued to take it in payment for goods. The amount
of it for which the owner of any article would part with his possession
was always uncertain. Prices were regulated largely by accident, and
were therefore wholly incongruous.

In the winter of 1863-64 Congress became aware of the fact that prices
were higher than they should be under a sound currency. If Congress
suspected this at any earlier date, there is nothing in the proceedings
of that body to indicate it. Now, however, the newspapers were calling
attention to an uncommonly ugly phase of the matter, and reminding
Congress that what the Government bought with a currency depreciated to
less than one per cent. of its face, the Government must some day pay
for in gold at par. The lawgivers took the alarm and sat themselves down
to devise a remedy for the evil condition of affairs. With that
infantile simplicity which characterized nearly all the doings and quite
all the financial legislation of the Richmond Congress, it was decided
that the very best way to enhance the value of the currency was to
depreciate it still further by a declaratory statute, and then to issue
a good deal more of it. The act set a day, after which the currency
already in circulation should be worth only two-thirds of its face, at
which rate it was made convertible into notes of the new issue, which
some, at least, of the members of Congress were innocent enough to
believe would be worth very nearly their par value. This measure was
intended, of course, to compel the funding of the currency, and it had
that effect to some extent, without doubt. Much of the old currency
remained in circulation, however, even after the new notes were issued.
For a time people calculated the discount, in passing and receiving the
old paper, but as the new notes showed an undiminished tendency to still
further depreciation, there were people, not a few, who spared
themselves the trouble of making the distinction.

I am sometimes asked at what time prices attained their highest point in
the Confederacy, and I find that memory fails to answer the question
satisfactorily. They were about as high as they could be in the fall of
1863, and I should be disposed to fix upon that as the time when the
climax was reached, but for my consciousness that the law of constant
depreciation was a fixed one throughout the war. The financial condition
got steadily worse to the end.

The Government's course in levying a tax in kind, as the only possible
way of making the taxation amount to anything, led speedily to the
adoption of a similar plan, as far as possible, by the people. A
physician would order from his planter friend ten or twenty visits'
worth of corn, and the transaction was a perfectly intelligible one to
both. The visits would be counted at ante-war rates, and the corn
estimated by the same standard. In the early spring of 1865 I wanted a
horse, and a friend having one to spare, I sent for the animal, offering
to pay whatever the owner should ask for it. He could not fix a price,
having literally no standard of value to which he could appeal, but he
sent me the horse, writing, in reply to my note:

"Take the horse, and when the war shall be over, if we are both alive
and you are able, give me as good a one in return. Don't send any note
or due-bill. It might complicate matters if either should die."

A few months later I paid my debt by returning the very horse I had
bought. I give this incident merely to show how utterly without
financial compass or rudder we were.

How did people manage to live during such a time? I am often asked; and
as I look back at the history of those years, I can hardly persuade
myself that the problem was solved at all. A large part of the people,
however, was in the army, and drew rations from the Government. The
country people raised upon their plantations all the necessaries of
life, and were generally allowed to keep enough of them to live on, the
remainder being taken by the subsistence officers for army use.

In the cities, living was not by any means so easy as in the country.
Business was paralyzed, and abundant as money was, it seems almost
incredible that city people got enough of it to live on. Very many of
them were employed, however, in various capacities, in the arsenals,
departments, bureaus, etc., and these were allowed to buy rations at
fixed rates, after the post-office clerks in Richmond had brought
matters to a crisis by resigning their clerkships to go into the army,
because they could not support life on their salaries of nine thousand
dollars a year. For the rest, if people had anything to sell, they got
enormous prices for it, and could live a while on the proceeds. Above
all, a kindly, helpful spirit was developed by the common suffering, and
this, without doubt, kept many thousands of people from starvation.
Nobody formed any plans or laid by any money for to-morrow or next week
or next year, and indeed to most of us there really seemed to be no
future. We were not used to think of ourselves as possible survivors of
a struggle which was every day perceptibly thinning our ranks. The
coming of ultimate failure we saw clearly enough, but the future beyond
was a blank.

The reader may find it difficult to believe that with gold at a hundred
and twenty-five for one, or 12,400 per cent. premium; when every day
made the hopelessness of the struggle more apparent; when our last man
was in the field; when the resources of the country were visibly at an
end, there were financial theorists who honestly believed that by a mere
trick of legislation the currency could be brought back to par. I heard
some of these people explain their plan during a two days' stay in
Richmond. Gold, they said, is an inconvenient currency always, and
nobody wants it, except as a basis. The Government has some
gold--several millions in fact--and if Congress will only be bold enough
to declare the treasury notes redeemable at par in coin, we shall have
no further difficulty with our finances. So long as notes are redeemable
in gold at the option of the holder, nobody wants them redeemed.... The
gold which the Government holds will suffice to satisfy a few timid
ones, and there will be an end of high prices and depreciated currency.
I am not jesting. This is, as nearly as I can repeat it, the utterance
of a member of the Confederate Congress.

The matter of prices was frequently made a subject for jesting in
private, but for the most part it was carefully avoided in the
newspapers. As with the accounts of battles in which our arms were not
successful, necessary references to the condition of the finances were
crowded into a corner, as far out of sight as possible. The _Examiner_,
however, on one occasion denounced with some fierceness the charges
prevailing in the schools; and I quote a passage from Prof. Sidney H.
Owens's reply, which is interesting as a summary of the condition of
things in the South at that time:

"The charges made for tuition are about five or six times as high as in
1860. Now, sir, your shoemaker, carpenter, butcher, market man, etc.,
demand from twenty, to thirty, to forty times as much as in 1860. Will
you show me a civilian who is charging only six times the prices charged
in 1860, except the teacher only? As to the amassing of fortunes by
teachers, spoken of in your article, make your calculations, sir, and
you will find that to be almost an absurdity, since they pay from twenty
to forty prices for everything used, and are denounced exorbitant and
unreasonable in demanding five or six prices for their own labor and
skill!"

There were compensations, however. When gold was at 12,000 per cent.
premium with us, we had the consolation of knowing that it was in the
neighborhood of one hundred above par in New York, and a Richmond paper
of September 22, 1864, now before me, fairly chuckles over the high
prices prevailing at the North, in a two-line paragraph which says, "Tar
is selling in New York at two dollars a pound. It used to cost eighty
cents a barrel." That paragraph doubtless made many a five-dollar
beefsteak palatable.

FOOTNOTES:

[8] Adapted from Wesley Clair Mitchell, _A History of the Greenbacks_,
Part II, The University of Chicago Press, 1903.

[9] Adapted from A. D. Noyes, _Forty Years of American Finance_, pp.
7-20. G. P. Putnam's Sons, New York and London, 1909.

[10] _Ibid._, pp. 21-22.

[11] _Ibid._, pp. 23-31.

[12] _Ibid._, pp. 44-47.

[13] A. Piatt Andrew, The Essential and the Unessential in Currency
Legislation, in _Questions of Public Policy_, Addresses delivered in the
Page Lecture Series, 1913, before the Senior Class of the Sheffield
Scientific School, Yale University, pp. 55-59. Yale University Press,
New Haven, Connecticut. 1913.

[14] Adapted from George Gary Eggleston, _A Rebel's Recollections_, pp.
78-107. Hurd and Houghton. Boston, 1875.

CHAPTER VI

INTERNATIONAL BIMETALLISM

[15]... There are natural and commercial causes which may operate to
produce either an incessant fluctuation in the relative value of silver
and gold, or a wide and increasing divergence, from year to year,
through a long period, from the ratio of exchange existing between the
two metals at the commencement of the period. So far are the sources and
conditions of supply of the one different from those of the other that,
notwithstanding the influence of the durableness of the metals in giving
steadiness of value to either by turns, and hence to the two in their
relation to each other, it would be in the highest degree unreasonable
to assume that the ratio of exchange between gold and silver would
remain unaltered through any considerable term of years. The annual or
monthly variations may take the form of oscillations, now on one side
and now on the other of any historical ratio, or they may be cumulative
on one side of that ratio, producing a divergence increasing from month
to month, and year to year; but variations in some degree, in some
direction, are to be expected under the unrestrained operation of causes
influencing the demand for, or the supply of, each metal.

The conditions, natural and commercial, which determine the ratio of
exchange of the two metals being such, we have seen that government may
enter, and, by making the two indifferently legal tender for debts at a
ratio fixed by law, may, for the time, counteract the operation of any
and all forces tending to produce divergence. So long as any country
establishing such a principle holds a considerable amount of that metal
which, under the natural and commercial conditions of supply and demand
prevailing at the time, tends to become the dearer of the two, it is
impossible that the cheapened metal should there, or in any market, fall
far below that ratio. By the force of the bimetallic law, the
substitution of the cheapened for the dearer metal will at once begin;
and so long as that continues, the divergence of the market ratio from
the mint ratio can never be wide. Why should any one in London or New
York pay much more than fifteen and a half ounces of silver for an ounce
of gold, when gold can, at any time and in any amount, be obtained for
silver at the rate of fifteen and a half in Paris?

This operation of the bimetallic system can not be denied; but there is
ground for dispute as to the degree of the advantages to result, and as
to the cost at which those advantages are to be obtained. The
monometallist, or advocate of the so-called single standard, is disposed
to disparage the benefits to be expected, and to magnify the expense of
this system. He points to the fact that the two metals do not actually
circulate in the same country, at the same time, in any considerable
degree; that it is always the one metal or the other which is used as
money, according as the market ratio diverges to the one side or the
other of the mint ratio, while the coin made from the dearer metal
acquires a premium, and is exported or hoarded. Hence it is said
bimetallism really means the use of but one metal in a country at a
time. It is not a double standard, but an alternate standard.

To this the bimetallist replies that the concurrent use of the two money
metals, side by side, in the same markets, is a matter wholly of
indifference. The merit of the bimetallic scheme does not depend on this
at all.

The object of bimetallism is, by joining the two metals together in the
coinage, at a fixed ratio, to diminish the extent of the fluctuations to
which the value of each would be separately liable, by generating a
compensatory action between the two, by which the cheapening metal shall
receive a larger use, while the appreciating metal drops partially out
of its former demand, thus making the two fall together, if there must
be a fall, or rise together, in the opposite case: or, conceivably,
making the tendency of one to fall precisely counteract the tendency of
the other to rise.

Thus we may suppose four successive cases to illustrate the working of
this principle.

The first is, where the demand for the use of either metal in trade
remaining the same, a large increase in the supply of one metal, A,
takes place, the supply of the other, B, remaining unchanged. In this
case, without the bimetallic system, the value of A would tend to fall
rapidly through a considerable space, while the value of B would stand
fast. With the bimetallic system, the joint supply of the two metals
would be applicable to meet the joint demand for the two. Now, as the
joint supply has been increased without any change in the joint demand,
there must be a fall in value; but the fall will be in the two
indistinguishably, except for a slight degree of delay and friction in
exchange. Both will fall, but the depth of the fall will be diminished
as the surface over which it is to take place has been enlarged.

The second is where, the demands of trade for both metals remaining the
same, a diminution occurs in the supply of A, while the supply of B
remains unchanged. Here, by the operation of the same principle, a rise
in the value of money will take place, since the joint supply has been
reduced without any corresponding change in the joint demand. The rise
will be a rise of the two metals indistinguishably, the height of the
rise being diminished as the surface over which it is to take place has
been enlarged.

The third case is where, demand remaining the same, the supply of both
metals undergoes a change in the same direction, either of increase or
of diminution, at the same time. In this event, the fall or rise will
again be of the two indistinguishably, the point reached being a mean
between the points which would have been reached by the two severally.

The fourth case is where, demand remaining the same, the supply of the
two metals undergoes a change at the same time, but in opposite
directions, A through diminution, B through increase. In this case, the
opposite tendencies will counteract each other. If of equal force, the
value of money will be stable; if of unequal force, there will be
movement in the direction of the stronger to the extent of the
difference between the two. Instead of one falling and the other rising
in value, the change will be wrought in the two indistinguishably.

It will appear from the foregoing statements that, under the bimetallic
system, the value of money will be liable to vary more frequently than
under the monometallic system. That is, a change in respect to either
constituent of the money mass will produce a change of value; and it is
apparent that the chances of change are greater with two constituents
than with one. On the other hand, the variations under the bimetallic
system are likely to be less extensive. Indeed, it is a matter of
practical certainty that they will be far less extensive than they would
be under the monometallic system, whichever metal were adopted as the
standard of deferred payments.

But, again, the monometallist interposes the objection that the
bimetallic system is only to be supported at great expense to the States
maintaining it; that they lose by the exchange of the dearer for the
cheapened metal, even though they acquire a certain premium in doing so,
and that sooner or later the stock of the dearer metal in the bimetallic
countries will become exhausted, and the system will collapse, the price
of the two metals no longer being held closely or nearly at the former
ratio by the possibility of exchanging them at that ratio, freely, in
any amount.

How far a bimetallic country loses by the alternation of the metals in
circulation, as now one and now the other becomes the cheaper at the
coinage ratio, is a nice question.

That the service rendered to the commerce of the world by establishing a
normal price for each metal in terms of the other, and thus creating and
maintaining a par-of-exchange between gold countries and silver
countries, is worth far more than its cost, seems to me beyond a
rational doubt. It would, in my view, be as reasonable to doubt whether
London Bridge repays the expense of its erection and repair. Were the
cost of this bimetallic service, whatever it is, properly assessed upon
and collected from each commercial nation of the world by turns,
according to the proportion in which it derives advantage therefrom, I
think it might safely be said that no one of these nations would sustain
a single other charge which so fully justified itself in the return it
made, whether that other charge were for works of construction, for the
administration of justice, or for any other strictly necessary purpose.

But there is no assurance that the cost of the bimetallic system will be
thus equitably assessed. If the whole charge of erecting and repairing
London Bridge were thrown upon the merchants of the two or three streets
nearest thereto, while yet the whole population were allowed to use the
bridge, free of toll, there would not unnaturally arise a strong sense
of injustice on the part of those who bore this burden for the public
benefit; it might even become a question whether the undoubted
advantages derived by them from the use of the bridge repaid the
disproportionate expense which it caused them. If the maintenance of the
bimetallic system involves a certain burden on the nations which sustain
it, as I am disposed to think is the case, it fairly becomes a question
whether those individual nations are compensated for bearing the whole
expense of the service by their share of the advantages resulting
therefrom to the trade and industry of the world.

That England could well have afforded, throughout the present century,
to maintain this system for her own benefit, whatever it cost, even
though other nations profited by it in greater or less degree, is clear
as the light. That France, a country of far less extended international
trade, has been compensated for bearing so large a part as she has done
of the burden of maintaining a par-of-exchange for the commerce of the
world, by her share of the resulting advantages, I make no question; but
it must be admitted to be fairly a matter of dispute.

On such a point it is evidence of no small value that the French people
themselves and the French statesmen, though singularly acute and
sagacious in matters of finance, have apparently not doubted that the
bimetallic system was for the interest of their country. Certain of the
French political economists--MM. Chevalier, Levasseur, Bonnet,
Mannequin, Leroy Beaulieu--from their theory of the subject have held
that France lost by her policy in this respect; but the financiers of
that remarkable nation held firmly to the "double standard" from 1785
to 1874. And though France at the latter date restricted her silver
coinage, and two years later stopped it altogether, it was not done as
the result of any change of views. Partly it was from deference to her
monetary allies, Belgium and Switzerland, but chiefly because the
demonetization of silver by Germany and the sale of the discarded metal
of that empire brought a sudden strain upon the bimetallic system which
threatened to break it violently down. Hence France closed her mints to
silver, but not with any confession that her policy had been erroneous
under the conditions previously existing; not from any desire to abandon
that policy should the future offer conditions which would admit the
resumption of bimetallism. It was the declaration of M. Léon Say, the
French Minister of Finance, the President of the International Monetary
Conference of 1878, that France, in suspending the coinage of silver,
had taken no step towards the single gold standard, but had placed
herself in a position to await events, a position which she would not
leave till good reasons for action should appear, and then most probably
to re-enter on the system of the double standard....

The objection that the stock of the dearer metal in the bimetallic
States must, if the drain be indefinitely continued, become after a
while exhausted, and that the system will then lose all its efficiency
in holding the two metals together, is unquestionably valid; but an
altogether unreasonable weight has been assigned to it in the discussion
of bimetallism as a scheme of practical statesmanship.

If we look at almost any treatise written from the monometallic point of
view, we shall find that it is taken as conclusive against that scheme,
that conditions of supply and demand can be assumed for the two metals
separately which would result in the complete exhaustion of the dearer
metal, and the consequent loss of all virtue in the bimetallic scheme.
The bimetallist is confronted with a series of adverse conditions, taken
each at its maximum and piled one above the other without the least
regard to the modesty of nature, or the experience of the past; and is
then challenged to say whether the system he proposes could be
maintained under such circumstances. If he is candid enough to admit
that bimetallism would fail there, it is taken for granted that the
whole question is disposed of.

Now, human institutions are not to be judged of, and approved or
disapproved, by such methods. The folly of reasoning like this would be
seen at once were it applied to ordinary political matters. No
government on earth could stand against one-fourth or one-tenth of the
elements of hostility which might conceivably be arrayed against it.
Mankind do not, therefore, refuse to form governments.

Bimetallism is a political institution for practical ends, and is
entitled to be judged with reference to reasonable probabilities. It may
claim the benefit of the chance that adverse conditions will be offset
by conditions favourable, and that the adverse conditions will not prove
so severe at the start as they may be conceived, and that their force
will be more quickly spent than might be feared.

It would be perfectly legitimate ground on which to establish European
bimetallism, that the French system, with so little of support from
other States, passed within a quarter of a century through the three
successive shocks of the gold discoveries of Siberia, the gold
discoveries of California, and the gold discoveries of Australia, and
yet was not brought to the ground.

With Germany, France, and England joined in a monetary union, no changes
reasonably to be anticipated in the conditions of supply of the one
metal or the other would succeed in moving the market ratio far apart
from the mint ratio thus supported by maintaining over so wide a surface
a legal equivalence between the two metals in payment of debts.

And, moreover, while bimetallism is entitled to be judged like any other
political institution, with reference to the reasonable probabilities of
the future, the allowance which requires to be made for error and
extraneous force is less than in most political institutions, inasmuch
as the failure of bimetallism involves no disaster to industry or
society.

When an engineer designs a bridge which is intended to sustain a weight
of eighty tons, he introduces a "factor of safety," say three or five,
and makes the bridge strong enough to bear two hundred and forty or four
hundred tons. The greater the calamity which would result from the
breaking down of the bridge--the deeper the chasm which it spans, the
swifter the torrent below--the larger the factor of safety. With many
political institutions, likewise, the consequences of failure would be
so disastrous that the statesman seeks to introduce a high factor of
safety; but in the case of bimetallism no catastrophe whatever is to be
anticipated, even in the event of failure. At the worst, after the drain
of the dearer metal, in consequence of changes in the conditions of
supply, is completed, the bimetallic country is simply in the same
position with the countries of the single standard using the cheapened
metal. While the process of substitution is going on, it sells the
dearer metal at a premium; when the process is over, it is no worse off
than it would have been had it originally selected as its sole money of
full legal-tender power the metal which it has bought at a discount, and
which other countries, perhaps its immediate neighbours, are still
using. It is not the case of a country seeking to reject the cheapening
metal, and to supply its place with the metal which is continually
becoming scarcer and dearer.... There is all the difference, in the two
cases, between going down hill and going up hill.

Not only is no catastrophe involved in the failure of bimetallism
through the exhaustion of the dearer metal, but it is always in the
power of the Government to arrest the drain at any point without shock.

Thus, in 1874, France and her monetary allies, seeing the prospect of a
considerable drain of gold through the importation of the discarded and
cheapened silver of Germany, and having decided, whether wisely or
unwisely, not to prevent that drain, restricted the coinage of silver
without repealing or suspending the law which made gold and silver legal
tender indifferently at a fixed ratio. Two years later, finding that the
forces operating to lower the value of silver were powerful and
persistent, the coinage of silver was peremptorily stopped.

Can one point to any sign that France has suffered any special injury to
her trade and production from this act?...

We now have to note ... that every additional State which joins the
bimetallic group, having the same mint ratio between gold and silver,
does not only share the cost or the burden with those already in the
system, but diminishes the aggregate cost or burden to be borne, and
this, not in a slight, but in an important degree, so that should the
monetary league become general, the total cost or burden to be divided
among the many allies would be inappreciable; while, should the system
come to embrace all commercial States, there would, in theory, be no
burden at all to be borne by any one.

Thus let us suppose the commercial world to be divided into sixteen
States, A to P, inclusive, the first six having the single gold
standard, four, G to J, the so-called double standard of gold and
silver, say at 15-1/2:1; the remaining six States having the single
standard of silver, thus:

A, B, C, D, E, F (G, H, I, J), K, L, M, N, O, P.

It is evident that in the case of a change in the conditions of supply
tending to cheapen silver relatively to gold, the new silver would pass
into the countries of the double standard, G to J, be there exchanged
for gold at the rate of 15-1/2: 1, with some small premium as the profit
of the transaction, and the gold would go to the gold countries, A to F,
in settlement of trade balances.

The rapidity with which this substitution of silver for gold will go
forward will depend, first, on the force of the natural causes operating
to cheapen silver, and, secondly, on the force of the commercial causes
operating to maintain or advance the value of gold. The length of time
during which the drain of the dearer metal can be sustained without
exhaustion will (given the rate of movement) depend solely on the stock
of that metal existing in the bimetallic States jointly when the drain
begins.

But chief among the commercial causes operating to maintain or advance
the value of gold is the exclusive power with which gold is invested by
law to pay debts within States A to F; while the stock of the dearer
metal available to sustain the drain described is made up, not of all
the gold in the sixteen States A to P, or in the ten States A to J, but
only of the gold in the four bimetallic States, G to J.

Hence we see that for every gold State which adopts the "double
standard" the amount of gold available, in the case of a cheapening of
silver, to meet the drain of the dearer metal (on which the virtue of
the bimetallic system depends) is increased; while the demand for gold
in preference to silver at 15-1/2:1 (the only cause which threatens the
stability of the bimetallic system) is, in just so far, diminished. On
the other hand, every silver State that adopts the "double standard"
strengthens the bimetallic system in the case of a cheapening of gold.

Let us suppose the sixteen commercial States to be divided as four gold
States, eight gold and silver States, and four silver States, as
follows:

A, B, C, D (E, F, G, H, I, J, K, L), M, N, O, F.

We see that the bimetallic system is now not twice as strong merely as
in the case first assumed, but many times as strong, since not only is
the amount of the dearer metal (whichever that may at the time be)
subject to drain greatly increased, but the demand for that metal, in
preference to silver at 15-1/2:1, now comes from four countries only,
instead of six, as formerly. The transfer of still another State from
each of the two single-standard groups would vastly increase the
stability of the bimetallic system, A, B, C (D, E, F, G, H, I, J, K, L,
M), N, O, P. Not only would the base of the system be broadened by
bringing the dearer metal of ten States, D to M, under tribute in the
event of changes operating on the supply of either to affect its value;
but the force of the causes threatening the equilibrium of the system
would be reduced, since the demand for the dearer metal would now come
from only three States: A, B, C, in the case of a cheapening of silver
relatively to gold; N, O, P, in the case of a cheapening of gold
relatively to silver.

Bring still another State from each group into the monetary union, and
the danger of a breaking down of the system, under any change in the
conditions of supply which it would be reasonable to anticipate, almost
disappears.

A, B (C, D, E, F, G, H, I, J, K, L, M, N), O, P. Twelve States now
supply the dearer metal; only two States will take it in preference to
the other at the ratio of the mint. Those two States--whether A, B, or
O, P--can not take the dearer metal indefinitely. They will soon be
surfeited. A further increase of money in them would only be followed
by a fall in its value, which would soon proceed so far as to bring the
metals together again. What the one metal would tend to lose in value
through increase of supply, the other would tend to lose through
diminution of demand.

This is the Modern Bimetallic Scheme advocated by Wolowski and Cernuschi
in France, Malou and de Laveleye in Belgium, Mees and Vrolik in Holland,
Schneider in Germany, Haupt in Austria, Seyd and the Liverpool writers
in England, Horton, Nourse, and George Walker in the United States.

It differs widely from the plan of the so-called "double standard,"
which was pronounced impracticable by Locke, Adam Smith, and Ricardo.
Not the smallest presumption against the reasonableness of this scheme
is created by the fact that eminent economists of the past century, and
of the first half of the present, declared in favour of the single
standard, whether of gold or of silver. Those writers contemplated a
condition of international relations in which anything like general and
permanent concert of action, in establishing and maintaining a ratio
between the metals in the coinage, would have been wholly beyond
reasonable expectation....

A general or universal system of bimetallism would involve no machinery,
no international accounts, no detail whatever. The simple agreement of
governments to coin at a certain ratio would be sufficient for all the
objects that have been discussed. If unification of coinage, identity of
moneypieces, and mutual acceptance of coins by the several nations
forming such a monetary league, were to be added, some machinery for the
redemption of worn pieces might require to be brought into existence;
but this is not a necessary feature of successful bimetallism, which
would be entirely compatible with the retention by each State of its own
devices and denominations, and with the exchange of moneys as at present
effected....

FOOTNOTES:

[15] Francis A. Walker. _Money in Its Relations to Trade and Industry_,
pp. 164-176; 178-182. Henry Holt & Company. New York. 1889.

CHAPTER VII

THE SILVER QUESTION IN THE UNITED STATES

[16]Such was the singular combination of events after the peace of 1865
that almost at the moment when a million citizens were turned from
organised destruction to pursuit of peaceful industry, the avenues of
American employment and production were widened in a degree
unprecedented in the history of trade. Within eight years after Lee's
surrender, the railway mileage of the United States was literally
doubled. Only a fraction of this increase belonged to the
transcontinental lines which linked the two oceans in 1869. Quite aside
from the 1,800 miles of the Pacific railways, upwards of 30,000 miles of
track were laid in the United States between 1865 and 1873. Four
noteworthy economic developments accompanied this extension of the
transportation system. A fertile interior domain, hitherto untouched,
was opened up to industry. With the rush of population to these Western
districts, not only did the disbanded army resume production without
industrial overcrowding such as followed the Napoleonic wars, but
provision was made for three or four hundred thousand immigrants
annually. European capital in enormous volume was drawn upon to provide
the means for this development. Finally, the United States rose from the
position of a second- or third-class commercial State to the first rank
among agricultural producers and exporters. Each of these several
phenomena had its special influence on the period.

Not less immediately connected with this opening up and settlement of
our agricultural West was still another phenomenon, of peculiar interest
to the study of the ensuing period. The average price of grain had
advanced with great rapidity during the Civil War. In 1867, the price of
wheat, even on the Chicago market, reached the remarkable level of
$2.85 per bushel; nor was this price very greatly above the annual
maximum of the period. In a large degree, this advance resulted from
inflation of the American currency. But the upward movement was
world-wide; in 1867 and 1868 the average price, even in England, was
close to the equivalent of two dollars a bushel. That any such abnormal
market could be maintained in the face of the new American supplies was
at least improbable. The increase in cereal production was twice as
rapid as the country's increase in population; the United States became
therefore the leading figure in the world's export markets; and this was
certain to have important influence on prices.

As in America, so in Europe, production received immediate stimulus.
While American capital was opening up the Mississippi Valley, European
capital was similarly busy along the fertile river basins of the Dnieper
and the Danube. The Russian railway system grew during this period from
something like 2,000 miles to upwards of 13,000. In Austria-Hungary the
percentage of increase was almost equally large. All of these new
transportation lines, like our own new Granger railways, were at once
engaged in carrying to the seaboard supplies of grain which never before
had reached an export market. The problem of an earlier generation had
been how to feed the constantly increasing population; a wholly new
problem was presently to arise, based on the question how to find a
ready and profitable market for the year's output of breadstuffs.
Prices, in short, which rose almost continuously throughout the world
during the period of slack production from 1858 to 1873, receded almost
as continuously in the ensuing generation. Nowhere was this phenomenon
destined to have more immediate importance, economically, socially, and
politically, than in the United States.

The opinion is more or less widely held that the decline in prices,
notably of grain, has resulted from legislation on the currency. Without
for the present arguing that proposition, it may be affirmed with entire
safety that a good share of the period's currency legislation has
resulted from the decline in the price of grain. The fall in wheat has
been the typical argument for arbitrary increase of the silver or paper
currency in almost every Congressional debate since 1872. What is
perhaps even more significant, the division in almost every
Congressional vote upon these subjects has been, not political but
geographical--the commercial East against the agricultural West.

AGITATION FOR SILVER AND THE PASSAGE OF THE BLAND BILL

[17]In the summer session of 1876, several bills had been introduced,
providing for increased silver coinage and for remonetization of the
silver dollar. None of these propositions came to anything; they were
chiefly remarkable from the fact that they first gave vogue to the
theory of the "crime of 1873"--a theory which assumed that the dropping
of the silver dollar from the list of coins in the statutes of that year
was the outcome of a conspiracy which carried its legislation through in
secret. The entire baselessness of this assertion has been demonstrated
often enough and in convincing detail; this very provision regarding the
silver dollar was a subject of public discussion in the House, and met
with no serious opposition. The assertion in itself is so patently
absurd that I shall not pause to discuss it. The truth is that silver in
1873, and during a generation before that date, was worth more to its
owner in the form of bullion than in the form of coin. In 1872 the
silver requisite to coin a dollar at the established ratio was worth
$1.02. For years, therefore, nobody thought of bringing his silver to
the mint for coinage; he sold it in the commercial markets. The total
silver-dollar coinage of the United States, between 1789 and 1873, was
barely eight million dollars, and when, in 1873, the law provided that
except for the so-called trade dollar coined for export, "no deposit of
silver for other coinage shall be received," no one had interest enough
in the matter to offer criticism.

But in 1874 and 1875 came one of those curious coincidences which render
possible for all time conflicting theories of an economic event.
Germany, having adopted the gold standard of currency in July, 1873,
began to sell its old silver coin as bullion. At exactly the same time,
Mackay and Fair, in the heart of the Nevada Mountains, were opening up
the Great Bonanza. The Pacific Coast was in fact going wild over the
rise in mining shares while the East was financially and industrially
paralysed.

The statute dropping the silver dollar from this country's coinage list
was enacted February 12, 1873; the German law for retirement of silver
coinage was adopted July 9, 1873; and a year later the news of the rich
Nevada "ore-finds" became public property. Between the German sales and
the sales at Nevada City, the price of silver yielded. In 1874, for the
first time in a generation, 412-1/2 grains of standard silver would have
been worth more when coined into a legal-tender dollar than when sold in
the bullion market. The motive of the mining interest in the free-silver
coinage agitation of 1876 and 1877 was not mysterious.

The motive of the anti-Administration party in Congress was somewhat
different. There is not the slightest question that the silver-coinage
movement, in the agricultural West particularly, had the same origin and
the same following as the paper inflation movement of a few years
before. Mr. Bland himself, the author of the silver bill, declared that
the question was presented as between what he called "honest resumption"
with silver coinage, "or on the other hand a forced unlimited inflation
of paper money." In the heat of debate on the silver bill, the same
statesman declared in Congress that if his coinage plan could not be
passed, he was "in favour of issuing paper money enough to stuff down
the bondholders until they are sick." The point of these remarks lies in
their frank assumption that the free-silver sentiment and the fiat-money
sentiment were interchangeable.

So much, then, for the origin and nature of the silver movement. The
Bland Bill passed the House on November 5, 1877, under the previous
question and without debate, by a vote of 164 to 34, and the resumption
operations of the Government came to an instant halt. The market price
of silver then was such that the legal-tender dollar of the Act would
have been worth intrinsically less than ninety cents. Foreign
subscribers to our resumption bonds suspected instantly that payment of
the Government debt in a depreciated coin was planned by Congress; their
suspicions were confirmed by a resolution introduced December 6th by
Stanley Matthews, Mr. Sherman's own successor in the Senate, and passed
by both houses. The resolution explicitly declared that in the opinion
of Congress, all the bonds of the United States, "issued or authorized
to be issued," were payable in the silver dollars of the Bland Law. The
extraordinary character of this resolution may be judged from the fact
that it was proposed and passed in both houses while the Coinage Act was
still pending, and while, therefore, there was not in existence the coin
which was duly declared a legal tender for settlement with public
creditors. To the conservative portion of the public, the resolution
seemed a piece of financial lunacy; to the Treasury, it was not only
embarrassing but humiliating. Hardly a month before, in his annual
report to Congress, the Secretary had repeated his official statement,
previously made to bond subscribers, that payment of the bonds in gold
might safely be anticipated. The publication of this statement in New
York and London had been followed by greatly increased subscriptions to
the bonds, in payment of which gold was required by the Government. The
Matthews resolution amounted, so far as Congress was concerned, to
repudiation of a formal bargain of which the Government had already
obtained the fruits. The debate was such as might have been expected on
a measure of the sort. It centred repeatedly on denunciation of
Government bond investors. Foreign subscribers were treated with
especial scorn; indeed, our foreign customers in general were not
spared. It was this debate which drew forth Senator Matthews's somewhat
celebrated query: "What have we got to do with abroad?"--a remark which
was perhaps as typical of the session's deliberations as any utterance
made from the floor of Congress.

The situation, during the early months of 1878, was extremely critical.
For the time the three direct assaults on the public credit were warded
off. The Matthews resolution was "concurrent," and hence a mere
expression of opinion without binding force. The bill repealing the
Resumption Act of 1875 was killed by disagreement in the Senate.
Meantime the Silver-Coinage Act was modified by the Senate into a
compromise requiring purchase and coinage by the Government of two to
four millions' worth of silver monthly. Even thus modified, it
encountered the veto of the President, but was passed over his veto,
without a day's delay, by the requisite two-thirds majority. Executive
conservatism seemed to be fruitless; nevertheless, there is no doubt
whatever that the steadfast policy of Mr. Hayes did much to stem the
current of reaction.

Congress adjourned on June 19th. Even before Congressional adjournment,
the canvass for the November State elections had begun. The State
Convention platforms in the summer of 1878, were not in all respects
such as the session's work in Congress would have suggested.

The opposition had gone too far in Congress, and popular opinion to that
effect was expressed with sufficient emphasis in November, 1878. The
Administration party gained what amounted to a decided victory. There
were but four States, East or West, where opposition majorities were
increased in 1878 or Administration majorities diminished, and these
were agricultural States, where the season's sharp decline in wheat had
stirred up discontent. There was not much danger from the closing
session of a Congress whose earlier ventures had received this response
from the people.

PROVISIONS OF THE ACT OF 1878

[18]Although the silver dollar of which the coinage was resumed in 1878,
dates back as a coin to the earlier days of the Republic, its reissue in
that year marks a policy so radically new that the experience of
previous years throws practically no light on its working. The act of
1878 provided for the purchase by the Government, each month, of not
less than two million dollars' worth, and not more than four million
dollars' worth of silver bullion, for coinage into silver dollars at the
rate of 412-1/2 grains of standard silver (or 371-1/4 grains of fine
silver) for each dollar. The amount of the purchases, within the
specified limits, was left to the discretion of the Secretary of the
Treasury. As every Secretary of the Treasury, throughout the period in
which the act was in force, kept to the minimum amount, the practical
result was a monthly purchase of two million dollars' worth of silver
bullion.

The act is sometimes described as having called for a monthly issue of
two million silver dollars; but this was not the exact situation. The
amount of silver obtainable with two million dollars obviously varies
according to the price of the metal in terms of the dollars with which
the purchases are made. In February, 1878, when the first purchases were
made, those dollars were the inconvertible United States notes, or
greenbacks, worth something less than their face in gold. The amount of
silver bullion obtainable with two million such dollars depended, on the
one hand, on the price of silver bullion in terms of gold, and on the
other hand on the value of the dollars themselves in terms of gold. When
specie payments were resumed, on the first of January, 1879, and the
greenbacks became redeemable in gold, the measure of value in the United
States became gold, and the extent of the coinage of silver dollars
under the act of 1878 became simply a question of how much silver
bullion could be bought with two million dollars of gold. The price of
silver in 1878 was, in terms of gold, not far from a dollar for an ounce
of standard silver. Since 1878 it has gone down almost steadily, and ...
in 1889 was barely above 80 cents an ounce.[19] The silver dollar of
412-1/2 grains contains less than an ounce (480 grains) of standard
silver. The monthly purchase of two million dollars' worth of silver has
therefore always yielded more than two million silver dollars, the
amount being obviously greater as the price of silver went lower. On the
average, the monthly yield [was] not far from two million and a half of
silver dollars.... Thirty millions of silver dollars a year was roughly
the addition to the currency of the community from the act of 1878.

SILVER CERTIFICATES

[20]An important provision of the act of 1878 was that authorising the
issue of silver certificates against the deposit of silver dollars. This
authority was limited at the time to certificates in denominations only
of ten dollars and upward: a restriction which ... proved to be of great
importance. At the time it does not seem to have been expected that the
silver certificates would enter directly into the circulating medium; we
may infer from the restriction to large denominations that no such
expectation was entertained. But in fact, it has been chiefly in the
form of certificates that the silver has entered into circulation. These
certificates, it is true, are not, like the dollars themselves, a legal
tender; but they are receivable for all public dues, customs included,
and they pass from hand to hand at least as readily as the bulky pieces
which they represent.

CAUSES OF THE ACT

[21]The passage of that act was due to causes easily described. It was
part of the opposition to the contraction of the currency and the
resumption of specie payments which forms the most important episode in
our financial history between 1867 and 1879. The resumption of specie
payments had been provided for by the act of 1875, and was to take place
on January 1, 1879. In the meanwhile, the long-continued depression
which followed the crisis of 1873 intensified the demand for more money
and higher prices. That demand led to the inflation bill passed by both
Houses of Congress in 1878, and killed by the veto of President Grant.
The same feeling led to the silver act. The great fall in the price of
silver, beginning in 1873, and showing itself markedly in 1876, made
silver, at the old ratio, a cheaper currency than gold, and so caused
the opponents of the return to specie payments to prefer silver to gold,
as they preferred paper to either. No doubt some additional force was
given to the movement in favor of the use of silver from the desire of
the silver-mining States and their representatives, that the price of
the metal should be kept up through a larger use of it for coinage....

WHEREIN PECULIAR

[22]Although the specific measure passed in 1878 thus rested on a long
train of historical causes, it contained details that were essentially
new, not only in our own experience, but in that of the world at
large.... It ... provided for a regular mechanical addition of large
amount to the general circulating medium. No precise experiment of this
kind had ever been tried. It is true that Germany and the countries of
the Latin Union possess, in their circulating medium, large quantities
of overvalued thalers and five-franc pieces which are exactly like our
silver dollars. They also are legal tender without limit; their total
quantity is limited; and it is only by this limitation of the quantity
that their value is kept above that of the bullion contained in them.
But the thalers and francs in these countries are not new additions to
the currency. They are remnants from an earlier period, when Germany had
a silver standard, and the Latin Union a complete bimetallic standard.
No addition whatever to the thalers is made in Germany; and if some
coinage of five-franc pieces takes place in France and in other
countries of the Latin Union, the additions are meant merely to fill the
place of abraded coins, to provide for the ordinary losses from daily
use, and to make any additions to the supply which may be needed for
convenience in making small change. No other country has ever entered on
an addition of overvalued coin to its circulating medium having the
object and extent of that made by our silver act of 1878. This
characteristic of the measure, it need hardly be said, was the result
not of any deliberate intention to try a new experiment, but of the
spirit of compromise which explains so many anomalies in the legislation
of democratic communities. The silver act, as passed by the House of
Representatives, provided for complete bimetallism--for the free and
unlimited coinage of the silver dollar at the old ratio of 16 to 1. In
the Senate, it was amended by the substitution of the provisions for a
limited coinage, which were finally enacted. The compromise was meant to
satisfy both those who objected to the cheaper standard and those who
wanted more money; and it afforded a welcome escape to the legislators
who were trying to satisfy all parties. At the time, no one probably
expected that the measure would remain in force for any great length of
time. The conservative element hoped that it would be repealed after a
short trial; the inflationists (for by that name they might, then at
least, fairly be called) believed that it would soon be superseded by
the free and unlimited coinage of silver. As it happened, the act
remained in force, unamended, and indeed without very serious attempt at
amendment, for over twelve years; and the measure which succeeded it in
1890, though different in many details, followed the same method of
forcing a large regular injection into the circulating medium of money
based on silver purchases by the Government.

LIMITED CIRCULATION OF THE SILVER DOLLARS

[23]The Government has made every effort to get the dollar coins out of
its hands.... But the great bulk of the coins thus got out of the
treasury return to it almost at once. The degree of favor which they
meet with of course ... varies in different parts of the country,
apparently reflecting in a curious way the popular feeling as to the
desirability of having silver currency at all. They circulate very
little east of the Alleghanies, but are used more freely and permanently
in the Mississippi Valley. Among the negroes of the South the big pieces
are said to be favorites, and to find a permanent lodgment. Their
greatest circulation ... was reached in 1886; after that time the change
in the denominations of silver certificates caused a decline in the
amount used.

PROVISIONS OF THE ACT OF 1890

[24]The act of July 14, 1890, is[25] more remarkable than that of 1878.
It is unique in monetary history. It provides that the Secretary of the
Treasury shall purchase each month at the market price four and a half
million ounces of silver bullion. In payment he shall issue Treasury
notes of the United States, in denominations of between one dollar and
one thousand dollars. These Treasury notes, unlike the old silver
certificates, are a direct legal tender for all debts, public or
private, unless a different medium is expressly stipulated in the
contract. They differ from the silver certificates in another respect;
they are redeemable either in gold or silver coin, at the discretion of
the Secretary of the Treasury. The indirect process of redemption
which,... was applied to the silver certificates, is replaced for the
new notes by direct redemption. The avowed object is to keep the silver
money equal to gold, for it is declared to be "the established policy of
the United States to maintain the two metals at a parity with each other
on the present legal ratio, or such ratio as may be provided by law."
The act of 1878 is repealed; but the coinage of two million ounces of
silver into dollars is to be continued for a year (until July 1, 1891).
Thereafter it is directed that only so many silver dollars shall be
coined as may be needed for redeeming any Treasury notes presented for
redemption. Practically this means that the coinage shall cease;
redemption in silver dollars will not be called for under present
conditions. The coinage of silver dollars accordingly was suspended by
the Treasury on July 1, 1891; a change which was the occasion of some
vociferous abuse and equally vociferous praise, but which in reality was
of no consequence whatever.

AMOUNT OF MONTHLY ISSUES

[26]The monthly issues of the new Treasury notes vary, like those of the
old silver certificates, with the price of silver. But the new issues
vary directly with the price of silver, while as we have seen, the old
issues varied inversely with the price. The volume of Treasury notes
issued is equal to the market price of four and one-half million ounces
of silver. For a month or two after the passage of the act, the price of
silver advanced rapidly, and at its highest, on August 19, 1890,
touched $1.20. After September a steady decline set in....

THE POLICY OF THE BANKS

[27]Shortly after the passage of the act [of 1890], some sort of
understanding seems to have been reached between the Treasury Department
and the banks of New York. The banks came to an agreement that the new
notes were to be treated as "current funds," receivable in all payments,
clearing-house settlements included....

The fact that the new notes were received by the banks from the
Sub-Treasury in settlement of clearings, was of sensible advantage to
the Government. The success of the Government in maintaining its nominal
willingness to pay gold to all comers was due to the forbearance of the
banks. Gold was called for by them only when needed for export.

THE ARGUMENT FOR SILVER

THE BIMETALLIST ARGUMENTS

[28]... Is it desirable that we should have more money? Does the
maintenance of the gold standard involve injustice or hardship to
debtors, or to any class in the community? Does it have any ill effects
in hampering industry or checking the advance of production? Is the free
coinage of silver, or any measure leading ultimately to a silver basis,
fairly open to the objections commonly urged against it on the grounds
of dishonesty and injustice?...

In considering these questions, we must look to the ultimate and
permanent results of the silver standard. The details ... as to the mode
in which the silver issues circulate and the degree of promptness with
which they will affect prices, are here of no great importance. Under a
silver standard the rise in prices will take place in the end; and we
are concerned with the social consequences of such an eventual
result....

I propose here to take up chiefly one set of serious arguments--those
which rest on the changes in general prices which have taken place
throughout the civilised world in the last twenty years. The conclusions
in favor of a wider use of silver, drawn from such changes, have been
maintained by distinguished economists. It is true that the particular
plans for the use of silver which are now in vogue in the United States
have generally been opposed by these economists. They have urged
international agreements for the wider use of silver, and have
deprecated independent action by any one nation. But the more
thoroughgoing advocates of free silver in the United States say,
certainly with much force, that an international agreement has proved to
be simply impracticable, and that if the wider use of silver is to be
deferred until there is concerted action by the great nations, it will
never come. If anything in this direction is to be done, some one
country must be courageous enough to take the lead, trusting that others
will follow in due time. And certainly it is true that the scheme for
international bimetallism has practically no prospect of adoption;
while, on the other hand, the serious arguments urged by its advocates
tell, in some degree, in favor of any scheme for enlarging the use of
silver as money. These arguments, moreover, are of weight, and deserve a
more painstaking consideration than is often admitted by those who
oppose the silver legislation of the United States.

The serious and important arguments, then, among those who, both in this
country and in Europe, advocate a greater use of silver as money, are
derived from the general fall in prices which has been so conspicuous
among the economic phenomena of the last twenty years. To that fall they
ascribe two evils: first, an unjust increase in the burdens of debtors;
and, second, a check to enterprise and to the efficient working of the
productive machinery of the community. The increase in the burdens of
debtors is one which all economists have pointed to as the result of a
general fall in prices, or rise in the value of the circulating medium.
The debtor who borrows a hundred dollars now, and repays them five years
hence, when all prices have fallen, gives back more than he received. On
debts running for short periods of time, changes in general prices are
not likely to be great enough to cause serious hardship; but on debts
running over long periods the loss to debtors and the gain to creditors
will be great and continuing. But such a steady and continuous fall, it
is urged, has taken place since 1873; and the fall is likely to continue
further, and to renew its hardships on each new act of borrowing,
because its cause is a permanent one. That cause is found in the growing
scarcity of gold, which has been selected as the sole standard of value
among civilised countries. The production of gold, after having
increased with great rapidity in the twenty years following the
Californian and Australian discoveries in 1850, has gone on but slowly
since 1870. Meanwhile, the population of the civilized countries, their
wealth, their production of commodities to be exchanged, have increased
with extraordinary rapidity; while the adoption of the gold standard by
Germany in 1873, and the resumption of specie payments by the United
States in 1879 and by Italy in 1883, have added to the demands for which
the scanty annual supply of gold must suffice. Hence the general fall in
prices; in other words, the appreciation of gold.

The second effect of the appreciation of gold, in checking industrial
progress and promoting industrial depression, has been less insisted on
in the United States than in European countries. The classic economists
had generally reasoned that a general rise or fall in prices was
indifferent, except in regard to the relations of debtor and creditor.
If money became scarce, if its value rose and all prices fell, every
producer, to be sure, would receive a smaller money income than before,
and would have a smaller money capital. But he would be able to buy as
many commodities and as much labor as before, and would be in reality
just as rich and prosperous. In the middle of the eighteenth century,
when economic thought was just beginning to assume its modern form,
David Hume had argued that though a fall in prices is at bottom
indifferent to everybody (except as debtor or creditor), it would yet,
in its effects on men's spirits and expectations, which are all
connected with money and with terms of money, exert a depressing
influence on industry, and would so be harmful; while rising prices,
though also really indifferent to all, would stimulate hope and
confidence, and so arouse to more active exertion and more plentiful
production. The younger Mill, in his _Political Economy_, thought it
worth while to enter on a careful refutation of Hume's reasoning. But
the bimetallists of our time are disposed to agree with the shrewd
Scotchman. They say that the active manager of industry, the business
man or _entrepreneur_, in the first place is always more or less in
debt; in the second place, is always buying labor, or materials, or
goods, with the intention of selling a product at a later date at an
advance in price. He habitually measures his gains in terms of money,
and not in terms of the commodities he can buy with the money. In times
when prices are falling, he finds it harder to meet his debts, and to
dispose of his goods in hand at a money advance over what they cost him.
But the business man, or entrepreneur, in our day is the director and
initiator of industry. He employs labor, borrows capital, sets the
wheels of industry in motion; it is his expectations and fears and hopes
which determine primarily whether the investment of capital shall take
place in large or small amount, and whether the machinery of production
shall move smoothly and effectively, or slowly, hesitatingly,
inefficiently. The argument certainly does not lack plausibility; nor
can it be said to have often been squarely met. No doubt it takes the
form, in the United States, more frequently of confused encomiums on the
inspiriting effects of plentiful money, than of direct reasoning as to
the ill effects of too little money, such as I have endeavored to state
with fairness in the preceding sentences. Yet it does not lack weighty
backing. So eminent an economist as President Francis A. Walker has ...
insisted on the evils of a deficient supply of money as strangling the
arteries of industrial life.

On the whole, however, the other argument, bearing on the increase in
the burdens of debtors under falling prices, has been more often heard
in the United States, and certainly has been of more effect. Prosperity,
activity, general industrial advance, have been in this country so great
and so obvious that the argument as to any check to industry could take
serious hold only in occasional periods of depression or slackened
advance. The burden on American debtors from falling prices has
therefore been much more steadily complained of, chiefly in regard to
the debts of the farmers and other borrowers on a comparatively small
scale. No doubt there are other debtors whose burdens are affected at
least as much, notably the railways, among whom the practice of
borrowing heavily on long time has sometimes had its serious effects.
But it is the farmer whose case has received most attention, and in some
ways doubtless has deserved it most.

The discussion of the relations of debtors and creditors under the gold
standard has led to some further conclusions as to the "honesty" of the
gold and silver standards. Those who oppose a silver basis speak of the
silver dollar as a "dishonest" coin. But those who attack the gold
standard retort that the really dishonest dollar is that of gold. It is
pointed out by them that the fall in the price of silver which has taken
place since 1873 has not been greater than that in the prices of
commodities generally. As compared with commodities, therefore, silver
has been more steady in value than gold. The fall in the gold price of
silver, which is adduced by the mono-metallists to show that silver is
not a good standard of value, is said to be the very thing which proves
it to be a good standard of value; for a given amount of silver will buy
the same amount of commodities, roughly, as it would twenty years ago,
while a given amount of gold will buy more. If debts had been expressed
in terms of silver, the debtor would have had to repay the creditor the
same amount of commodities that he received--not more commodities, as he
has had to do, with debts measured and repaid in terms of gold. So far
as the attainment of the closest possible approach to ideal justice is
concerned, a silver standard would have served the purpose better than a
gold one.

THE EFFECT OF IMPROVEMENTS IN PRODUCTION

The bimetallist agitation for a return to the wider use of silver
concurrently with gold first became prominent in the years of depression
which followed the crisis of 1873. For some time those who opposed it
took the ground that the alleged evils did not exist--that in fact there
had been no permanent fall in general prices. The decline in the years
after 1873 was supposed to be simply the usual reaction from the rise
in prices which marks a period of speculative activity. It was expected
that the upward movement of the next period of activity would bring the
average range of prices as high as it had been before. The general
revival which set in after 1879 in all civilized countries did indeed
check the downward tendency, and in some countries brought about an
appreciable rise. But this counter-movement by no means offset the
marked fall which had preceded it; and in any case it soon came to an
end, and was followed by a new fall, which has continued with no
considerable interruption to the present time (1891). It is true that
some part of the fall is no more than a recoil from the abnormally high
prices of the years 1871-73. It is true, also, that some commodities
have shown a tendency to rise, and that in one very important
respect--in money incomes and the money rate of wages--there has been a
striking exception to the general movement. Further, it must be borne in
mind that even the lowered level which has now been reached cannot be
described as abnormally low, being still as high as that which obtained
at the middle of the present century. But on the whole, the fact of a
general fall in the prices of commodities during the last fifteen or
twenty years cannot be denied. The fall has not been uninterrupted; it
has not been so rapid or general as to bear on the face of it proof of
harmful results; but it has been steady, and, in the opinion of the
present writer at least, is likely to continue slowly and steadily for
some time to come.

Recently, therefore, those who combat the bimetallist reasoning have
taken a different position. They have reasoned that while prices may in
fact have gone down, the fall is not due, as the bimetallists allege, to
an appreciation of gold. It is to be accounted for, they say, by other
causes, notably by the extraordinary improvements in the production of
commodities. New inventions and the perfecting of old ones have
cheapened almost all manufactured articles. Raw materials and food
products have been cheapened partly by the discovery of new sources of
supply, and partly by that improvement which has been transforming the
industrial situation more radically than any other--the wonderful
cheapening of transportation by railways and steamships, which has made
the resources of the plains of our West and of the sheep-runs of
Australia available for the supply of the markets of London and New
York.

So far as this train of reasoning undertakes to explain the mode in
which the fall in prices has been brought about, it seems to me
impregnable. But in so far as it endeavors to disprove the appreciation
of gold, or to show that the general fall is not due to this
appreciation, I have never been able to see its force. In truth, both
the bimetallists and their opponents seem to confuse the question when
they speak of the appreciation of gold as causing lower prices. The
appreciation of gold _is_ the general fall in prices. The two are not
related as cause and effect; they are simply two names for one and the
same thing--namely, a different rate of exchange between gold on the one
hand and commodities in general on the other, by which the same amount
of gold buys more commodities than before. When the general fall in
prices is admitted, the case of the bimetallists as to the appreciation
of gold is established once for all. Improvements in the production of
commodities may explain how it happens that they are more abundant, and
exchange on less favorable terms with gold, of which the quantity has
not been increased by new rich mines or great improvements in
production; but the fact of the depreciation of commodities, or of the
appreciation of gold, is not thereby explained away.

Nevertheless, the improvements in production do seem to me to have an
important bearing on the question in hand: a bearing not on the simple
fact of the appreciation of gold, but on the social consequences which
are said to flow from it, and therefore on the questions of policy which
are here under consideration. A moment's thought will show, for example,
that a general increase in the efficiency of labor affects very
materially the mode in which a fall in prices acts on the relations of
debtor and creditor. If A borrows from B a hundred dollars, repayable in
five years, and if at the end of the five years prices in general have
fallen to one-half of the previous rates, B, in paying back to A the one
hundred dollars, clearly returns twice as many commodities as he got.
But if, at the same time, the efficiency of labor has been doubled by
improvements in production, B can produce with the same labor twice as
many commodities as before; and he returns to A the product of the same
quantity of labor as he received. The classic economists and the
socialists (at least some schools of socialists) have maintained alike
that the ideally perfect standard of justice in the exchange of
commodities and services is equality of sacrifice or labor; that if
things so exchanged for each other that equal sacrifice got the same
reward, complete justice would be attained. Applying this test to the
relations of debtor and creditor in the case supposed, we find it not
one of hardship to the debtor, but apparently one of justice to both
parties. It is true the creditor gets more commodities than he gave; but
he gets the product of the same amount of labor as he devoted to the
commodities originally lent; and why should he not share with the rest
of the community the benefits of a general increase in the
productiveness of labor?

This line of reasoning will become simpler and more concrete if we
approach it from another point of view. Reference has already been made
to the most striking and important exception to the general tendency of
prices to fall, namely, that money wages and incomes in all civilized
countries have shown a tendency not to fall, but to rise. Whether the
incomes of the rich have increased faster than those of the poor, or
whether the movement has shown itself with rough uniformity for all
classes, is immaterial for the present discussion. The admitted fact of
a general upward movement alike among rich, middle class, and poor is
the significant thing. In other words, there has been an inverse
movement of money wages and of the prices of commodities, the one going
up while the other went down. Now, such an inverse movement is what must
take place in case of any real improvement in material welfare. The only
concrete way in which civilized people can become better off, is by
being able to buy more--by their money incomes going further in the
purchase of commodities. The improvement may take the form either of
higher money incomes, with stationary prices; or that of stationary
incomes, with lower prices; or the intermediate form which in fact seems
to have occurred, of money incomes rising somewhat and prices at the
same time falling somewhat. If we assume a monetary supply that is
limited, or does not increase as fast as improved means of production
cause the quantities of commodities to increase, one or the other of the
two forms last mentioned must be found.

In such a state of things there can hardly be said to be any real
hardship for the debtor. It is true that prices have fallen, and that
the money he repays the creditor will buy more goods than it did when
the loan was contracted; but his own money income has risen, or at least
has not fallen, and the repayment of the loan can cause him no special
hardship--none greater than he must have expected. The case clearly
differs fundamentally from that of a simple rise in the value of money,
or general fall in both prices and wages.... The fall in prices in the
United States since 1879, and that in European countries in the period
since 1873, are the result, on the whole and in the long run, of ... the
general improvements in production; they have not been accompanied by a
fall in money incomes, and they cannot be said to have caused an
increase in the burden of debtors.

The reasoning of the preceding paragraphs bears also on the second part
of the bimetallist indictment--that, namely, as to the depressing
effects of falling prices on industrial enterprise. Whether a simple
rise in the value of money, unaccompanied by any other circumstance,
would have the depressing effects which the bimetallists predict and the
classic economists deny, is a question radically different from that
which in fact presents itself. It may be that in this simple case the
bimetallists might prove to be, in some degree at least, in the right,
and that the classic reasoning, here as on many other subjects, while
sound in the long run, would need some qualifications and correction. In
the long run, no doubt, it is immaterial whether prices are high or low,
whether money returns fall or rise; and yet it might turn out that the
habitual association of gain or loss with "making money" would cause a
period of simple falling prices to be one of hesitating investment of
capital and unenterprising conduct of business. But what the world in
fact has seen has been the complex case of a fall in prices accompanied
by great improvements in production. The business man and capitalist has
had, to be sure, to deal with falling prices; but the same amount of
capital and labor has turned out more commodities than before; and his
total money returns, so far from declining, have generally increased.
The money incomes of the managers of industry have shown the same upward
movement as the money incomes of the other classes in society. So long
as this is the case, it is idle to talk of a depressing effect on
enterprise from the fall in prices, or of a strangling of the industrial
organism from insufficiency of the circulating medium. In fact, the
immediate cause of the fall in prices has been the pushing on the market
for sale of larger and larger quantities of commodities, produced with
profit at lower and lower cost: a state of things fortunate for the
community, and surely not depressing for the business man....

This effect on the entrepreneur of improvements and of falling prices
combined, doubtless accounts for the failure of the bimetallist
agitation to secure any appreciable hold in the business world. The
bimetallists, both in England and on the Continent, have labored
zealously to engage support among the business men, but never with a
degree of success at all proportionate to the energy displayed. The
simple reason is that the business world has not been in any state of
chronic depression. In the ups and downs of industrial activity there
have been periods which seemed to confirm the pessimistic accounts of
the bimetallist and of other persons malcontent with the present order
of things; but in due time the tide has always turned....

On the whole, then, the fall in prices, when considered in connection
with the other great changes which have accompanied it, does not afford
so much countenance to the bimetallist proposal as at first sight it
seems to. The rise in money incomes and the improvements in production
disprove any intolerable burden on debtors, and make it highly
improbable that the change has had any general depressing effect on
industry.

THE CASE OF THE FARMER

Nevertheless, there is something more to be said, in explanation and
justification of the discontent with falling prices, and of the silver
agitation which rests on that discontent. While the effects of the fall
in prices on debtors as a class and on producers as a whole have not
given real grounds for complaint, certain particular debtors and
producers have undoubtedly been injured. The case of these latter have
given plausibility to the general arguments of the bimetallists, and,
what is more important at the present juncture, has given strength to
the movement in the United States for more money and more silver.

The situation will be best understood if we contrast for a moment the
different modes in which the improvements in production have been
brought about in manufacturing industries on the one hand, in
agriculture on the other hand. In manufactures the improvements have
been better machinery, new processes, labor-saving inventions, the
conduct of business on a larger scale, and so the greater and more
effective division of labor. In agriculture the main cause of cheaper
production has been different: it has been the opening up of new lands
and new sources of supply. No doubt there are important exceptions to
these general statements. In agriculture there have been advances in the
arts--new plants, better fertilizers, improved implements, more
effective ways of cultivating the soil. In manufactures, on the other
hand, there have been important changes due to the discovery of new and
rich mines of materials, such as coal, iron, copper. But on the whole,
the difference holds good. In agriculture undoubtedly the opening of new
lands through the improvements in transportation has been the most
important single cause at work. The cheapening of agricultural products
has been due not so much to the more effective use of the soil already
under cultivation, as to the development of soil not formerly available
for the supply of the market.

The changes in production and prices have consequently affected the
producers in these two branches of production in very different ways. In
manufactures all alike have felt them, and have been able to accommodate
themselves to the effects. No doubt the shrewder producers adopt
improvements and new inventions first, and, so long as they keep in the
lead, have the advantage of their competitors. They gain by doing a
large business at lower prices, while for the time being their slower
competitors lose. But new processes and new inventions spread over the
whole field in no long time. The opening of a new source of supply, on
the other hand, cheapens production through a process which the holders
of the old source of supply cannot avail themselves of. If wheat is
raised in large quantities in Dakota, the price goes down as effectively
as if the wheat fields of England and New York had suddenly become more
fertile; but as those wheat fields produce no more than before, the
farmer or land owner on the old soil has nothing to offset the lower
price. This is the explanation of the agricultural distress of which so
much has been heard in Europe in recent years, and which has been the
main occasion of the revival of protectionist feeling in France,
Germany, and other countries of the Continent. The farmer on the old
lands does not find in improvements in production any compensation for
lower prices. If he owns the land, he must pocket the loss, and perhaps
in the end abandon his land and turn to something else; such has been a
common case in New England. If he is a tenant on the land, he will
probably, after a period of struggle and hardship, get lower rents,
leaving the landlord as the permanent sufferer; such has been the
outcome in old England. If he was in debt before the change took place,
he will find his debts growing more burdensome as his money income goes
down; such has been the result with many a Western farmer.

It is in causes of this sort that we find the explanation, in part at
least, of the restlessness among the Western farmers of which the silver
agitation is one sign. The fall in the prices of wheat, corn, and other
staples has been due to enormously increased production in regions which
were formerly out of reach of the market: in India, Australia, Russia,
as well as in California, Dakota, Washington, Oregon, and the Far West
generally....

It is probable that some of the complaints in regard to the burden of
debt on the farmers are simply a legacy from the old days of inflated
paper money. Not a few of the debts of the present [1891] go back to the
years before 1870, when we had prices high in terms of over-issued paper
money. These debts have been renewed and continued, in whole or in
part; and the fall in prices has made them heavier and heavier to bear.
The evil here again is real, and a remedy is now hard to find. The only
conclusion which can be laid down with perfect conviction is that we
should make sure of preventing the recurrence of a new era of excessive
paper money.

... Another important circumstance is the general transition in
agricultural methods inevitable in those western states which have been
settled for a generation or more. When new land is first taken into
cultivation the most effective use of it is found in the continuous
production of some staple crop like wheat and corn, which can be grown,
so long as the cream of the soil is not exhausted, year after year with
large returns. After a while, however, the land begins to show signs of
exhaustion. The staple crops do not yield as largely as before, and less
crude methods of using the soil must be resorted to. Manures have to be
applied, and the rotation and selection of crops practised. Meat and
dairy products, vegetables, fruits, and the miscellaneous agricultural
articles, must take their place in rural economy. This change has been
carried through very largely in states like New York, Pennsylvania, and
Ohio. In the heart of the Mississippi Valley it is now under way; but
the transition is trying, and to some of the farmers it is impossible. A
good share of the American agricultural population has been so steadily
bred to the easy and careless use of virgin soil that it cannot
accommodate itself to more intensive methods. It is constantly moving
westward; settling for a generation in one spot, and then, as the land
shows signs of exhaustion, moving farther west. The more intelligent and
versatile stay behind, adapt themselves to new conditions, and in time
prosper under them. The least active also stay behind, and flounder
hopelessly in the old ways. But a large number are always moving west.
In every state between the Alleghanies and the Missouri river there are
large tracts formerly cultivated by native settlers, who have sold their
lands, as they showed signs of giving out, to German or Swedish
immigrants. These latter have not infrequently paid good prices for the
lands: but they have been bred to intensive farming, to careful and
varied use of the soil, and they have prospered where their native
predecessors have been unwilling or unable to adapt themselves to the
new conditions. The period of transition is a hard one for all of the
native farmers, whether they stay behind or move on, and the lesson of
using the soil with more skill and care is learned only under the
pressure of necessity. In such periods all sorts of remedies for hard
times make their appearance and have their run.

THE REPEAL OF THE SHERMAN SILVER PURCHASE ACT AND THE FINANCIAL AND
ECONOMIC CONSEQUENCES OF SILVER LEGISLATION

[29]For fourteen years, 1878-1892, only an insignificant amount of gold
was paid out of the Treasury in the redemption of legal-tender notes;
the total amount of gold in the Treasury increased almost steadily and
continuously from $140,000,000 on January 1, 1879, to $300,000,000 in
1891. In 1890 the new issue of Treasury notes, together with a change in
commercial conditions, placed heavy burdens upon the reserve, the rapid
diminution of which is shown in the following figures:

_Date_ _Net gold reserve_

June 30, 1890 $190,232,405
June 30, 1891 117,667,723
June 30, 1892 114,342,367
June 30, 1893 95,485,413
June 30, 1894 64,873,025

The reasons for the fall in the gold reserve are too various and
complicated to be treated here: the failure of the great English
banking-house of Baring Brothers in 1890 brought about a considerable
withdrawal of English capital invested in the United States; and an
unhealthy and inflated industrial development in this country was
stimulated by the new tariff. To outward appearances the country was
very prosperous; expenditures were large, imports increased, and a
failure of the crops in Europe in 1891 enlarged our grain exports. For a
brief season only, were the natural effects of the Sherman law delayed:
Europe soon recovered, American exports fell, and in the six months
ending June 30, 1893, the balance of trade against the United States
was $68,800,000. The tariff of 1890 was followed by diminished customs
receipts. The revenue from customs was as follows:

1890 $229,668,000
1891 219,522,000
1892 177,452,000
1893 203,355,000
1894 131,818,000

... Fortunately the internal revenue receipts maintained their customary
level with something to spare; but increased appropriations, due largely
to the passage of a dependent pension bill in 1890, cut deep into the
funds of the Treasury. In 1890 the surplus was $105,344,000; in 1891,
$37,239,000; in 1892, $9,914,000; in 1893, $2,341,000; but in 1894
appeared a deficit amounting to $69,803,000. The Treasury had been
weakened by the reluctance of Secretary Windom to deposit government
funds in national bank depositories, and by his preference to rely
entirely upon the purchase of bonds for getting money back into
circulation. In the earlier years of Harrison's administration, bonds
were purchased freely--too generously in view of the impending strain
upon the resources of the Treasury.

Another element of concern was due to the change in the kind of money
received by the Government in the payment of revenue. Before the passage
of the Sherman Act nine-tenths or more of the customs receipts at the
New York custom-house were paid in gold and gold certificates; in the
summer of 1891 the proportion of gold and gold certificates fell as low
as 12 per cent., and in September, 1892, to less than 4 per cent. The
use of United States notes and Treasury notes of 1890 correspondingly
increased....

The reason for this substitution of notes for gold was partly due to a
reversal in Treasury practice. For many years it had been the custom of
the Sub-Treasury in New York to settle its clearing-house balances
almost exclusively in gold or gold certificates. For example, in the
fiscal year 1889-1890 the Sub-Treasury paid gold balances to the banks
of nearly $230,000,000, and in the next year $212,000,000. The banks
were thus daily supplied with gold which they in turn could furnish to
their customers either for customs purposes or export deliveries. In
August, 1890, the Treasury began the policy of using ... the new
Treasury notes in the settlement of New York balances, and in the year
ending June, 1891, Secretary Foster, apparently convinced of the need of
a larger gold reserve to support the credit of the Treasury notes,
increased the use of the older United States notes and held on to the
gold reserve. The unexpected result was that the banks, deprived of
their usual supply of gold for trade purposes, sought for it at the
Treasury by the presentation of government notes....

In March, 1893, Cleveland for a second time entered upon the presidency.
He demanded as the first condition of relief the suspension of silver
purchases. The silver advocates, however, were still powerful in both
parties, and President Cleveland was at a disadvantage in not having the
undivided support of his own party. Even the position of Secretary
Carlisle was ... doubted: it was publicly declared that he stood ready,
if expediency demanded it, to redeem the Treasury notes of 1890 in
silver instead of gold, and, while standing upon the letter of the law
which demanded their redemption in _coin_, practically to cut asunder
the parity of gold and silver which had thus far been maintained.
Although the President attempted by a specific declaration to make clear
the harmonious purpose of the administration that redemption would
continue in gold, public apprehension would not be allayed. Whatever
might be the wishes of the administration, it was feared that it would
not have power to carry them out; particularly when it was announced in
April, 1893, that the gold reserve had been drawn down to $96,000,000 by
redeeming the Treasury notes of 1890.

At this juncture of financial and commercial difficulties, in June,
1893, the British Government closed the mints in India to the free
coinage of silver. The price of silver bullion fell promptly and
rapidly, and, while such a decline might on another occasion have
produced no immediately serious consequences to the Treasury, it came at
a moment when public opinion, at least in the Eastern States, was
aroused to a belief that the entire financial problem was associated
with the coinage of silver; and it thus furnished one of the
contributory forces which drove the commercial community into a state
of panic.

It was not until June 30, 1893, when the panic was well under way, that
a special session of Congress was called for August 7; only by the most
strenuous efforts could an adequate support, composed of elements in
both political parties, be rallied to uphold the President's insistence
that purchases of silver by the Government should cease. The House
quickly acquiesced, and on August 21, by a vote of 239 to 108, passed a
bill for the repeal of the purchasing clause; but the Senate was
stubborn, and not until October 30 could a favorable vote, 43 to 32, be
secured. So far as the Treasury was concerned, the mischief had been
done; although the Government was relieved from further purchase of
silver which increased the volume of the obligations to be supported by
gold, the old burdens still were sufficiently heavy, in connection with
the low state of commerce and industry, to exhaust its immediate
revenues. Thus on December 1, 1893, the actual net balance in the
Treasury above the gold reserve, pledged funds, and agency accounts was
only $11,038,448. Trade and industry had been disorganized; the panic of
1893 extended into every department of industrial life. In December,
1893, the Comptroller of the Currency announced the failure during the
year of 158 national banks, 172 state banks, 177 private banks, 47
savings banks, 13 loan and trust companies, and 6 mortgage companies.
Some of these institutions afterwards resumed business, but the
permanent damage was great. The fright of depositors was general and the
shrinkage in deposits enormous; bank clearings were the lowest since
1885; clearing-house loan certificates were once more resorted to, this
time on a much larger scale than ever before, and extended to cities
throughout the country.

The production of coal, both anthracite and bituminous, fell off; the
output of pig-iron, which had been about 9,157,000 tons in 1892, fell to
6,657,000 tons in 1894; new railway construction almost ceased; in 1894
there were 156 railways, operating a mileage of nearly 39,000 miles, in
the hands of receivers; among these were three great railway
systems,--the Erie, Northern Pacific, and Union Pacific. The total
capitalization in the hands of receivers was about $2,500,000,000, or
one-fourth of the railway capital of the country. The earnings of
railroads and the dividends paid to stockholders were seriously
affected; securities fell to one-half and even one-quarter their former
value; commercial failures increased from 10,344 in 1892, with
liabilities of $114,000,000, to 15,242 in 1893, with liabilities of
$346,000,000. The problem of the unemployed became general; special
committees were organized in nearly all of the large cities to provide
food, and in many places relief work by public bodies was instituted. In
the spring of 1894 general want and distress led to labor strikes and
riots, as in Chicago, and even to more abnormal outbreaks, as seen by
the march of Coxey's army of unemployed from Ohio to Washington. The
distress was increased by the failure of the corn crop in 1894; the
demand for wheat in Europe fell off and wheat was sold on the Western
farm for less than fifty cents a bushel.

SALE OF BONDS FOR GOLD

Under these adverse conditions it was inevitable that the revenues of
the Government should continue to decline. In the six months, January to
June, 1893, the excess of expenditures over receipts was $4,198,000, and
during the fiscal year ending June 30, 1894, this excess increased to
$69,803,000. It was even necessary to encroach upon the gold reserve for
current expenses, and for months this fund was far less than caution and
prudence demanded. When the integrity of the gold reserve was first
assailed, both Secretary Foster, in the closing months of Harrison's
administration, and Secretary Carlisle, at the beginning of Cleveland's
term, endeavored, with some success, to tide over emergencies by
appealing to the banks to exchange gold for legal tenders. The banks
recognized that the instability of Government credit seriously affected
the value of all securities in which they were interested; and in
February, 1893, they handed over to the Treasury about $6,000,000 in
gold, and in March and April about $25,000,000 more. The expedient was
not enough to stop the continued drain upon the Treasury. At the very
moment that the Government was relieved of notes through the exchange
of gold by the banks, other notes were presented to the Treasury for
redemption, largely to draw gold for exportation in the settlement of
trade balances....

The only way to protect the fund of gold reserve under the circumstances
was borrowing--that is, the sale of bonds for gold--yet some people who
were opposed to the overthrow of the gold standard consistently urged
that borrowing be postponed until the last moment, so as to add as
little as possible to the resources available for purchases of silver.
Some of the gold party would even have permitted the drain to go on to
the end, notwithstanding the inevitable evils, in the belief that the
country could be convinced of its errors in no other way.

Eventually, to prevent a suspension of specie payments in gold, the
Treasury Department made successive issues of bonds for the purchase of
gold. These issues are very interesting to the student of finance. No
administration wishes to add to public indebtedness in times of peace;
and Secretary Carlisle had scruples against selling bonds, except with
the authority of the Congress then sitting; hence the issue of bonds was
put off to the last possible moment. The only existing authority for
selling bonds was the resumption act of 1875; this provided only for
ten-year 5 per cent., fifteen-year 4-1/2, and thirty-year 4 per cent.
bonds, all of which would command a premium so high as to diminish their
attractiveness as an investment, and, taken in connection with the
length of time which they ran, to hamper the Treasury in purchasing or
refunding the debt when the crisis was over. The administration asked
for the issue of low-rate bonds, but Congress, inspired in part by free
silver arguments, and in part by political intrigues to discredit the
administration, paid no attention to the recommendation of the
Secretary. Finally, in January, 1894, without special legislation, but
under the ancient authority of the resumption act, $50,000,000 of 5 per
cent. ten-year bonds were sold, yielding $58,660,917; and again in
November an equal amount of bonds with like conditions were marketed,
yielding $58,538,500. The sale of the first issue was on the whole
creditable, considering that at about the same time the President was
obliged to veto a bill providing for coining the silver seigniorage,
and that an effort had been made in the courts to enjoin the Secretary
of the Treasury from selling bonds under the law of 1875.

In each case the sale of bonds called for subscriptions in gold, but the
new supplies were quickly exhausted by fresh redemption of notes. The
fluctuations in the volume of gold in the Treasury as a consequence of
the bond sales is seen in the following figures:

_Date_ _Gold in Treasury_
January 31, 1894 $65,650,000
February 10, " 104,119,000 _Bond issue._
November 20, " 59,054,000
November 30, " 105,424,000 _Bond issue._
February 9, 1895 41,393,000

The endless chain appeared to be in full and unceasing operation; not
only was gold being withdrawn for export but also for individual
hoarding, in fear of an impending suspension of gold payments. The
Treasury finally recognized the futility of selling bonds for gold, most
of which was drawn out of the Treasury itself, by the presentation of
legal-tender notes for redemption. A new device was tried: in February,
1895, the Secretary of the Treasury entered into a contract with certain
bankers for the purchase of 3,500,000 ounces of standard gold at the
price of $17.80441 per ounce, to be paid for by the delivery of United
States bonds having thirty years to run and bearing 4 per cent.
interest; not less than one-half of this gold was to be procured abroad,
and the parties with whom the contract was made stipulated that they
would "as far as lies in their power exert all financial influence and
make all legitimate efforts to protect the Treasury of the United States
against the withdrawals of gold, pending the complete performance of
this contract." An ounce of standard gold was worth $18.60465, and the
difference between that sum and the contract price represented the
premium received by the Government on the bonds, making the price at
which the bonds were accepted $104.4946. A condition was affixed to the
contract, by which, in case Congressional authority could be secured, a
3 per cent. _gold_ bond might be substituted, and for this the syndicate
agreed to pay a higher price.

In view of the unfavorable terms of the bargain imposed by this
contract, the administration hoped that Congress would promptly act and
authorize the issue of the lower and more remunerative bond. Faithful in
its adherence to silver, Congress could not be swerved; it defeated the
bill authorizing the sale of a low-rate gold bond, and then engaged in
an angry debate denouncing the Executive for his subserviency to the
gold standard banking interests in entering into a contract not only
disgraceful but illegal. In reply it could be shown that the New York
Sub-Treasury was within forty-eight hours of gold exhaustion....

At first the syndicate was successful, because of some slight
improvement in trade, but later it practically failed to control the
price of exchange. It once more became cheaper for merchants to ship
gold than to purchase bills, and gold continued to be withdrawn from the
Treasury. On December 3, 1895, the gold reserve stood at $79,333,000,
and after the commercial apprehension caused by President Cleveland's
Venezuelan message a fortnight later, the reserve was still further
reduced. Once more the administration resorted to a bond sale, and again
the action was preceded by a special message from the President to
Congress asking for a grant of authority to issue gold bonds instead of
coin bonds, and also for the retirement of the legal-tender notes which
continued in an endless chain their journey to the Treasury, and drove
off gold to the commercial market. As Congress still refused to act, the
Treasury resorted to a fourth issue of $100,000,000 4 per cent. bonds.
The Treasury now carefully avoided any appearance of dealing through a
syndicate and publicly advertised for offers, with the encouraging
result of 4,640 bids, amounting to $684,262,850. Seven hundred and
eighty-one bids were accepted and the premium yielded about $11,000,000.
The relief obtained by the Treasury, however, was meagre, for it is
estimated that $40,000,000 of the bonds were purchased with gold
withdrawn from the Treasury by the redemption of notes. This was the
Government's penalty for its endeavor to separate itself from all
dealings with a banking syndicate.

In spite of this sale of bonds the reserve remained near the traditional
danger line. In July, 1896, it fell to $90,000,000 because of hoarding
due to popular apprehension as to the success of the silver movement in
the November presidential election. Fearful that a new bond issue might
strengthen the claims of the silver advocates, bankers and dealers in
foreign exchange voluntarily combined to support the Treasury by
exchanging gold for notes. The effort succeeded, and the reserve was
placed in safety. After the elections in November gold came out from its
hiding-places, and was turned into the Treasury in large amounts.
Business and revenue improved and the difficulties of the Treasury
Department were tided over.

Many Republicans held the earnest conviction that the issue of bonds
would not have been necessary if the revenue had been sufficient. Not
only had industry and commerce been unsettled by the tariff act of 1894,
but the operations of the endless chain must certainly continue, it was
held, until there was a generous income in excess of expenditures,
whereby a considerable part of the credit currency might be covered into
the Treasury and thus lessen the possible claims for redemption. The
administration emphatically replied that at no time when bonds were
issued was there intention of paying the expenses of the Government with
their proceeds, and that the Treasury Department had no authority
whatever to issue bonds for such purposes. President Cleveland was
insistent that on each occasion of a bond issue there were sufficient
funds in the Treasury to meet the ordinary expenditures of the
Government. The proceeds of the bonds sold for the maintenance of the
national credit were, however, turned into the general fund of the
Treasury, and consequently, though not originally designed for that
purpose, employed to meet indiscriminately all demands made upon the
Government, whether for redemption of notes or the payment of debts....
There was a series of deficits beginning with 1894, but the deficit by
no means equalled the amounts of bonds sold.

FOOTNOTES:

[16] Adapted from A. D. Noyes, _Forty Years of American Finance_, pp.
2-6 G. P. Putnam's Sons, New York and London. 1909.

[17] _Ibid._, pp. 35-44.

[18] F. W. Taussig, _The Silver Situation in the United States_, pp. 8,
9. G. P. Putnam's Sons. New York. 1893.

[19] I have stated the price here, for simplicity, in terms of so much
per ounce of standard silver, _i. e._, silver containing 10 per cent. of
alloy. The usual quotation in the United States is per ounce of fine
silver. [Thus, the New York price, March 10, 1916, was 56-3/4 cents per
ounce of fine silver.]

[20] _Ibid._, pp. 9, 10.

[21] _Ibid._, pp. 10, 11.

[22] _Ibid._, pp. 11-13.

[23] _Ibid._, pp. 19, 20.

[24] _Ibid._, pp. 50, 51.

[25] [Present tense because written while the act was still in force.]

[26] _Ibid._, pp. 51, 52.

[27] _Ibid._, pp. 52, 59.

[28] _Ibid._, pp. 84-106.

[29] Davis R. Dewey, _Financial History of the United States_, pp.
442-455. Longmans, Green and Company, New York, 1915.

CHAPTER VIII

INDEX NUMBERS

[30]Index numbers are used to indicate changes in the value of money.
The objects for which this measurement is undertaken are thus well
stated by Sir R. Giffen (Second Report of the committee appointed for
the purpose of investigating the best method of ascertaining and
measuring variations in the value of the monetary standard. Report of
the British Association, 1888): (1) The fixation of rents or other
deferred payments extending over long periods of time, for which it has
been desired to obtain a currency of a more stable sort than money is
supposed to be. (2) To enable comparisons to be made between the value
of money incomes in different places, which is often an object of great
practical interest; not only individuals contemplating residential
changes, but also governments and other large spending bodies, spending
money in widely distant places, having to consider this question. (3) To
enable historians and other students making comparisons between past and
present to give an approximate meaning to the money expressions which
they deal with, and say roughly what a given fine, or payment, or amount
of national revenue or expenditure in a past age would mean in modern
language. To which some would add: (4) To afford a measure of the extent
to which trade and industry have been injuriously affected by a
variation in prices; and of the correction which it would be desirable
to apply to the currency.

An index number is constructed by combining several items, each of which
is a ratio between the price of a certain article at a particular date
under consideration (_e. g._, last year or month) and the price of the
same article at a period taken as base or standard (_e. g._, 1867-77, in
the index number constructed by Mr. Sauerbeck, _Journal of the
Statistical Society_, 1886 and 1893). These ratios are generally
expressed as percentages. _E. g._, the percentage for _flour_ in 1885,
as given by Mr. Sauerbeck, is 63; meaning that the price of flour in
1885 is to the average price of the same article in 1867-77 as 63:100.
The term index number is sometimes applied (_e. g._, by Mr. Sauerbeck,
_op. cit._) to each of these items, as well as to their combination.

The percentages are usually compounded by taking an AVERAGE of them. But
a result of equal generality may be obtained by taking their sum. One of
the best-known index numbers, that of the _Economist_, is thus
constructed. Twenty-two articles having been selected, the price of each
article at the current date compared with its price at the standard
period (1845-50) is expressed as a percentage; and the sum of these
percentages is put as the index number. Thus the _Economist_ index
number for the year 1873 is 2947; such a sum is easily reduced to the
form of an average by simple division (_e. g._, 2947 ÷ 22 = 134).
Accordingly in what follows it will be sufficient to consider the latter
form only.

The construction of an index number presents the following problems:
(_a_) What are the commodities of which the prices are to be taken?
(_b_) How are the prices to be ascertained? (_c_) How are the ratios
between the prices of each article at the current and the standard dates
to be combined?

The answers to these questions vary according to the purpose in hand....
As appropriate to the first purpose, a standard of deferred payments,
two methods present themselves, viz., to arrange that the debtor should
pay, the creditor receive, either (1) the same quantity of goods and
services, the same amount of utility, so to speak; or (2) the product of
the same quantity of labour--or more exactly effort and sacrifice.

Of these methods the former has been more generally accepted. It is
adopted for instance by the British Association Committee already
referred to, as _par excellence_ the measure of the change in the value
of the monetary standard. The former method is indeed more intelligible.
However, in favour of the latter there are some weighty considerations
and authorities. It seems to be the nearest possible approach to
Ricardo's conception of a commodity invariable in value, "which at all
times requires the same sacrifice of toil and labour to produce it."
(_Principles_, iii. ch. xx., "On Value and Riches," cp. Mill, bk. iii.
ch. xv., "On a Measure of Value.") "A standard," says Mr. Leonard
Courtney, "should be something which as far as possible involves the
same labour and the same sacrifice in obtaining it" (_Nineteenth
Century_, March, 1893). Prof. Marshall, in his evidence before the royal
commission on gold and silver, says, speaking of appreciation of gold:
"When it is used as denoting a rise in the real value of gold, I then
regard it as measured by the diminution in the power which gold has of
purchasing labour of all kinds--that is, not only manual labour, but the
labour of business men and all others engaged in industry of any kind"
(Question 9625).

If the first method is adopted, the answers to the questions above set
are as follows: (_a_) The commodities of which the prices are to be
taken should be articles of consumption rather than materials and
implements. Payments for personal services should be included, but not
wages in general. (_b_) Retail prices should be used. (_c_) The proper
combination of the ratios is an average of the kind technically called
_weighted_.... The general principle according to which the weights are
to be assigned is that they should represent the importance of each
commodity to the consumer. But this idea may be embodied in different
plans.

1. One plan is to assign as the weight of each percentage, or ratio
between prices, the value of the corresponding commodity at the initial
or standard period. According to this plan the index number is the ratio
between these two values: the quantities initially consumed at the
prices of the current date, and the same quantities at the standard
prices. This method is exemplified by Sir R. Giffen's estimate of the
change in the value of money between 1873 (and 1883) and _earlier_
years, in his report on prices of exports and imports, 1885, table v.

2. Another plan is to assign, as the relative importance of each
percentage, its value at the particular epoch, the current year. This
plan is adopted by Mr. Palgrave in his memorandum on _Currency and
Standard of Value_ ... in the third report of the royal commission on
depression of trade and industry, table xxvii.

3. According to another plan, the index number is the ratio between the
following two values: the quantities consumed at the current date at the
current prices, and the same quantities at standard prices. This plan is
adopted by Mr. Sauerbeck (_Journ. Stat. Soc._, 1886, p. 595).

4. Or, instead of taking either the initial quantities or those of the
current date, a mean between the two may be taken. This is the plan
adopted by the British Association Committee. They estimate "the average
national expenditure on each class of article at present and for the
last few years"; and put for the relative importance of each commodity a
round number corresponding to that estimate. Thus the estimated
expenditure per annum on _wheat_ is £60,000,000, and on _meat_
£100,000,000: that is respectively 6.5 per cent., and 11 per cent. of
the sum of the corresponding estimates for all the commodities utilized
by the committee. As convenient approximations, the weights five and ten
are recommended by the committee.

If the index number based on labour ... rather than on consumption, is
adopted as the standard for deferred payments, it would be proper by
analogy to take as the measure of appreciation or depreciation the
change in the pecuniary remuneration of a certain set of services,
namely all, or the principal, which are rendered in the course of
production throughout the community during a year, either at the initial
or the current epoch; or some expression intermediate between the two
specified. But it may be doubted whether the statistics requisite for
this method are available.

With regard to the second and third of the purposes above enumerated,
the determination of the comparative value of money at distant places
and remote times--one or other of the two methods indicated would seem
to be theoretically proper.

For the fourth purpose, the regulation of currency, the proper
construction of the index number would seem to be as follows: (_a_) The
"articles" of which the prices are taken into account should be both
commodities and services; (_b_) both wholesale and retail prices should
be used; (_c_) the relative importance of each article should be
proportioned to the demand upon the currency which it makes. But here as
in other parts of the subject theory halts a little, and statistics lag
far behind theory.

Considering the theoretical doubts and statistical difficulties which
attend the determination of _weights_ proper to each purpose, there is
much to be said in favour of assigning equal relative importance to all
the items; especially if care is taken to include many articles such as
_corn_, _cotton_, etc., which for any of the purposes which may be
contemplated must be of first-rate importance. Such is the character of
some of the principal index numbers which have been constructed--those
of the _Economist_, of Jevons, of Soetbeer, and of Mr. Sauerbeck.

In the construction of such an index number the use of the arithmetic
mean is not imperative. Jevons employs the geometric mean. His reasons
for preferring it are not very clear (the "Variation of Prices,"
_Currency and Finance_, p. 120).... The geometric mean has also the
advantage of being less liable than the ordinary average to be unduly
affected by extremely high prices (_Report of the British Association_,
1887, p. 283). The great objection to the geometric mean is its
cumbrousness.

There is another kind of mean which has some of the advantages of the
geometric, and is free from its essential disadvantage; namely, the
median ... which is formed by arranging the items in the order of
magnitude, and taking as the mean that figure which has as many of the
items above as below it. For instance the median of the forty-five
percentages on which Mr. Sauerbeck's index number is based was, for
1892, 66; while the arithmetic mean was 68. It is difficult to see why
the latter result is preferable to the former; if what is required is an
_index_ of the change in general prices, not specially referred to any
particular purpose, such as of securing a constant benefit to a legatee.

The perplexity of a choice between such a variety of methods is much
reduced by the two following considerations. _First_, beggars cannot be
choosers. The paucity of statistical data (see the report drawn up by
Sir R. Giffen in the _Report of the British Association_ for 1888, p.
183) restricts the operation. Thus for the purpose of index numbers
based on consumption ... retail prices are theoretically appropriate;
but "practically it is found that only the prices of leading
commodities, capable of being dealt with in large wholesale markets, can
be made use of" (Giffen, _loc. cit._). _Second_, the difference between
the results of different methods is likely to be less than at first
sight appears. For instance, the probable difference between the index
number constructed by the British Association committee, and six others
which have been proposed by high authorities--supposing the different
methods to be applied to the same data, viz., the prices of twenty-one
articles specified by the Committee may thus be expressed. The
discrepancy which is as likely as not to occur between the committee's
and other results is from 2 to 2.5 per cent. The discrepancy which is
very unlikely to occur is from 8 to 11 per cent. (_Report of the British
Association_ for 1888, p. 217). In fact, the index number for the year
1885, as determined from the same data by seven different methods,
proved to be 70, 70.6, 73, 69, 72, 72, 69.5 (_ibid._, p. 211).

The practical outcome of these two considerations is thus well expressed
by Giffen (_loc. cit._ p. 184), "The articles as to which records of
prices are obtainable being themselves only a portion of the whole,
nearly as good a final result may apparently be arrived at by a
selection without bias, according to no better principle than
accessibility of record, as by a careful attention to weighting....
Practically the committee would recommend the use of a weighted index
number of some kind, as, on the whole, commanding more confidence.... A
weighted index number, in one aspect, is almost an unnecessary
precaution to secure accuracy, though, on the whole, the committee
recommend it."

FOOTNOTES:

[30] _Dictionary of Political Economy_, edited by R. H. T. Palgrave.
Vol. II, pp. 384-7. Macmillan and Company, Limited. London. 1912.

CHAPTER IX

BANKING OPERATIONS AND ACCOUNTS

[31]The intermediate employed in actual transactions is, in increasing
degree, that form of currency called credit, the lowest order of
currency, rather than money itself. Checks and drafts make up a
progressively larger share of the circulating medium. The net deposit
credits in the national banks in the United States--to say nothing of
the other banks--are double the volume of the actual money in the
country. And a large share of this actual money is really employed as
reserves to support the credit circulation. More than 90 per cent. of
the larger sorts of transactions are mediated through the use of deposit
credit, and probably more than one-half of the remaining transactions
are similarly effected. Thus the study of banking is essential to any
understanding of monetary problems....

[32]For a bank, as well as for any other considerable establishment, it
is requisite that a capital should be provided at the outset. There can
be no constant proportion between the amount of this capital and the
extent of the business which may be built up by its means. We can only
say that, other things being equal, the larger the business that can be
carried on with safety with a given capital, the larger will be the
field from which profits can be earned, and the higher the proportion
which the profits will bear to the original investment; but the point at
which the extension of the business passes the line of safety, must be
determined by the circumstances of the particular bank, by the kind of
business carried on by those dealing with it, and by the condition of
the community in which it is established. The attempt has sometimes
been made to limit by law for incorporated banks the proportion of
transactions for a given amount of capital, but no such provision has
any foundation except a conjectured average, too rough to be of service
in any individual case. In this respect, as in so many others, the
judgment of the persons most interested, acting under the law of
self-preservation, is far more trustworthy than any legislative
decision.

The capital thus to be provided at the outset is, of course, in the case
of a private bank, the contribution of the partners, as in any other
undertaking. In the case of an incorporated bank the capital is divided
by law into equal shares or units of fixed amount; as _e. g._, under the
law of the United States, a capital of $100,000 is divided into 1,000
shares of $100 each; and these shares are contributed by the individual
shareholders, in such proportion as they please. The law may as a matter
of public policy limit the proportion of capital stock to be owned by
any one individual or firm, and it may also limit the liability of
shareholders for debts due by the bank, in case of its failure; but in
general, in the absence of special provisions to the contrary, the
powers, rights, and liabilities of every shareholder are now usually
determined by the number of shares of the stock contributed or owned by
him. In the election of directors and of other officers for the
immediate management of the business, every share entitles its owner to
cast one vote; the dividend of profit is divided in the ratio of shares
owned, and contributions to meet losses, if required by law, are called
for in the same ratio.

The capital subscribed by the intending shareholders must necessarily be
paid in in money or in the legal tender of the country. It is not
necessary that the whole should be paid in at the outset, but the
payment of the whole usually precedes the full establishment of the
business; and, in the case of incorporated banks, the law often requires
that some definite proportion, as _e. g._, one-half, shall be paid in
before the opening of business, in order to insure good faith and a
solid basis for the business undertaken.

If, now, we undertake to represent by a brief statement of account the
condition of a bank having a capital of $100,000 paid in, in specie, on
the morning when it opens its doors for business, we shall have the
following:

_Liabilities_ _Resources_
Capital $100,000 Specie $100,000

It may at first sight appear to be a contradiction in terms, that the
capital should be set down as a liability and not as a resource. But we
must here distinguish between the financial liability for what has been
received from the shareholders and the right of property in the thing
received. The bank has become accountable to its shareholders for the
amounts paid in by them respectively, but the money actually paid in has
become the property of the bank; or, in the language of accountants, the
bank has become liable for its capital, and the money in hand is for the
present its resource for meeting this liability, or for explaining the
disposition made of what has been received.

As the bank requires banking-rooms and a certain supply of furniture and
fixtures for the convenient transaction of its business, we may suppose
it to expend $5,000 of its cash in providing this "plant." The property
thus procured, with the remaining $95,000 in cash, will then be the
aggregate resources by means of which the capital is to be accounted
for, and the account will stand as follows:

_Liabilities_ _Resources_
Capital $100,000 Real estate, furniture, fixtures, etc. $ 5,000
Specie 95,000
-------- --------
$100,000 $100,000

The bank, however, cannot answer the purposes of its existence, or earn
a profit for its shareholders, until its idle cash is converted into
some kind of interest-bearing security. Nor is it enough that a
permanent investment of the ordinary kind should be made, as by the
simple exchange of the cash for government bonds or railway securities.
It is the chief business of the bank to afford to purchasers and dealers
the means of using, by anticipation, funds which are receivable by them
in the future, and this implies both the purchase of private securities
or "business paper" to a considerable extent, and also frequent change
and renewal of purchases. Moreover, while the private capitalist finds
it advantageous to make simple investments of a permanent sort, this
would plainly be insufficient for the shareholders of a bank, who have
to pay from its profits some serious expenses of management, and need,
therefore, a larger field for earnings than the ordinary returns on
their capital alone. The bank being obliged then to extend its
operations beyond the amount of its capital, is compelled for this
purpose to make use of its credit. In fact, it is only by such a use of
its credit that the establishment becomes in reality a bank.

Most of the conditions of the case are best answered by the "discount"
of commercial paper as above described. The time for which such
obligations have to run varies with the custom of the trade which gives
rise to them, but is in most cases short enough to imply early repayment
to the bank. And even where custom gives the paper longer time, if the
paper itself is used only as a collateral security, the note which is
the actual object of negotiation with the bank is by preference usually
made not to exceed four months. It is easy then to arrange the purchases
of paper with reference to the times of maturity, so as to provide for a
steady succession of payments to the bank, and thus facilitate the
reduction of the business, if necessary, or its direction into new
channels, as prudence or good policy may require. The certainty of
prompt payment at maturity, needed for this end, is presented in a high
degree by the paper created in the ordinary course of business.
Independently of the collateral security which the bank may hold, the
written promise of a merchant or manufacturer to pay on a fixed day is
an engagement which involves the credit of the promisor so far that
failure is an act both of legal insolvency and of commercial dishonor.
Selected with judgment, then, such paper is not only the investment
which most completely answers the purposes of the bank's existence, but
is probably as safe as any investment which could be found.

It may easily happen, however, that the bank may find it desirable to
invest a part of its resources in some other form, either because good
commercial paper cannot be procured in sufficient amount, or as a matter
of policy. In this case it will purchase such other securities as offer
not only complete safety of investment, but the possibility of easy
conversion into cash in case of need. In this country United States
bonds, and many descriptions of State, municipal, and corporation bonds
might answer this purpose. Stocks would more rarely answer it, being
more liable to the fluctuations in price caused by misfortune or the
ordinary vicissitudes of business. Mortgages on real estate, however,
would not be admissible, except when held as a security, collateral to
some other which is more easily convertible, for even when the mortgaged
property is so ample and stable as to insure the goodness of the
mortgage, the conversion of the mortgage into cash by sale is not always
easy, and is especially difficult at those times when the bank most
needs to have all its resources at command. Indeed, the danger to be
apprehended from the locking up of resources, in securities which may be
solid but are not easily realized, is so great, that it has been said to
be the first duty of the banker to learn to distinguish between a note
and a mortgage, his business lying with the former. Real estate, of
course, cannot be regarded as a banking security, however desirable it
may be as an investment for individuals, for it is not only subject to
great fluctuations in value, but is at times unsaleable....

The results of the process of investment in commercial paper and in
other securities are best understood when we trace the effect in the
account of the bank. Taking then the account as it stood after the
purchase of fixtures, let us suppose that the bank buys paper or
securities from those dealing with it, or, in the common phrase, makes
"loans to its customers," to the amount of $90,000, the paper being in
many pieces and having various lengths of time to run, but averaging
about three months. Supposing the interest to be computed at 6 per
cent., we should have the account changed by the operation as follows:

_Liabilities_ _Resources_

Capital $100,000 Loans $90,000
Undivided profits 1,350 Real estate, furniture, fixtures, etc. 5,000
Deposit 88,650 Specie 95,000
-------- --------
$190,000 $190,000

Here we have the securities which certify the right of the bank to
demand and receive $90,000 at a future date placed among the resources;
the net proceeds of the securities, or the aggregate of the sums which
the bank holds itself liable to pay for them on demand, stand among the
liabilities as deposits; and the interest deducted in advance, or the
profit on the operation, which the bank must at the proper time account
for to the stockholders, also stands as a liability. This, however, is
the condition of the account at the moment of making the investment,
when the bank has made its purchase of securities by merely creating a
liability. As this liability is real and must be met, so far as the
depositors at any time see fit to press it, let us suppose that
depositors call for cash to the amount of $15,000, and we shall have a
further change in the account as follows:

_Liabilities_

Capital $100,000
Undivided profits 1,350
Deposits 73,650
------
$175,000

_Resources_

Loans $90,000
Real estate, etc 5,000
Specie 80,000
------
$175,000

It is clear that, unless the enforcement of the liability for deposits
and consequent withdrawal of specie goes much farther than this, the
bank can safely increase its loans or its purchase of securities,
although its method of doing so is by the increase of its liabilities.
We will suppose it, therefore, to have expanded its affairs until it has
reached something like the average condition of those banks in the
United States, which, being incorporated under the laws of the several
States, are not authorized to issue notes. It will then stand thus:

_Liabilities_

Capital $100,000
Surplus 29,000
Undivided profits 10,000
Deposits 305,000
--------
$444,000

_Resources_

Loans $305,000
Bonds and stocks 23,000
Real estate 15,000
Other assets 20,000
Expenses 1,000
Legal-tender notes }
Cash items } 80,000
Specie }
--------
$444,000

Postponing for the present the consideration of some terms which here
occur for the first time, it appears from the above account that
purchases of securities have been made to more than three times the
amount of the capital, and that this has been effected chiefly by the
creation of liabilities in the form of deposits. What determines the
limit to which this process can be carried?

If depositors seldom demanded the payment to which they are entitled,
but were contented with the mere transfer of their rights among
themselves as a conventional currency, the bank might dispense with
holding any large amount of specie or cash in any form and keep most of
its resources employed in its productive securities. The expansion of
the deposits would then resemble in its effects the expansion of any
other currency and might go on until a check should be interposed by the
consequent rise of prices and demand for specie for exportation. And it
is true, as we shall see, that in communities where banking is largely
practised, the use of deposits as currency by transfer from hand to hand
is so extensive, that a bank in good credit can rely upon their being
withdrawn so slowly, or rather to so small an extent, as to make it
unnecessary to have cash in readiness for the payment of more than a
small proportion at any given moment. But in a period of financial
disorder or alarm, withdrawals may be made earlier or more frequently,
and a larger provision of cash may be needed for safety, than at other
times; the kind of business carried on by depositors may expose one
bank, or the banks in one place, to heavier occasional demands, or may
on the other hand make demands steadier, than is the case elsewhere; and
a city bank may be more subject to heavy calls from depositors than a
country bank. In general, then, for every bank, in its place and under
the circumstances of the time, there is some line below which its
provision of cash cannot safely fall. This provision of cash, which in
the account last given includes the cash items, specie, and legal-tender
notes, is called the reserve, and the necessity of maintaining a certain
minimum reserve fixes a limit to the ability of the bank to increase its
securities. For obviously any increase of securities, that is, of loans
or bonds, must ordinarily be effected, either by an increase of
deposits, or by an actual expenditure of cash. If, then, the reserve
were already as low as prudence would allow, or were threatened by
approaching heavy demands from depositors, no increase of securities
could be made without serious risk.

What proportion the reserve should bear to the liabilities which it is
to protect is a question which the law has sometimes attempted to
settle, by requiring a certain minimum, leaving it to every individual
bank to determine for itself how much may be required in addition to
this minimum. And this is no doubt as far as any general rule can go. As
has already been suggested, the requirements for safety of different
banks and in different places must vary, and so must the requirements of
the same bank at different times. In fact, the question as to the proper
amount of reserve never depends simply on the absolute ratio of the
reserve to the liabilities, but always involves further questions as to
the probable receipts of cash by the bank and probable demands upon it,
in the near future. It can only be said that the reserve should be large
enough, not only to insure the immediate payment of any probable demand
from depositors, but also to secure the bank from being brought down to
the "danger line" by any such demand. If 25 per cent. is the minimum
consistent with safety, the reserve should be far enough above this to
be secure from reduction to a point where any further demand or accident
may make the situation hazardous.

In the management of its reserve the bank itself necessarily feels a
strong conflict of interests. On the one hand, it is impelled to
increase its securities as far as possible, for it is from them that it
derives its profits, and the retention of a large amount of idle cash is
felt as a loss. On the other hand, the maintenance of a reserve
sufficient, not only to enable the bank to continue its payments but to
inspire the public with confidence in its ability to continue them, is a
necessity of its existence, even though a part of its resources do thus
appear to be kept permanently idle. As a natural consequence, the actual
settlement of the question in favor of a large or of a small reserve in
any particular case will depend in good measure on the temperament of
the managers. In every banking community may be found "conservative"
banks, the caution of whose managers forbids them to take risks by
extending their business at the expense of an ample reserve; and by
their side may be seen the more "active" banks, whose managers
habitually spread all possible sail, and provide for the storm only when
it comes.

It is to be observed that the necessity of providing a cash reserve is
not met by the excellence of the securities held by the bank. Although
their certainty of payment at maturity be absolute, still the demands
upon the banks are demands for cash, and cannot be answered by the offer
of even the best securities. If the depositor or creditor does not
receive cash in full for his demand when it is made, the bank has
failed, and any satisfaction of his claim by the delivery of a security
is, as it were, only the beginning of a division of the property of the
bank among its creditors. Specie, therefore, or the paper which is a
substitute for it as a legal tender for debt, forms the real banking
reserve. The reserve of the bank may, however, be greatly strengthened
by the judicious selection of securities. For example, if, in the
account above given, the "bonds and stocks" are, as they should be, of
descriptions which are readily saleable, they afford the means of
replenishing the reserve in case of need, without foregoing the
enjoyment of an income from this amount of resources for the present. In
extreme cases of general financial panic, it is true, even the strongest
government securities may find but few purchasers; still such a
provision is the best support which can be had in the absence of, or as
an auxiliary to, a sufficient reserve of actual cash.

The natural method of securing the proper apportionment of resources
between securities and reserve, under ordinary circumstances, is by
increasing or diminishing the loans, or, in other words, the purchases
of securities made from day to day in the regular course of business.
That part of the securities which consists of the promises of
individuals or firms to pay to the bank at fixed dates, is made up of
many such pieces of commercial paper, maturing, if properly marshalled,
in tolerably steady succession. The payment of one of these engagements
when it becomes due may be made either in money, or by the surrender to
the bank of an equal amount of its own liabilities ... [in the form of
deposits]. In the former case, the payment of the maturing paper to the
bank is in fact the conversion of a security into cash, and increases
the reserve without change in the liabilities; in the latter, the
reduction of securities is balanced by a reduction of liabilities which
raises the proportion of reserve. If, then, the bank stops its
"discounts" or the investments in new securities, or if it even slackens
its usual activity in making such investments, the regular succession of
maturing paper will gradually strengthen its reserve; if it increases
its activity in investment, it will weaken or lower its reserve; and if
it adjusts the amount of its new investments to the regular stream of
payments made by its debtors, it may keep the strength of its reserve
unaltered, until some change in the condition of affairs brings cash to
it or takes cash away by some other process.

This natural dependence of the reserve upon the more or less rapid
re-investment of its resources by the bank is distinctly recognized by
the law of the United States, which provides that when the reserve of
any national bank falls below the legal minimum, such bank "shall not
increase its liabilities by making any new loans or discounts," until
its reserve has been restored to its required proportion. By a less
harsh application of the same principle, the Bank of England operates
upon its reserve by lowering or raising its rate of discount, and thus
encouraging or discouraging applications for loans. And it was with a
view of facilitating the replenishment of the reserve by the curtailment
of loans, that the law of Louisiana formerly provided that the banks of
New Orleans should hold what were called "short bills," or paper
maturing within ninety days, to the amount of two-thirds of their cash
liabilities, so that the constant stream of payments of such paper might
always insure to every bank the early command of a large part of its
resources.

To return, in conclusion, to the account last given; we have there among
the liabilities certain sums classified as "surplus" and as "undivided
profits." Taken together these sums represent the profits which have
been made, but not divided among the stockholders, and which are
therefore to be accounted for by the bank. The surplus is that portion
of these profits which as a matter of policy it has been determined not
to divide and pay over to the stockholders, but to retain in the
business, as in fact, although not in name, an addition to the capital.
The remaining portion, the undivided profits, is the fund from which,
after payment of current expenses and of any losses which may occur, the
next dividend to the stockholders will be made. The current expenses are
for the present entered on the other side of the account, as they
represent a certain amount of cash which has disappeared; but at the
periodical settlement of accounts they must be deducted from the
undivided profits, and will thus drop out from the statement. "Other
assets," here set down as an investment, may be supposed to cover any
form of property held by the bank and not otherwise classified, but
especially the doubtful securities, or such property, not properly dealt
in by a bank, as it may have been necessary to take and to hold
temporarily, for the purpose of securing some debt not otherwise
recoverable. For example, although the bank could not properly invest in
a mortgage, it might be wise for it to accept a mortgage in settlement
with an embarrassed debtor, and in this case the mortgage would stand
among the "other assets." And, finally, "cash items" include such
demands on individuals or other banks as are collectible in cash and can
therefore fairly be deemed the equivalent of cash in hand. In the
absence of any legal provision limiting the classification of such
demands as reserve, they may be regarded as virtually a part of the
reserve, which in the case before us may therefore be treated as made up
of cash items, specie, and legal-tender notes.

To illustrate what has been said in this chapter we will now suppose the
bank to make the following operations:

a. To add to its securities $20,000, by discount of three-months paper
at 6 per cent., three-fourths being purchased by the creation of
liabilities, and one-fourth by the expenditure of cash. The account
would then stand as follows:

_Liabilities_

Capital $100,000
Surplus 29,000
Undivided profits 10,300
Deposits 319,775
--------
$459,075

_Resources_

Loans $325,000
Bonds and stocks 23,000
Real estate 15,000
Other assets 20,000
Expenses 1,000
Reserve 75,075
--------
$459,075

b. To retrace its steps by diminishing its "discounts" or holding of
securities to the extent of $50,000, of which four-fifths are paid to it
by the surrender of demands for deposits to a like amount and one-fifth
in cash; to pay $1,250 for current expenses; and further to increase its
reserve by the sale of bonds and stocks to the amount of $10,000. The
following would then be the state of the account:

_Liabilities_

Capital $100,000
Surplus 29,000
Undivided profits 10,300
Deposits 279,775
--------
$419,075

_Resources_
Loans $275,000
Bonds and stocks 13,000
Real estate 15,000
Other assets 20,000
Expenses 2,250
Reserve 93,825
--------
$419,075

c. To sell $2,000 of its other assets for cash with a loss of $500; to
make a semi-annual dividend of 4 per cent., of which one-half is
credited to stockholders who happen to be depositors also, and one-half
is paid in cash; to sell $4,000 of bonds at a profit of 15 per cent.,
and to carry $1,000 of its undivided profits to surplus. The account
would then stand at the beginning of the new half year, as follows:

_Liabilities_

Capital $100,000
Surplus 30,000
Undivided profits 3,150
Deposits 281,775
--------
$414,925

_Resources_

Loans $275,000
Bonds and stocks 9,000
Real estate 15,000
Other assets 18,000
Reserve 97,925
--------
$414,925

STATEMENT OF A REPRESENTATIVE NATIONAL BANK

_Resources_

Loans and discounts $739,743.27
Overdrafts, secured 973.08
U. S. bonds deposited to
secure circulation 100,000.00
U. S. bonds pledged to
secure U. S. deposits 1,000.00
Bonds other than U. S.
bonds pledged to secure
postal savings deposits 7,000.00
Other Securities 191,098.05
Stock of Federal Reserve
bank 4,800.00
Banking House 30,000.00
Furniture and Fixtures 5,000.00
Due from Federal Reserve
Bank 20,000.00
Due from approved reserve
agents 89,919.25
Due from other banks 12,074.23
Checks on banks in same
city 6,051.46
Outside checks and other
cash items 13,171.83
Fractional currency, nickels,
and cents 283.14
Notes of other national
banks 1,295.00
Coin and certificates 38,604.05
Legal-tender notes 25,000.00
Redemption fund 3,500.00
-------------
$1,289,513.36

_Liabilities_

Capital stock
paid in $100,000.00
Surplus fund 60,000.00
Undivided
profits 40,877.46
Less current
expenses, interest,
and
taxes paid 17,110.28 23,767.18
Circulating
Notes Out-standing 98,500.00
Individual deposits
subject
to check 404,871.37
Certificates of
deposit due
in less than
30 days 596,335.82
Certified
Checks 125.00
United States
deposits 1,000.00
Postal savings
deposits 4,913.99
-------------
$1,289,513.36

[33]~The Method and Extent of Credit Issue.--~Assume that a bank with a
cash capital of $100,000 is opening for business in an isolated town and
is the only bank in that town. How much can it lend? Ordinarily a bank
lends by discounting a customer's note and by giving the customer a
deposit credit upon its books for the proceeds of the note.... If, now,
our bank in question lends $100,000, giving deposit credit for this sum,
it has $100,000 of cash on hand against $100,000 of cash liability. Its
statement will stand as follows:

_Resources_

Cash $100,000
Notes 100,000
--------
$200,000

_Liabilities_

Capital Stock $100,000
Deposits 100,000
--------
$200,000

Now let it lend another $100,000. With its loans and deposits each
standing at $200,000 its reserves are 50 per cent. of its demand
liability. Only with $666,666 of loans will its reserves have reached
... [a] 15 per cent. limit:

_Resources_

Cash $100,000
Notes (Loans and Discounts)
666,666
--------
$766,666

_Liabilities_

Capital Stock $100,000
Deposits 666,666
--------
$766,666

Further: Suppose that $100,000 of cash is deposited with the bank from
the channels of business; how much more can it lend? Fifteen thousand
dollars must be retained as reserve against the new liability; $85,000
is available as reserves against further lending. Based upon these
further reserves loans may be granted to the extent of nearly $600,000
more. In fact, only with an expansion of $1,233,333 in loans and in
derived deposits--a total deposit of $1,333,333--has its reserve fallen
to the ratio of 15 per cent. of its liability.

_Resources_

Cash (original) $100,000
Loans and Discounts 666,666
Cash (new) (85,000
(15,000
L & D (new) 566,666
----------
$1,433,333

_Liabilities_

Capital Stock $100,000
Deposits 666,666
Deposits (new) (100,000
(566,666
----------
$1,433,333

The situation summarizes as follows: On its asset side the bank has
$200,000 of cash and $1,233,333 of securities (Bills and Notes). Its
deposit liabilities amount to $1,333,333.

Its cash is 2/13.3+ of its liability--15 per cent.

~The Function of Reserves.~--If this is what actual banking means, is
banking safe? What would happen if all these deposits were immediately
called for in cash? True, not all are likely to be called for, but some
cash will be demanded. In fact, the borrowers, instead of accepting all
of the proceeds of these notes in deposit credit, will in some measure
require and receive cash. Precisely so; and so the bank must keep on
hand a cash reserve to meet this possibility. For the most part,
however, the customers of the bank make payments through checks upon the
bank, and these credits are deposited in turn to the credit of other
customers. No cash, but only bookkeeping, is required. And if some
customers draw out cash, other customers will probably receive it and
return it to the bank. A reserve of 15 per cent. is enough for the case.
There, would, indeed, be small gain in banking if against every deposit
an equal sum in cash must be held in store by the bank.

~Economy of Redemption Money.~--It is thus evident that the employment of
$200,000 cash as a banking reserve has made possible the existence of a
more than sixfold volume of circulating medium--currency. Against each
$1,000 of deposit liability there need be only $150 of actual cash. The
bank customer, however, thinks of his deposit claim as money, and it
really serves him all the purposes of money. The right to have the money
when desired is as good as the actual money, is more convenient, and is
as readily and as serviceably transferred.

The economy of money through the use of credit substitutes for money
extends really further than the foregoing analysis indicates. Under the
[now superseded] law, three-fifths of the reserves of a rural bank may
be on deposit with banks in reserve cities. Thus against $100,000 of
deposit liability the rural bank needs hold only $6,000 of reserve
money. Against the deposit of the remaining $9,000, the reserve city
bank is required in turn to hold a reserve of only 25 per cent.--$2,250.
And of this required $2,250, one-half may be represented by deposits in
central reserve cities, _e. g._, New York, Chicago, and St. Louis.
Against the $1,125 deposited with it the central reserve bank is
required to hold only 25 per cent. of reserves--$281.25. Thus at the
outside limit of credit extension, $100,000 of deposit currency may be
supported by only $7,406.25 of reserves in money,

(6000 + 1/2 × (9000/4) + (1125/4)).

one dollar of reserves upholding $13 of currency.[34]

It is, of course, not true that the banks ordinarily allow their
reserves to run as low as the legal limit, or make the utmost possible
use of the privilege of counting claims against one another as legal
reserves. Nor is it accurately true that all forms of money are of equal
efficiency in the support of credit. Not all forms of money, but only
those of the higher levels in the money scale, are allowed to be counted
as legal reserves.... Some forms of money make demands upon other forms
for redemption, or are limited in exchange power to the exchange power
of the form in which redemption is to be made. The total exchange
efficiency of the money of a country is, then, not accurately to be
computed on the assumption that all moneys are equally efficient for all
purposes--that some are not in varying degree burdens upon the money
functions of the others.

~Banking Viewed in Detail and in the Aggregate.~--And one further
modification is called for. The analysis so far made, while valid for
any isolated bank, or for the banking system regarded as an aggregate,
is not precisely accurate for the affairs of any one competing bank
among other banks. When the check drawn by the borrowing depositor may
be deposited in other banks and collected by them against the lending
bank, its granting of credits rapidly draws down its reserves to swell
the reserves of its competitors. One hundred thousand dollars of new
reserves may not mean to it an increase of lending power of more than,
say, $125,000. For banks in the aggregate, however, this increase of
reserves brings its full several-fold increase of lending power,
provided that all the reserve efficiency is utilized in whatever bank it
rests. As the lending by each bank is depleting its reserves, the
lending which other banks are doing is reinforcing these reserves. The
aggregate possible extension of credit is not changed.

~What Banks Actually Do and Lend.~--It follows from the foregoing analysis
that, in the main, banks do not lend their deposits, but rather, by
their own extensions of credit, create the deposits; that these deposits
are funds which the deposit-creditors of the bank can lend if they will,
and that many men into whose hands these deposits fall through transfer
are certain to use them as funds to be lent. In fact, also, even when
the deposits in the bank are not derived from the lending activity of
the bank, but are really funds deposited from outside sources, these
funds are commonly used by the bank as a reserve basis on which loans
are extended rather than as funds which are themselves loaned out by the
bank. Banks are, in truth, mostly intermediaries between debtors and
creditors--but not in the sense of borrowing funds from one class of
customers in order to lend them to another class, but rather in the
sense of creating for their borrowing customers funds which may be used
by these borrowers as present purchasing power. The borrower becomes
indebted to the bank in order that for his own purposes he may use the
promise of the bank as the equivalent of cash to himself. In the form of
a deposit liability the bank becomes a debtor to whomever the borrower
shall nominate. The fact that the borrower pays interest while the bank
undertakes a noninterest-bearing obligation, or pays relatively low
interest, explains in the main the gains attending the business of
commercial banking.

~Deposits and Solvency.~--It is, therefore, a sheer blunder to infer that
a bank is rich or strong because of its great total of deposits, or to
regard deposits in banking institutions as making part of the aggregate
wealth of the community. Instead, the deposits indicate for a bank the
extent of its operations, and indicate for a community the extent to
which the banks, under the guise of noninterest-bearing obligations,
have assumed the debts of business men, on terms of these business men
becoming debtors--and interest-paying debtors--to the banks. The
solvency of the bank is in its portfolio of securities. Its deposits are
not its assets, but its liabilities. These liabilities it has mostly
created for the use of its borrowers. The further it may safely go in
assuming liabilities, the larger its holdings of borrowers' notes may
be, and the more interest or discount charges it may collect.
Essentially, therefore, the business of a bank is a form of
suretyship--the guaranteeing of its borrowers' solvency--an underwriting
of the credit of its customers. The bank transfers its customers'
prospective future paying power into present funds. It is for this
reason that the contract takes the form of a money loan and the premium
the guise of an interest payment.

~Bank Loans Related to Currency and Loan Funds.~--And note now that it is
precisely because the business of a bank is to furnish to its borrower
a present purchasing power for his own use that the business of banking
becomes the source of the larger part of the circulating medium of
society. In their service to their customers the banks create currency;
and in creating currency they create loan funds which, in the hands of
the holders of them, are available like other currency for any purpose,
either lending or other.

~The Sources of Currency Supply.~--It is, then, clear that the larger part
of the circulating medium of society is not money; that not all of the
money that there is is bullion money; and that not even all of the
bullion money need be ultimate money--redemption money of the highest
rank. The sources of currency in society are various--some of it
bullion, with a cost of production limit upon its supply, some of it
government paper, substantially free of cost, some of it banking credit
with certain peculiar and appropriate costs attending its issue.

~Currency and Its Cost of Production.~--It is obvious that the actual
limitations upon the supply of exchange media must be made clear if we
are to understand the influences which are fundamental to the exchange
values of the currency unit. Only, indeed, by this investigation of the
sources of the supply, and of the terms on which each different factor
of the supply is available, are we in position to understand the
influences which impose upon bidders for money a certain level of
sacrifice in obtaining it.

What, then, are the limitations upon the supply of credit currency
supplied by the banks? In other words, what are the banking costs in the
granting of demand deposit rights to customers? Evidently limitations
there must be, and limitations in the nature of costs, else the
competitive activity of the banks would indefinitely increase the supply
of currency, and any would-be purchaser of goods or payor of debts or
projector of an enterprise could have the time use of purchasing power
gratis; no limit would exist to the rise in prices which must attend
this increase in the circulating medium.

What are these limitations? (1) Each bank must conform the volume of its
lending, and therewith its issue of circulating credit, to the
fundamental requirement that it be always able to make good its
agreement to discharge its deposit liabilities on demand. To maintain
reserves involves expense. Especially may it be expensive if they have
been allowed to get low; securities may have to be marketed at a
sacrifice, or good customers pressed for payment at inconvenient times.
In periods of general pressure or panic, other banks are not likely to
be in a position to lend their own reserve funds or to consent to create
deposit credit in aid of still other suffering banks. Not rarely the
Bank of England, in the attempt to attract reserve funds, advances bank
notes or deposit credit to importers of gold, without imposing the
customary interest charge for the covering of the delays of the mint. In
at least one case, in 1890, it borrowed reserves from the Bank of
France. In 1907 the United States Treasury made especially large money
deposits with the national banks of New York to help eke out the needed
reserves. Meantime the interior banks were compelled to pay to exporting
merchants generous premiums for exchange bills upon Europe, through
which, despite the high interest rates ruling in European markets, these
banks were able to import 107 millions of gold for their own reserve
requirements. In fact, the banking business involves the hazard not
merely that some of the debtors of the bank may become insolvent, but
also the general and overhead hazard attaching to its underwriting
service that it may itself in time of stress become unable to meet its
obligations. Its liabilities must not be allowed to get seriously out of
ratio to its cash resources.

~The Protection of Reserves.~--In point of fact also the efforts of the
various different banks to maintain each its own reserve place a limit
on the extent to which any one bank can extend its activity in the
expansion of loans and of the derivative liabilities. Just as a
relatively liberal granting of credit by one bank must tend to transfer
its reserves to other banks, so a relatively great extension of credit
in one center or in one country must tend to transfer the reserves, _e.
g._, gold, to other centers or countries. Even were it true that a local
credit expansion has no effect upon local prices and thereby upon the
currents of trade, some transfers of reserves would still take place,
and would impose a policy of restriction in credit accommodations....
The influence is actually exerted by both methods.

~(2) Another Cost in Bank-Made Currency.~--The loan rates of the bank must
also provide a fund to cover its costs of administration--salaries,
clerk hire, rents, and the like. Where transactions run in large units
the ratio of expense to the volume of business may be low. This is in
part the explanation for the low rates of discount in the great
financial centers compared with the rates outside. Credit currency has
its cost of production rate as truly as any other service upon the
market....

THE RELATION BETWEEN LOANS AND DEPOSITS

[35]The money of modern English commerce and finance is the cheque, and
the credit dealt in in the London money market is the right to draw a
cheque....

Now that we have come to the point at which the manufacture of the right
to draw cheques has to be made as clear as may be, it will be well to
come into close touch with the facts of the case and look at a bank
balance-sheet of to-day. In order to get a fair average specimen I have
taken the latest available balance-sheets of half a dozen of the biggest
London banks, and put their figures together.... Let us examine the
aggregated specimen that I have drawn up.

_Millions of £_
Capital paid up 16
Reserve Fund 11
Current and deposit accounts 249
Acceptance on behalf of customers 16-1/2
Profit and Loss account 1-1/2
-------
294

_Millions of £_
Cash in hand and at the Bank of England 43
Loans at call and short notice 27-1/2
Bills discounted and advances 153
Investments 48
Liability of customers on acceptances 16-1/2
Premises 6
-------
294

The above statement does not include the figures of the Bank of England,
but is an agglomeration of the balance-sheets of six of the biggest of
the ordinary joint-stock banks.

The first feature that strikes the casual observer is the smallness of
the paid-up capital of the banks when compared with the vastness of the
figures that they handle. We see that only 16 millions out of the 294
that they have to account for have been actually paid up by
shareholders, though 11 millions have been retained out of past profits
and accumulated in reserve funds ["surplus," in United States], and
1-1/2 millions are due to shareholders, for distribution as dividend or
addition to reserve, in the shape of the profit and loss account balance
for the period covered by the balance-sheet. A profit of 1-1/2 millions
on 16 is handsome enough, especially when it is considered that most of
these balance-sheets covered a half-year's work, but 1-1/2 millions out
of 294 is a trifle, and it thus appears that a narrow margin of profit
on their total turnover enables the banks to pay good dividends, and
that the business of credit manufacture earns its reward, as might be
expected, out of the credit that it makes.

Proceeding in our examination, we see that the item of acceptances on
behalf of customers on one side is balanced by the liability of
customers on the other. This means that the banks have accepted bills
for their customers (so making them first-class paper and easily
negotiable), and are so technically liable to meet them on maturity; but
since the customers are expected to meet them, and have presumably given
due security, this liability of the customer to the bank is an
offsetting asset against the acceptance. And since the acceptance
business is a comparatively small item, and a bank's liability under its
acceptances is not a liability in quite the same sense as its deposits,
and does not immediately affect the present question of the manufacture
of currency, it may be omitted for the present. We can thus simplify the
balance-sheet by taking out this contra entry on both sides.

Further analysis of the liabilities shows that the capital, reserves, or
surplus, and profit and loss balance may be regarded as due from the
banks to their shareholders, and that the remaining big item, current
and deposit accounts, is due to their customers. This is the item which
is usually spoken of as the deposits, according to the tiresome habit of
monetary nomenclature which seems to delight in applying the same name
to a genus and one of the species into which it is divided. Just as the
bill of exchange is divided into cheques and bills of exchange, so the
English banks' deposit accounts are divided into current and deposit
accounts. But most people who have a banking account know the meaning of
this distinction. Your current account is the amount at your credit
which you can draw out, or against which you can draw cheques, at any
moment; your deposit account is the amount that you have placed on
deposit with the bank and can only withdraw on a week's or longer
notice, and it earns a rate of interest, usually 1-1/2 per cent. below
the Bank of England's official rate. The essential point to be grasped
is the fact that the banks' deposits, as usually spoken of, include both
the current and deposit accounts, and are due by the banks to their
customers.

Now let us see how this huge debt from the banks to the public has been
created. An examination of the assets side of the balance-sheet proves
that most of it has been created by money lent to their customers by the
banks, and that the cheque currency of to-day is, like the note currency
of a former day, based on mutual indebtedness between the banks and
their customers. For the assets side shows that the banks hold 43
millions in cash and at the Bank of England, 48 millions in investments,
and 6 millions invested in their premises--the buildings in which they
conduct their business--and that 180-1/2 millions have been lent by them
to their customers, either by the discounting of bills or by advances to
borrowers, or by loans at call or short notice. We can now reconstruct
our balance-sheet, leaving out the acceptances on both sides, as
follows:

_Millions of £._ _Millions of £._
Due to shareholders 28-1/2 Cash in hand and at Bank
Due to customers 249 of England 43
-------- Investments 48
277-1/2 Premises 6
Due from customers 180-1/2
--------
277-1/2

And it thus appears that nearly three-quarters of the amount due from
the banks to their customers are due from their customers to the banks,
having been borrowed from them in one form or another. And this
proportion would perhaps be exceeded if we could take the figures of
English banking as a whole. But that cannot be done at present, because
some of the smaller banks do not separate their cash from their loans at
call in their published statements. The greater part of the banks'
deposits is thus seen to consist, not of cash paid in, but of credits
borrowed. For every loan makes a deposit, and since our balance-sheet
shows 180-1/2 millions of loans, 180-1/2 out of the 249 millions of
deposits have been created by loans.

To show how a loan makes a deposit, let us suppose that you want to buy
a thousand-guinea motor-car and raise the wherewithal from your banker,
pledging with him marketable securities, and receiving from him an
advance, which is added to your current account. Being a prudent person
you make this arrangement several days before you have to pay for the
car, and so for this period the bank's deposits are swollen by your
£1,050, and on the other side of its balance-sheet the entry "advances
to customers" is also increased by this amount, and the loan has clearly
created a deposit.

But you raised your loan for a definite purpose, and not to leave with
your bank, and it might be thought that when you use it to pay for your
car the deposit would be cancelled. But not so. If the seller of your
car banks at your bank, which we will suppose to be Parr's, he will pay
your cheque into his own account, and Parr's bank's position with regard
to its deposits will be unchanged, still showing the increase due to
your loan. But if, as is obviously more probable, he banks
elsewhere--perhaps at Lloyd's--he will pay your cheque into his account
at Lloyd's bank, and it will be the creditor of Parr's for the amount of
£1,050. In actual fact, of course, so small a transaction would be
swallowed up in the vast mass of the cross-entries which each of the
banks every day makes against all the others, and would be a mere needle
in a bottle of hay. But for the sake of clearness we will suppose that
this little cheque is the only transaction between Parr's and Lloyd's on
the day on which it is presented; the result would be that Parr's would
transfer to Lloyd's £1,050 of its balance at the Bank of England, where
all the banks keep an account for clearing purposes. And the final
outcome of the operation would be that Parr's would have £1,050 more
"advances to customers" and £1,050 less cash at the Bank of England
among its assets, while Lloyd's would have £1,050 more deposits and
£1,050 more cash at the Bank of England. And the £1,050 increase in
Lloyd's deposits would have been created by your loan, and though it
will be drawn against by the man who sold you the car, it will only be
transferred perhaps in smaller fragments to the deposits of other banks;
and as long as your loan is outstanding there will be a deposit against
it in the books of one bank or another, unless, as is most unlikely, it
is used for the withdrawal of coin or notes; and even then the coin and
notes are probably paid into some other bank, and become a deposit
again; and so we come back to our original conclusion that your
borrowing of £1,050 has increased the sum of banking deposits, as a
whole, by that amount.

The same reasoning applies whenever a bank makes a loan, whatever be the
collateral, or pledge deposited by the borrower, whether Stock Exchange
securities, as in the case cited, or bales of cotton or tons of copper;
or, again, whenever it discounts a bill. In each case it gives the
borrower or the seller of the bill a credit in its books--in other
words, a deposit; and though this deposit is probably--almost
certainly--transferred to another bank, the sum of banking deposits is
thereby increased, and remains so, as long as the loans are in
existence. And so it appears that the loans of one bank make the
deposits of others, and its deposits consist largely of other banks'
loans....

RELATION BETWEEN RESERVES AND DEMAND LIABILITIES AGAIN

[36]... a bank must so regulate its loans and note issues as to keep on
hand a sufficient cash reserve, and thus prevent insufficiency of cash
from ... threatening. It can regulate the reserve by alternately selling
securities for cash and loaning cash on securities. The more the loans
in proportion to the cash on hand, the greater the profits, but the
greater the danger also. In the long run a bank maintains its necessary
reserve by means of adjusting the interest rate charged for loans. If it
has few loans and a reserve large enough to support loans of much
greater volume, it will endeavor to extend its loans by lowering the
rate of interest. If its loans are large and it fears too great demands
on the reserve, it will restrict the loans by a high interest charge.
Thus, by alternately raising and lowering interest, a bank keeps its
loans within the sum which the reserve can support, but endeavors to
keep them (for the sake of profit) as high as the reserve will support.

If the sums owed to individual depositors are large, relatively to the
total liabilities, the reserve should be proportionately large, since
the action of a small number of depositors can deplete it rapidly.
Similarly, the reserves should be larger against fluctuating deposits
(as of stock brokers) or those known to be temporary. The reserve in a
large city of great bank activity needs to be greater in proportion to
its demand liabilities than in a small town with infrequent banking
transactions.

Experience dictates differently the average size of deposit accounts for
different banks according to the general character and amount of their
business. For every bank there is a normal ratio and hence for a whole
community there is also a normal ratio--an average of the ratios for the
different banks. No absolute numerical rule can be given. Arbitrary
rules are often imposed by law. National banks in the United States, for
instance, are required to keep a reserve for their deposits, varying
according as they are or are not situated in certain cities designated
by law as "reserve" cities, _i. e._, cities where national banks hold
deposits of banks elsewhere. These reserves are all in defense of
deposits. In defense of notes, on the other hand, no cash reserve is
required--that is, of national banks. True, the same economic principles
apply to both bank notes and deposits, but the law treats them
differently. The Government itself chooses to undertake to redeem the
national bank notes on demand.

The state banks are subject to varying restrictions. Thus the
requirement as to the ratio of reserve to deposits varies from 12-1/2
per cent. to 22-1/2 per cent., being usually between 15 per cent. and
20 per cent. Of the reserve, the part which must be cash varies from 10
per cent. (of the reserve) to 50 per cent., usually 40 per cent.

Such legal regulation of banking reserves, however, is not a necessary
development of banking....

THE RÔLE OF A SPECIE RESERVE ILLUSTRATED BY THE INCONVERTIBLE NOTES OF
THE BANK OF ENGLAND ISSUED DURING THE OPERATION OF THE RESTRICTION
ACT[37]

[38]... Your Committee proceeded, in the first instance, to ascertain
what the price of gold bullion [in terms of Bank of England notes] had
been, as well as the rates of the foreign exchanges, for some time past;
particularly during the last year.

Your Committee have found that the price of gold bullion, which, by the
regulations of his Majesty's Mint, is £3 17_s._ 10-1/2_d._ per ounce of
standard fineness, was, during the years 1806, 1807, and 1808, as high
as £4 in the market. Towards the end of 1808 it began to advance very
rapidly, and continued very high during the whole year 1809; the market
price of standard gold in bars fluctuating from £4 9_s._ to £4 12_s._
per ounce. The market price at £4 10_s._ is about 15-1/2 per cent. above
the Mint price....

It is due,... in justice to the present Directors of the Bank of
England, to remind the House that the suspension of their cash payments,
though it appears in some degree to have originated in a mistaken view
taken by the Bank of the peculiar difficulties of that time, was not a
measure sought for by the Bank, but imposed upon it by the Legislature
for what were held to be urgent reasons of state policy and public
expediency. And it ought not to be urged as matter of charge against the
Directors, if in this novel situation in which their commercial company
was placed by the law, and entrusted with the regulation and control of
the whole circulating medium of the country, they were not fully aware
of the principles by which so delicate a trust should be executed, but
continued to conduct their business of discounts and advances according
to their former routine.

It is important at the same time to observe that under the former
system, when the Bank was bound to answer its notes in specie upon
demand, the state of the foreign exchanges and the price of gold did
most materially influence its conduct in the issue of those notes,
though it was not the practice of the Directors systematically to watch
either the one or the other. So long as gold was demandable for their
paper, they were speedily apprised of a depression of the exchange, and
a rise in the price of gold, by a run upon them for that article. If at
any time they incautiously exceeded the proper limit of their advances
and issues, the paper was quickly brought back to them, by those who
were tempted to profit by the market price of gold or by the rate of
exchange. In this manner the evil soon cured itself. The Directors of
the Bank having their apprehensions excited by the reduction of their
stock of gold, and being able to replace their loss only by reiterated
purchases of bullion at a very losing price, naturally contracted their
issues of paper, and thus gave to the remaining paper, as well as to the
coin for which it was interchangeable, an increased value, while the
clandestine exportation either of the coin, or the gold produced from
it, combined in improving the state of the exchange and in producing a
corresponding diminution of the difference between the market price and
Mint price of gold, or of paper convertible into gold.

Your Committee do not mean to represent that the manner in which this
effect resulted from the conduct which they have described, was
distinctly perceived by the Bank Directors. The fact of limiting their
paper as often as they experienced any great drain of gold, is, however,
unquestionable....

It was a necessary consequence of the suspension of cash payments, to
exempt the Bank from that drain of gold, which, in former times, was
sure to result from an unfavourable exchange and a high price of
bullion. And the Directors, released from all fears of such a drain, and
no longer feeling any inconvenience from such a state of things, have
not been prompted to restore the exchanges and the price of gold to
their proper level by a reduction of their advances and issues. The
Directors, in former times, did not perhaps perceive and acknowledge the
principle more distinctly than those of the present day, but they felt
the inconvenience, and obeyed its impulse; which practically established
a check and limitation to the issue of paper. In the present times the
inconvenience is not felt; and the check, accordingly, is no longer in
force....

By far the most important ... consequence ... [of the Restriction Act]
is, that while the convertibility into specie no longer exists as a
check to an over-issue of paper, the Bank Directors have not perceived
that the removal of that check rendered it possible that such an excess
might be issued by the discount of perfectly good bills. So far from
perceiving this ... they maintain the contrary doctrine with the utmost
confidence.... That this doctrine is a very fallacious one, your
Committee cannot entertain a doubt. The fallacy, upon which it is
founded, lies in not distinguishing between an advance of capital to
merchants, and an addition of supply of currency to the general mass of
circulating medium. If the advance of capital only is considered, as
made to those who are ready to employ it in judicious and productive
undertakings, it is evident there need be no other limit to the total
amount of advances than what the means of the lender, and his prudence
in the selection of borrowers, may impose. But in the present situation
of the Bank, intrusted as it is with the function of supplying the
public with that paper currency which forms the basis of our
circulation, and at the same time not subjected to the liability of
converting the paper into specie, every advance which it makes of
capital to the merchants in the shape of discount, becomes an addition
also to the mass of circulating medium. In the first instance, when the
advance is made by notes paid in discount of a bill, it is undoubtedly
so much capital, so much power of making purchases, placed in the hands
of the merchant who receives the notes; and if those hands are safe, the
operation is so far, and in this its first step, useful and productive
to the public. But as soon as the portion of circulating medium in which
the advance was thus made performs in the hands of him to whom it was
advanced this its first operation as capital, as soon as the notes are
exchanged by him for some other article which is capital, they fall into
the channel of circulation as so much circulating medium, and form an
addition to the mass of currency. The necessary effect of every such
addition to the mass is to diminish the relative value of any given
portion of that mass in exchange for commodities. If the addition were
made by notes convertible into specie, this diminution of the relative
value of any given portion of the whole mass would speedily bring back
upon the Bank which issued the notes as much as was excessive. But if by
law they are not so convertible, of course this excess will not be
brought back, but will remain in the channel of circulation, until paid
in again to the Bank itself in discharge of the bills which were
originally discounted. During the whole time they remain out, they
perform all the functions of circulating medium; and before they come to
be paid in discharge of those bills, they have already been followed by
a new issue of notes in a similar operation of discounting. Each
successive advance repeats the same process. If the whole sum of
discounts continues outstanding at a given amount, there will remain
permanently out in circulation a corresponding amount of paper; and if
the amount of discounts is progressively increasing, the amount of
paper, which remains out in circulation over and above what is otherwise
wanted for the occasions of the public, will progressively increase
also, and the money prices of commodities will progressively rise. This
progress may be as indefinite as the range of speculation and adventure
in a great commercial country....

FOOTNOTES:

[31] Herbert Joseph Davenport, _The Economics of Enterprise_, pp. 259,
60. The Macmillan Company, New York. 1913.

[32] Charles F. Dunbar, _Chapters on the Theory and History of Banking_,
pp. 20-38, G. P. Putnam's Sons, New York and London. 1902.

[33] Herbert Joseph Davenport, _The Economics of Enterprise_, pp. 260-6.
The Macmillan Company. New York. 1913.

[34] It should not be overlooked, furthermore, that the velocity of the
circulation of deposits is approximately two and one-half times that of
money.--EDITOR.

[35] Hartley Withers, _The Meaning of Money_, pp. 57-73. E. P. Dutton
and Company. New York. 1914.

[36] Irving Fisher, _The Purchasing Power of Money_, pp. 45-47. The
Macmillan Company. New York. 1911.

[37] This act, passed in 1797 in order to prevent a drain of gold to the
continent during the Napoleonic War, forbade the Bank of England to
redeem its notes. It remained in force until 1821, when specie payment
was resumed.--EDITOR.

[38] Report from the Select Committee on the High Price of Gold Bullion.
Ordered by the House of Commons, to be printed, 8 June, 1810.

CHAPTER X

THE USE OF CREDIT INSTRUMENTS IN PAYMENTS IN THE UNITED STATES

[39]Discussions concerning the issue of notes by banking institutions,
which largely occupied the attention of students of finance and business
men in the eighteenth and the first three quarters of the nineteenth
centuries, have been succeeded by equally intense discussions of the
amount and influence of credit deposits on the books of the banks, when
drawn on by their customers with checks. The fact that the use of checks
against deposits renders unnecessary a large amount of money, or
currency, attracted attention early in the history of deposit banking,
and efforts have been made from time to time to determine the proportion
of money, or currency, replaced with checks and credit documents of
similar character.[40]

We may summarize the results of our inquiry and inferences therefrom
briefly as follows:

1. In the first place, it is very clear that a large proportion of the
business of the country, even the retail trade, is done by means of
credit instruments. While it is probably true that wage-earners, as a
class, do not commonly use checks, it is also true that a great many of
them do. Moreover, the use of checks is common among people who derive
their income from other sources, even though it be not larger than the
well-paid day laborer. We are justified ... in concluding that 50 or 60
per cent. of the retail trade of the country is settled in this way.

2.... Over 90 per cent. of the wholesale trade of the country is done
with checks and other credit documents.

3. The very general use of checks is shown in the deposits of "all
other" depositors. The average is close up to that of the wholesale
trade, and while many corporations, public and private, are doubtless
represented here, and many speculative transactions are included, there
is no reason for excluding any one of those in determining the
proportion of business done, whatever we may think of its legitimacy
from the point of view of public morals or public utility.

4. The use of checks is promoted in a measure by the payment of wages by
check. It appears from our investigation that of weekly pay rolls
reported by the banks, aggregating $134,800,000 for the week ending
March 13 last, 70 per cent. was in checks....

5. The great use of checks is shown also by the large number of accounts
under $500....

6. We may therefore safely accept an average of 80 to 85 per cent. as
the probable percentage of business of this country done by check.

7. The fact that so large a proportion of business is done with credit
paper may or may not be a good thing. Whether it is or not depends on
circumstances. If any part of the country is compelled to use checks
because of the lack of currency, when it would prefer the latter, the
situation is an evil.

8. The transaction of so large a volume of our business by checks is an
element of danger in times of stringency and crisis. In such times the
uncalled balance of credit transactions creates a larger demand for
money, but the habit of settling by check has meantime kept the
available amount of money at a minimum.

9. Consequently there ought to be some means of supplying additional
currency when credit as a means of payment diminishes. This currency
ought to be as safe and as uniform as the ordinary currency, and it
should be capable of being quickly emitted and recalled. That is, it
should possess elasticity.

10. The large money circulation of the country is explained by the facts
that our prices and wages range high, that our people probably carry a
larger average amount of money on their persons than do foreigners,
that some portion of our currency has been destroyed or lost or
hoarded.... As our business grows, the amount of money needed as reserve
to perform this vast volume of business transactions increases, too....

13. The volume of credit transactions very likely tends to increase as
population and business grow. It does not increase uniformly, however,
but by periodic movements. That is to say, the rate of increase of
credit transactions, as compared with the whole volume of business,
grows, as it were, by jerks and at a decreasing rate.

Several important questions are closely related to the inquiry which has
been [made and summarized]. Among them are these:

1. What is the amount of money rendered unnecessary by the use of credit
paper?

2. What is the influence of the vast volume of credit transactions on
the value of money or the level of prices?[41]

3. Why is it that our per capita circulation is so large and where is
the money in active circulation?...

1. We will take these questions up in order.... No one can say ... with
definiteness what is the amount of money released if 75 or 80 per cent.
of our business transactions are settled by means of credit paper. This
is a matter in which the long experience of practical bankers is the
only safe guide, because the amount in question is changing from day to
day as the conditions change. No simple rule about it can be laid
down....

One point needs to be carefully borne in mind. However great the volume
of credit exchanges, however extensive the use of credit may become in a
community, they can never fully displace sales for direct money payment.
The extensive use of credit is not of itself a sign that a community is
well off. Credit is used in poor as well as in rich communities. Its
extensive use in a poor and undeveloped country is likely to indicate a
lack of capital rather than an abundance of wealth. Every community
tends to use the cheapest medium of exchange accessible to it. If its
capital is of very high value for producing goods for direct
consumption, a community will be averse to investing much of it in a
medium of exchange.

This is the reason why undeveloped countries, as our own was a century
ago, try to effect their exchanges by means of credit paper to a larger
extent than wealthier communities. Under such conditions paper money is
commonly thought to be the cheapest medium of exchange. If, now, part of
the money exchanges are replaced with credit exchanges, the amount of
money released, or the amount without which the community could now get
on, would be the whole amount formerly used in money payments ... minus
the reserve necessary to do this credit business. The important point,
however, is that less money is necessary. How much less we can not be
sure. We can get some light on the subject, however, by noting the
volume of business done by credit paper and the balances which from time
to time are carried as a basis of settlement.

It is important to note also that an increase in the volume of credit
transactions does not necessarily mean that we must get a proportionate
increase in our reserve of money. Every refinement of the credit
mechanism makes it possible to do a larger volume of business on the
same reserve....

The volume of business that can be done by credit paper depends on
several circumstances. Obviously, in the first place, it depends upon
the banking facilities of the country. If the banks are widely
distributed, if they are willing to deal in transactions small enough to
be within the reach of large numbers of people, many more transactions
will be settled through them than would otherwise be the case. This fact
undoubtedly explains in large measure the development of what may be
called the "banking habit" among the people of the United States.
Undoubtedly our people pay by check much more commonly and much more
largely than people of any other country. We settle smaller transactions
by check; our banks are willing to carry smaller accounts. Indeed, the
rapid industrial development of our country is probably due in no small
degree to our system of independent banks and the facility with which we
have permitted banks to be established. The small independent bank in
the country community has felt that its interests and success were bound
up with the interests and success of the community, and, therefore, has
undoubtedly been willing to do more for the general interests than a
branch of a large bank in some remote commercial center would have felt
like doing, even if it had been justified in doing so. The small capital
with which we have permitted banks to be established also has
undoubtedly been a contributing factor to our rapid economic
development, as well as to the promotion of the banking habit among our
people.

In the next place, the density of population is, of course, an important
factor for the growth of credit exchanges. A larger volume of business
is settled by bank paper in a commercial center than in an agricultural
community, even though the proportion of total business thus settled may
not be larger. However, it is necessary that there should be a certain
number of people within reach of a common center in order to have a bank
established there. Of course the smaller the bank the fewer the people
thus required. Thus again our inclination in the past to favor the
establishment of the small independent banks has facilitated the spread
of banking and promoted the volume of business settled in the country
districts by credit payment and stimulated the banking habit among our
people.

Finally, the general education and intelligence of the mass of the
people is an important factor. Men do not use banks unless they have
confidence in them, and they have come to be regarded as a settled part
of the ordinary commercial mechanism of the community. Our people are
people of a wide general education and high order of intelligence. They
understand the place and work of the bank in a community much better
than the same number of people, for example, in a European country. This
fact is strikingly brought out by a study of the proportion of retail
business settled by means of checks, in what are called the "foreign"
districts of our large cities, on the one hand, and in an agricultural
community on the other. The European immigrant is not a man who has had
banking connections in his home country, and he does not use them here,
even though the facilities are more numerous.

Such evidence as there is seems to indicate that payment by check has
shown an increase during the past few years:

(a) In the first place, the returns of our reports show a larger
percentage in retail trade....

(b) The prosperity of the farmers in the Central West has enabled many
to have bank accounts who fifteen years ago could not carry balances.
The writer's information from central Illinois is strongly in this
direction.

(d) The appearance of a considerable proportion of checks in the
deposits of mutual savings banks is also, to some degree,
significant....

On the other hand, the increase of that part of the population which
consists of the wage-earning class, by whom the use of checks is small,
is undoubtedly greater than that of our other classes of population.
However, the wealthy classes, though fewer in number, have more to spend
and their use of checks raises the proportion of credit paper in
payments.

We can not expect any social movement to continue steadily in one
direction for an indefinite time. Such evidence as inquiries of this
character furnish seems to show that there is a certain ebb and flow in
the proportion of checks used in business payments. With a given amount
of money a certain proportion of it can be used for bank reserves on
which to build credit transactions. For a time the volume of business
will increase more rapidly than the money supplies, so that the
proportion of credit business to the whole will increase, the
improvement of the credit machinery in the meantime facilitating the
movement. But the perfection of the facilities for utilizing to the
utmost a given reserve, or a slowly increasing one, will come to a stop
after a time, and it will be necessary to increase the money supply for
any further expansion of credit. In the language of business, another
unit of capital must be added to plant. The unit added to the social
capital devoted to exchange--that is, the additional amount of
money--will be larger than is necessary for most profitable immediate
use, consequently the proportion of money exchanges will for a time show
an increase. We may conclude, therefore, that the volume of business
done on credit gradually increases as the population and total amount of
business are enlarged, but at a decreasing rate and with occasional or
periodic retardations.

2. _Relation of credit exchanges to the volume of money and prices._--It
is pertinent to inquire, now, what effect, if any, this great settlement
of indebtedness by means of credit paper has upon the value of money.
Evidently, it can influence this value, or the general price level, only
as it changes the amount of demand for money. We have seen reason, now,
to think that 80 per cent. of our business transactions are settled by
means of credit paper. Credit paper cancellation enables a larger amount
of business to be done with the same amount of money and has an effect
in determining the value of money by increasing the demand for
reserves....

... The use of credit paper in effecting credit exchanges makes possible
a far larger volume of business than could otherwise be done, and that
this increased volume of business must in some way influence prices
seem[s] undeniable....

... We are told by many that there is a vast amount of credit
transactions embodied in banking and clearing-house statistics which may
be termed "fictitious." That is to say, they are not a part of the
necessary work of exchange in a community. For example, the cotton and
wheat crops are sold several times over on the exchanges of the country,
but not all these purchases and sales are a necessary part of the
process of getting the cotton from the planter to the manufacturer.
These sales, we are told, are purely speculative and born out of the
credit organization, which, it is urged, merely makes the transactions
possible.... However,... these exchanges actually exist. All the
purchases involved constitute a part of the demand for means of
settlement. Therefore they are to be regarded as a proper part of the
exchange business of the country, and in some degree they must influence
the need for money....

... The demand for money to effect exchanges includes, first, demand for
money for direct exchanges; second, demand for reserves for credit
exchanges. Some goods exchange by direct barter and still more probably
by indirect barter. If these last exchanges just cancelled one another,
the credit paper that grows out of them would also cancel, and no
balances would remain to be settled with money. Usually, however, they
do not cancel, and the balance must be settled with cash; hence a
reserve is necessary.... This demand for reserve is certainly one of the
influences that go to determine the value of money. In short, the demand
for money includes a demand for direct payment and a demand for
reserve....

3. _Our monetary circulation._--Our per capita circulation, as estimated
by the Comptroller of the Currency, has increased from $21.10 in 1906 to
$34.72 in 1908.[42] This is larger than the per capita circulation of
other great industrial and commercial countries with the exception of
France. Why is it necessary and where is it? It is necessary, perhaps,
for the following reasons:

(a) A larger amount of money is needed in this country because, in the
first place, our prices range higher. If the prices of articles commonly
consumed range 20 per cent. higher than they do abroad, the people who
buy them and pay for them with money need a larger amount to make their
purchases. The same cause makes a larger reserve necessary to exchange a
given volume of goods by credit. The demand for money, therefore, both
for reserve and direct money transactions, is greater on account of the
higher scale of prices.

(b) The same kind of reasoning applies to our wage scale. Whether the
wage scale be the cause of the higher cost of living or the higher cost
of living be the cause of the higher wage scale, more money will be
needed in proportion to the trade. If wages are paid with checks, more
money will be needed by the amount that the reserve must be increased to
furnish a basis for the checks.

(c) Our country is more sparsely settled than England, France, or
Germany. In spite of the large increase in the banking facilities of the
country, it still remains true that very many places are remote from
banks, so that business, so far as it is not barter, will probably be
carried on with money. It is necessary, therefore, to have a larger
amount of money than if population were denser....

(d) It may be that our spirit of individualism plays some part. So large
a proportion of our wage-earning population have come from conditions
where they had opportunity to handle very little money, that they like
to carry money on their persons. It makes them feel, as one man said to
the writer, "more independent." To quote the same informant, they would
"rather pay higher prices and have more money to pay with."

(e) Doubtless there is a good deal of hoarding by people who distrust
banks or are not near enough to use them. It might be urged that no
larger proportion of people here hoard than is the case in Europe.
Without disputing this, it is true, however, that if only the same
proportion hoard and in the same relative amounts as is done by
corresponding classes of the population, the absolute amount thus
withdrawn would be larger because of our higher scale of wages and
prices....

FOOTNOTES:

[39] David Kinley, _The Use of Credit Instruments in Payments in the
United States_, pp. 1, 2; 199-216. Senate Document No. 399. 61st
Congress, _2d Session_.

[40] In this discussion the phrase "credit documents" or "credit
instruments" does not include bank notes.

[41] [The effect of credit exchanges on the value of money, treated at
length in the next chapter, is only briefly discussed in the extracts
here reproduced.]

[42] [Approximately $40 in 1916.]

CHAPTER XI

A SYMPOSIUM ON THE RELATION BETWEEN MONEY AND GENERAL PRICES

The form of this chapter was suggested by the proceedings of
a session of the 1910 Meeting of the American Economic
Association, devoted to a consideration of the causes of the
rise in prices between 1896 and 1909. Selections from papers
there presented, and from the relative discussion, make up a
considerable part of the chapter, and it is suggested that
all of the selections, except the last, may well be
considered for purposes of study as having come from the
papers and discussion of the session referred to, although
numerous additions and substitutions have been made in order
to render the treatment one of principles involved in the
determination of general prices without special reference to
any particular period of years.

IRVING FISHER[43]: Overlooking the influence of deposit currency, or
checks, the price level may be said to depend on only three sets of
causes: (1) the quantity of money in circulation; (2) its "efficiency"
or velocity of circulation (or the average number of times a year money
is exchanged for goods); and (3) the volume of trade (or amount of goods
bought by money). The so-called "quantity theory,"[44] _i.e._, that
prices vary proportionately to money, has often been incorrectly
formulated, but (overlooking checks) the theory is correct in the sense
that the level of prices varies directly with the quantity of money in
circulation, provided the velocity of circulation of that money and the
volume of trade which it is obliged to perform are not changed.

The quantity theory has been one of the most bitterly contested theories
in economics, largely because the recognition of its truth or falsity
affected powerful interests in commerce and politics. It has been
maintained--and the assertion is scarcely an exaggeration--that the
theorems of Euclid would be bitterly controverted if financial or
political interests were involved.

The quantity theory has, unfortunately, been made the basis of arguments
for unsound currency schemes. It has been invoked in behalf of
irredeemable paper money and of national free coinage of silver at the
ratio of 16 to 1. As a consequence, not a few "sound money men,"
believing that a theory used to support such vagaries must be wrong, and
fearing the political effects of its propagation, have drifted into the
position of opposing, not only the unsound propaganda, but also the
sound principles by which its advocates sought to bolster it up.[45]
These attacks upon the quantity theory have been rendered easy by the
imperfect comprehension of it on the part of those who have thus invoked
it in a bad cause.

Personally, I believe that few mental attitudes are more pernicious, and
in the end more disastrous, than those which would uphold sound practice
by denying sound principles because some thinkers make unsound
application of those principles. At any rate, in scientific study there
is no choice but to find and state the unvarnished truth.

The quantity theory will be made more clear by the equation of exchange,
which is now to be explained.

The equation of exchange is a statement, in mathematical form, of the
total transactions effected in a certain period in a given community. It
is obtained simply by adding together the equations of exchange for all
individual transactions. Suppose, for instance, that a person buys 10
pounds of sugar at 7 cents per pound. This is an exchange transaction,
in which 10 pounds of sugar have been regarded as equal to 70 cents, and
this fact may be expressed thus: 70 cents = 10 pounds of sugar
multiplied by 7 cents a pound. Every other sale and purchase may be
expressed similarly, and by adding them all together we get the equation
of exchange _for a certain period in a given community_. During this
same period, however, the same money may serve, and usually does serve,
for several transactions. For that reason the money side of the equation
is of course greater than the total amount of money in circulation.

The equation of exchange relates to all the purchases made by money in a
certain community during a certain time. We shall continue to ignore
checks or any circulating medium not money. We shall also ignore foreign
trade and thus restrict ourselves to trade within a hypothetical
community. Later we shall reinclude these factors, proceeding by a
series of approximations through successive hypothetical conditions to
the actual conditions which prevail to-day. We must, of course, not
forget that the conclusions expressed in each successive approximation
are true solely on the particular hypothesis assumed.

The equation of exchange is simply the sum of the equations involved in
all individual exchanges in a year. In each sale and purchase, the money
and goods exchanged are _ipso facto_ equivalent; for instance, the money
paid for sugar is equivalent to the sugar bought. And in the grand total
of all exchanges for a year, the total money paid is equal in value to
the total value of the goods bought. The equation thus has a money side
and a goods side. The money side is the total money paid, and may be
considered as the product of the quantity of money multiplied by its
rapidity of circulation. The goods side is made up of the products of
quantities of goods exchanged multiplied by their respective prices.

The important magnitude, called the velocity of circulation, or rapidity
of turnover, is simply the quotient obtained by dividing the total money
payments for goods in the course of a year by the average amount of
money in circulation by which those payments are effected. This velocity
of circulation for an entire community is a sort of average of the rates
of turnover of money for different persons. Each person has his own rate
of turnover which he can readily calculate by dividing the amount of
money he expends per year by the average amount he carries.

Let us begin with the money side. If the number of dollars in a country
is 5,000,000, and their velocity of circulation is twenty times per
year, then the total amount of money changing hands (for goods) per year
is 5,000,000 times twenty, or $100,000,000. This is the _money_ side of
the equation of exchange.

Since the money side of the equation is $100,000,000, the goods side
must be the same. For if $100,000,000 has been spent for goods in the
course of the year, then $100,000,000 worth of goods must have been sold
in that year. In order to avoid the necessity of writing out the
quantities and prices of the innumerable varieties of goods which are
actually exchanged, let us assume for the present that there are only
three kinds of goods,--bread, coal, and cloth; and that the sales are:

200,000,000 loaves of bread at $ .10 a loaf,
10,000,000 tons of coal at 5.00 a ton, and
30,000,000 yards of cloth at 1.00 a yard.

The value of these transactions is evidently $100,000,000, _i. e._,
$20,000,000 worth of bread plus $50,000,000 worth of coal plus
$30,000,000 worth of cloth. The equation of exchange therefore (remember
that the money side consisted of $5,000,000 exchanged 20 times) is as
follows:

$5,000,000 × 20 times a year
= 200,000,000 loaves × $ .10 a loaf
+ 10,000,000 tons × 5.00 a ton
+ 30,000,000 yards × 1.00 a yard

This equation contains on the money side two magnitudes, viz. (1) the
quantity of money and (2) its velocity of circulation; and on the goods
side two _groups_ of magnitudes in two columns, viz. (1) the quantities
of goods exchanged (loaves, tons, yards), and (2) the prices of these
goods. The equation shows that these four sets of magnitudes are
mutually related. Because this equation must be fulfilled, the prices
must bear a relation to the three other sets of magnitudes--quantity of
money, rapidity of circulation, and quantities of goods exchanged.
Consequently, these prices must, as a whole, vary proportionally with
the quantity of money and with its velocity of circulation, and
inversely with the quantities of goods exchanged.

Suppose, for instance, that the quantity of money were doubled, while
its velocity of circulation and the quantities of goods exchanged
remained the same. Then it would be quite impossible for prices to
remain unchanged. The money side would now be $10,000,000 × 20 times a
year or $200,000,000; whereas, if prices should not change, the goods
would remain $100,000,000, and the equation would be violated. Since
exchanges, individually and collectively, always involve an equivalent
_quid pro quo_, the two sides _must_ be equal. Not only must purchases
and sales be equal in amount--since every article bought by one person
is necessarily sold by another--but the total value of goods sold must
equal the total amount of money exchanged. Therefore, under the given
conditions, prices must change in such a way as to raise the goods side
from $100,000,000 to $200,000,000. This doubling may be accomplished by
an even or uneven rise in prices but some sort of _a rise of prices
there must be_. If the prices rise evenly, they will evidently all be
exactly doubled.... If the prices rise unevenly, the doubling must
evidently be brought about by compensation; if some prices rise by less
than double, others must rise by enough more than double to exactly
compensate.

But whether all prices increase uniformly, each being exactly doubled,
or some prices increase more and some less (so as still to double the
total money value of the goods purchased), the prices _are_ doubled _on
the average_.... From the mere fact, therefore, that the money spent for
goods must equal the quantities of those goods multiplied by their
prices, it follows that the level of prices must rise or fall according
to changes in the quantity of money, _unless_ there are changes in its
velocity of circulation or in the quantities of goods exchanged.

If changes in the quantity of money affect prices, so will changes in
the other factors--quantities of goods and velocity of
circulation--affect prices, and in a very similar manner. Thus a
doubling in the velocity of circulation of money will double the level
of prices, provided the quantity of money in circulation and the
quantities of goods exchanged for money remain as before....

Again, a doubling in the quantities of goods exchanged will not double,
but halve, the height of the price level, _provided_ the quantity of
money and its velocity of circulation remain the same....

Finally, if there is a simultaneous change in two or all of the three
influences, _i. e._, quantity of money, velocity of circulation, and
quantities of goods exchanged, the price level will be a compound or
resultant of these various influences. If, for example, the quantity of
money is doubled, and its velocity of circulation is halved, while the
quantity of goods exchanged remains constant, the price level will be
undisturbed. Likewise, it will be undisturbed if the quantity of money
is doubled and the quantity of goods is doubled, while the velocity of
circulation remains the same. To double the quantity of money,
therefore, is not always to double prices. We must distinctly recognize
that the quantity of money is only one of three factors, all equally
important in determining the price level....

We now come to the strict algebraic statement of the equation of
exchange.... Let us denote the total circulation of money, _i. e._, the
amount of money expended for goods in a given community during a given
year, by _E_ (expenditure); and the average amount of money in
circulation in the community during the year by _M_ (money). _M_ will be
the simple arithmetical average of the amounts of money existing at
successive instants separated from each other by equal intervals of time
indefinitely small. If we divide the year's expenditures, _E_, by the
average amount of money, _M_, we shall obtain what is called the average
rate of turnover of money in its exchange for goods, _E_/_M_ that is,
the velocity of circulation of money. This velocity may be denoted by
_V_, so that _E_/_M_ = _V_; then _E_ may be expressed as _MV_. In words:
the total circulation of money in the sense of money expended is equal
to the total money in circulation multiplied by its velocity of
circulation or turnover. _E_ or _MV_, therefore, expresses the money
side of the equation of exchange. Turning to the goods side of the
equation, we have to deal with the prices of goods exchanged and
quantities of goods exchanged. The average price of sale of any
particular good, such as bread, purchased in the given community during
the given year, may be represented by _p_ (price); and the total
quantity of it purchased, by _Q_ (quantity); likewise the average price
of another good (say coal) may be represented by _p´_ and the total
quantity of it exchanged, by _Q´_; the average price and the total
quantity of a third good (say cloth) may be represented by _p´´_ and
_Q´´_ respectively; and so on, for all other goods exchanged, however
numerous. The equation of exchange may evidently be expressed as
follows:

_MV_ = _pQ_
+ _p´Q´_
+ _p´´Q´´_
+ etc.

The right-hand side of this equation is the sum of terms of the form
_pQ_--a price multiplied by a quantity bought. It is customary in
mathematics to abbreviate such a sum of terms (all of which are of the
same form) by using "Sigma" as a symbol of summation. This symbol
does not signify a _magnitude_ as do the symbols _M, V, p, Q_, etc. It
signifies merely the _operation_ of addition and should be read "the sum
of terms of the following type." The equation of exchange may therefore
be written:

_MV_ = Sigma_pQ_.

That is, the magnitudes _E_, _M_, _V_, the _p_'s and the _Q_'s relate to
the _entire_ community and an _entire_ year; but they are based on and
related to corresponding magnitudes for the individual persons of which
the community is composed and for the individual moments of time of
which the year is composed.

The algebraic derivation of this equation is, of course, essentially the
same as the arithmetical derivation previously given. It consists simply
_in adding together the equations for all individual purchases within
the community during the year_....

[We are now] ... prepared for the inclusion of bank deposits or
circulating credit in the equation of exchange. We shall still use _M_
to express the quantity of actual money, and _V_ to express the velocity
of its circulation.[46] Similarly, we shall now use _M´_ to express the
total deposits subject to transfer by check; and _V´_ to express the
average velocity of circulation. The total value of purchases in a year
is therefore no longer to be measured by _MV_, but by _MV_ + _M´V´´_.
The equation of exchange, therefore, becomes:

_MV_ + _M´V´_ = Sigma_pQ_ = _PT_[47]....

With the extension of the equation of monetary circulation to include
deposit circulation, the influence exerted by the quantity of money on
general prices becomes less direct; and the process of tracing this
influence becomes more difficult and complicated. It has even been
argued that this interposition of circulating credit breaks whatever
connection there may be between prices and the quantity of money.[48]
This would be true if circulating credit were independent of money. But
the fact is that the quantity of circulating credit, _M´_, tends to hold
a definite relation to _M_, the quantity of money in circulation; that
is, deposits are normally a more or less definite multiple of money.

Two facts normally give deposits a more or less definite ratio to money.
The first ... [is] that bank reserves are kept in a more or less
definite ratio to bank deposits. The second is that individuals, firms,
and corporations preserve more or less definite ratios between their
cash transactions and their check transactions, and also between their
money and deposit balances.[49] These ratios are determined by motives
of individual convenience and habit. In general, business firms use
money for wage payments, and for small miscellaneous transactions
included under the term "petty cash"; while for settlements with each
other they usually prefer checks. These preferences are so strong that
we could not imagine them overridden except temporarily and to a small
degree. A business firm would hardly pay car fares with checks and
liquidate its large liabilities with cash. Each person strikes an
equilibrium between his use of the two methods of payment, and does not
greatly disturb it except for short periods of time. He keeps his stock
of money or his bank balance in constant adjustment to the payments he
makes in money or by check. Whenever his stock of money becomes
relatively small and his bank balance relatively large, he cashes a
check. In the opposite event, he deposits cash. In this way he is
constantly converting one of the two media of exchange into the other. A
private individual usually feeds his purse from his bank account; a
retail commercial firm usually feeds its bank account from its till. The
bank acts as intermediary for both.

In a given community the quantitative relation of deposit currency to
money is determined by several considerations of convenience. In the
first place, the more highly developed the business of a community, the
more prevalent the use of checks. Where business is conducted on a large
scale, merchants habitually transact their larger operations with each
other by means of checks, and their smaller ones by means of cash.
Again, the more concentrated the population, the more prevalent the use
of checks. In cities it is more convenient both for the payer and the
payee to make large payments by check; whereas, in the country, trips to
a bank are too expensive in time and effort to be convenient, and
therefore more money is used in proportion to the amount of business
done. Again, the wealthier the members of the community, the more
largely will they use checks. Laborers seldom use them; but capitalists,
professional and salaried men use them habitually, for personal as well
as business transactions.

There is, then, a relation of convenience and custom between check and
cash circulation, and a more or less stable ratio between the deposit
balance of the average man or corporation and the stock of money kept in
pocket or till. This fact, as applied to the country as a whole, means
that by convenience a rough ratio is fixed between _M_ and _M´_. If that
ratio is disturbed temporarily, there will come into play a tendency to
restore it. Individuals will deposit surplus cash, or they will cash
surplus deposits.

Hence, both money in circulation ... and money in reserve ... tend to
keep in a fixed ratio to deposits. It follows that the two must be in a
fixed ratio to each other.

It further follows that any change in _M_, the quantity of money in
circulation, requiring as it normally does a proportional change in
_M´_, the volume of bank deposits subject to check, will result in an
exactly proportional change in the general level of prices except, of
course, so far as this effect be interfered with by concomitant changes
in the _V_'s or the _Q_'s. The truth of this proposition is evident from
the equation _MV_ + _M´V´_ = Sigma_pQ_; for if, say, _M_ and _M´_
are doubled, while _V_ and _V´_ remain the same, the left side of the
equation is doubled and therefore the right side must be doubled also.
But if the _Q_'s remain unchanged, then evidently all the _p_'s must be
doubled, or else if some are less than doubled, others must be enough
more than doubled to compensate....

The factors in the equation of exchange are ... continually seeking
normal adjustment. A ship in a calm sea will "pitch" only a few times
before coming to rest, but in a high sea, the pitching never ceases.
While continually seeking equilibrium, the ship continually encounters
causes which accentuate the oscillation. The factors seeking mutual
adjustment are money in circulation, deposits, their velocities, the
_Q_'s and the _p_'s. These magnitudes must always be linked together by
the equation _MV_ + _M´V´_ = Sigma_pQ_. This represents the
mechanism of exchange. But in order to conform to such a relation the
displacement of any one part of the mechanism spreads its effects during
the transition periods [_i.e._, periods of rising or falling prices]
over all parts. Since periods of transition are the rule and those of
equilibrium the exception, the mechanism of exchange is almost always in
a dynamic rather than a static condition....[50]

[Illustration]

[51]It is interesting to make a quantitative comparison of the various
magnitudes with the increase in the quantity of money as the most
important factor in raising the price level. While it is true, as shown
by the diagram, that the volume of deposits subject to check has
increased greatly, the major part of the increase has to be ascribed to
the increase in the quantity of money. Only so far as the volume of
deposits subject to check has increased relatively to the money in
circulation, can the increase of deposits be regarded as an independent
cause of the rise in prices. We have thus to consider the relative
importance of the five causes affecting prices:

1. The quantity of money in circulation (M).

2. The volume of bank deposits subject to check considered relatively to
money (M´/M).

3. The velocity of the former (V´).

4. The velocity of the latter (V).

5. The volume of trade (T).

We may best compare the relative importance of these five magnitudes by
answering the question: What would the result have been had any one of
these magnitudes remained unchanged, assuming that the other four
changed in the same manner that they actually did change. We find (1)
that if the money in circulation, M, had not changed, between the years
1896 and 1909, for example, the price level of 1909 would have been 45
per cent. lower than it actually was; (2) that if M´/M, the relative
deposits, had not changed, during the same period the price level in
1909 would have been 23 per cent. lower than it actually was; (3) if the
velocity of circulation of money, V, had not changed, the price level
for 1909 would have been 1 per cent. lower; (4) if the velocity of
circulation of deposits, V´, had not changed, the price level in 1909
would have been 28 per cent. lower; (5) if T had not changed, the price
level in 1909 would have been 106 per cent. _higher_.

Thus the changes in the first four factors have tended to raise prices,
while the change in T has tended to lower prices. The relative
importance of the four price-raising causes may be stated in terms of
the per cent. already given which represents how much lower prices would
have been except for each of these causes separately considered.
According to this test we find the relative importance of the four
price-raising factors to be as follows:

The importance of V is represented by 1,

The importance of M´/M is represented by 23,

The importance of V is represented by 28,

The importance of M is represented by 45.

That is, the increase in the quantity of money had an importance nearly
double that of any other one price-raising factor, during the period
mentioned.

INDIRECT INFLUENCES ON PURCHASING POWER[52]

Thus far we have considered the level of prices as affected by the
volume of trade, by the velocities of circulation of money and of
deposits, and by the quantities of money and of deposits. These are the
only influences which can _directly_ affect the level of prices. Any
other influences on prices must act through these five. There are
myriads of such influences (outside of the equation of exchange) that
affect prices through these five. It is our purpose ... to note the
chief among them....

We shall first consider the outside influences that affect the volume of
trade and, through it, the price level. The conditions which determine
the extent of trade are numerous and technical. The most important may
be classified as follows:

1. _Conditions affecting producers._

(a) Geographical differences in natural resources.

(b) The division of labor.

(d) The accumulation of capital.

2. _Conditions affecting consumers._

(a) The extent and variety of human wants.

3. _Conditions connecting producers and consumers._

(a) Facilities for transportation.

(b) Relative freedom of trade.

(d) Business confidence.

1 (a). It is evident that if all localities were exactly alike in their
natural resources, in other words, in their comparative costs of
production, no trade would be set up between them.... Cattle raising in
Texas, the production of coal in Pennsylvania, of oranges in Florida,
and of apples in Oregon have increased the volume of trade for these
communities respectively.

1 (b). Equally obvious is the influence of the division of labor....

1 (c).... The state of knowledge of production will affect trade. Vast
coal fields in China await development, largely for lack of knowledge of
how to extract and market the coal. Egypt awaits the advent of
scientific agriculture, to usher in trade expansion. Nowadays, trade
schools in Germany, England, and the United States are increasing and
diffusing knowledge of productive technique.

1 (d). But knowledge, to be of use, must be applied; and its application
usually requires the aid of capital. The greater and the more productive
the stock or capital in any community, the more goods it can put into
the currents of trade....

Since increase in trade tends to decrease the general level of prices,
anything which tends to increase trade likewise tends to decrease the
general level of prices. We conclude, therefore, that among the causes
tending to decrease prices are increasing geographical or personal
specialization, improved productive technique, and the accumulation of
capital. The history of commerce shows that all these causes have been
increasingly operative during a long period including the last century.
Consequently, there has been a constant tendency, from these sources at
least, for prices to fall.

2 (a).... An increase of wants, by leading to an increase in trade,
tends to lower the price level. Historically, during recent times
through invention, education, and the emulation coming from increased
contact in centers of population, there has been a great intensification
and diversification of human wants and therefore increased trade.
Consequently, there has been from these causes a tendency of prices to
fall.

3 (a). Anything which facilitates intercourse tends to increase trade.
Anything that interferes with intercourse tends to decrease trade. First
of all, there are the mechanical facilities for transport. As Macaulay
said, with the exception of the alphabet and the printing press, no set
of inventions has tended to alter civilization so much as those which
abridge distance,--such as the railway, the steamship, the telephone,
the telegraph, and that conveyer of information and advertisements, the
newspaper. These all tend, therefore, to decrease prices.

3 (b). Trade barriers are not only physical but legal. A tariff between
countries has the same influence in decreasing trade as a chain of
mountains. The freer the trade, the more of it there will be....

3 (c). The development of efficient monetary and banking systems tends
to increase trade. There have been times in the history of the world
when money was in so uncertain a state that people hesitated to make
many trade contracts because of the lack of knowledge of what would be
required of them when the contract should be fulfilled. In the same way,
when people cannot depend on the good faith or stability of banks, they
will hesitate to use deposits and checks.

3 (d). Confidence, not only in banks in particular, but in business in
general, is truly said to be "the soul of trade." Without this
confidence there cannot be a great volume of contracts. Anything that
tends to increase this confidence tends to increase trade....

We see, then, that prices will tend to fall through increase in trade,
which may in turn be brought about by improved transportation, by
increased freedom of trade, by improved monetary and banking systems,
and by business confidence. Historically, during recent years, all of
these causes have tended to grow in power, except freedom of trade....

Having examined those causes outside the equation which affect the
volume of trade, our next task is to consider the outside causes that
affect the velocities of circulation of money and of deposits. For the
most part, the causes affecting one of these velocities affect the other
also. These causes may be classified as follows:

1. _Habits of the individual._

(a) As to thrift and hoarding.

(b) As to book credit.

2. _Systems of payments in the community._

(a) As to frequency of receipts and of disbursements.

(b) As to regularity of receipts and disbursements.

3. _General causes._

(a) Density of population.

(b) Rapidity of transportation.

1 (a). Taking these up in order, we may first consider what influence
thrift has on the velocity of circulation. Velocity of circulation of
money is the same thing as its rate of turnover. It is found by dividing
the total payments effected by money in a year by the amount of money in
circulation in a year. It depends upon the rates of turnover of the
individuals who compose the society. This velocity of circulation or
rapidity of turnover of money is the greater for each individual the
more he spends, with a given average amount of cash on hand; or the less
average cash he keeps, with a given yearly expenditure....

1 (b). The habit of "charging," _i.e._, using book credit, tends to
_increase_ the velocity of circulation of money, because the man who
gets things "charged" does not need to keep _on hand_ as much money as
he would if he made all payments in cash. A man who pays _cash_ daily
needs to keep cash for daily contingencies. The system of cash payments,
unlike the system of book credit, requires that money shall be kept on
hand _in advance_ of purchases. Evidently, if money must be provided in
advance, it must be provided in larger quantities than when merely
required to liquidate past debts....

But we have seen that to increase the rate of turnover will tend to
increase the price level. Therefore, book credit tends to increase the
price level....

1 (c). The habit of using checks rather than money will also affect the
velocity of circulation; because a depositor's surplus money will
immediately be put into the bank in return for a right to draw by
check....

We see, then, that three habits--spendthrift habits, the habit of
charging, and the habit of using checks--all tend to raise the level of
prices....

2 (a). The more frequently money or checks are received and disbursed,
the shorter is the average interval between the receipt and the
expenditure of money or checks and the more rapid is the velocity of
circulation.

This may best be seen from an example. A change from monthly to weekly
wage payments tends to increase the velocity of circulation of money. If
a laborer is paid weekly $7 and reduces this evenly each day, ending
each week empty-handed, his average cash ... would be a little over half
of $7, or about $4. This makes his turnover nearly twice a week. Under
monthly payments the laborer who receives and spends an average of $1 a
day will have to spread the $30 more or less evenly over the following
30 days. If, at the next pay day, he comes out empty-handed, his average
money during the month has been about $15. This makes his turnover about
twice a month. Thus the rate of turnover is more rapid under weekly than
under monthly payments....

Frequency of disbursements evidently has an effect similar to the effect
of frequency of receipts; _i.e._, it tends to accelerate the velocity of
turnover, or circulation.

2 (b). _Regularity_ of payments also facilitates the turnover. When the
workingman can be fairly certain of both his receipts and expenditures,
he can, by close calculation, adjust them so precisely as safely to end
each payment cycle with an empty pocket. This habit is extremely common
among certain classes of city laborers. On the other hand, if the
receipts and expenditures are irregular, either in amount or in time,
prudence requires the worker to keep a larger sum on hand, to insure
against mishaps.... We may, therefore, conclude that regularity, both of
receipts and of payments, tends to increase velocity of circulation.

2 (c). Next, consider the synchronizing of receipts and disbursements,
_i. e._, making payments at the same intervals as obtaining receipts....
This arrangement obviates the necessity of keeping much money or
deposits on hand, and therefore increases their velocity of
circulation....

3 (a). The more densely populated a locality, the more rapid will be the
velocity of circulation.

There is definite evidence that this is true of bank deposits. The
following figures give the velocities of circulation of deposits in ten
cities, arranged in order of size:

Paris 116
Berlin 161
Brussels 123
Madrid 14
Rome 43
Lisbon 29
Indianapolis 30
New Haven 16
Athens 4
Santa Barbara 1

Madrid is the only city seriously out of its order in respect to
velocity of circulation.

3 (b). Again the more extensive and the speedier the transportation in
general, the more rapid the circulation of money. Anything which makes
it easier to pass money from one person to another will tend to increase
the velocity of circulation. Railways have this effect.... Mail and
express, by facilitating the transmission of bank deposits and money,
have likewise tended to increase their velocity of circulation.

We conclude, then, that density of population and rapidity of
transportation have tended to increase prices by increasing velocities.
Historically this concentration of population in cities has been an
important factor in raising prices in the United States....

[SUMMARY]

[53]The purchasing power ... of money has been studied as the effect of
five, and only five, groups of causes. The five groups are money,
deposits, their velocities of circulation, and the volume of trade.
These and their effects, prices, we saw to be connected by an equation
called the equation of exchange, _MV + M'V' = SigmapQ_. The five
causes, in turn,... are themselves effects of antecedent causes lying
entirely outside of the equation of exchange, as follows: the volume of
trade will be increased, and therefore the price level correspondingly
decreased by the differentiation of human wants; by diversification of
industry; and by facilitation of transportation. The velocities of
circulation will be increased, and therefore also the price level
increased by improvident habits; by the use of book credit; and by rapid
transportation. The quantity of money will be increased and therefore
the price level increased correspondingly by the import and minting of
money, and, antecedently, by the mining of the money metal; by the
introduction of another and initially cheaper money metal through
bimetallism; and by the issue of bank notes and other paper money. The
quantity of deposits will be increased, and therefore the price level
increased by extension of the banking system and by the use of book
credit. The reverse causes produce, of course, reverse effects.

Thus, behind the five sets of causes which alone affect the purchasing
power of money, we find over a dozen antecedent causes. If we chose to
pursue the inquiry to still remoter stages, the number of causes would
be found to increase at each stage in much the same way as the number of
one's ancestors increases with each generation into the past. In the
last analysis myriads of factors play upon the purchasing power of
money; but it would be neither feasible nor profitable to catalogue
them. The value of our analysis consists rather in simplifying the
problem by setting forth clearly the five proximate causes through which
all others whatsoever must operate. At the close of our study, as at the
beginning, stands forth the equation of exchange as the great
determinant of the purchasing power of money.

J. Laurence Laughlin[54]: To my mind, the following propositions contain
the essence of the theory of prices.... As every one will appreciate,
only general statements, without any limiting qualifications to speak
of, can be given in so small a compass.

1. The price of a commodity is measured by the quantity of a given
standard for which it will exchange.

2. A change of prices may be due to changes in the conditions affecting
the supply (thus including expenses of production) of goods, as well as
to changes in the demand for and supply of gold. A statistical statement
of a change of price is not a statement of the cause of the change.

3. Probably there is not so much difference of opinion regarding the
theory of prices as is sometimes supposed. Other causes being supposed
constant, an increased supply of gold would tend to raise prices. No one
can fail to see that, if by "money" is meant gold, a change in its
quantity would, other things being equal, be a factor affecting prices.
An increasing demand for gold, however, would work against the effect of
an increasing supply. If the new demand offset the new supply, then, if
changes of prices occurred, their cause must be sought in the influences
touching the producing and marketing of goods.

4. The effective demand for goods (granting their utility) is limited by
the buyer's purchasing power. This purchasing power is not identical
with the quantity of the media of exchange in circulation, any more than
the value of the total exchangeable wealth of the community is identical
with the value of the total money in circulation.

5. The general level of prices is not independent of particular prices;
since there can be no such thing as a general level, or average, of
prices which is not the resultant of a number of particular prices each
arrived at by individual buyers and sellers. The causes of price changes
must be sought in the forces settling particular prices. This does not
exclude the consideration of any causes affecting the value of the
standard in which the prices of goods are expressed, because the
standard is itself a particular commodity.

6. In particular cases, competitive prices in this country are arrived
at by the higgling of the market, which depends on buyers' and sellers'
judgment of the demand and supply of the commodity (_e. g._, wheat);
and, when the price is fixed, the credit medium by which the commodity
is passed from seller to buyer comes easily and naturally into existence
and, of course, for a sum exactly equaling the price agreed upon,
multiplied by the number of units of goods. Price-making generally
precedes the demand upon the media of exchange, and does not at all
imply any necessary demand at the moment upon the standard in which the
prices are expressed (cf. 10).

7. The offer of "money" for goods is only a resultant of price-making
forces previously at work, and does not measure the demand for goods
(cf. 6). That is, the quantity of the actual media of exchange thus
brought into use is a result and not a cause of the price-making
process. The supposed offer of money has no money as its basis, but is
only the offer of a purchasing power, previously existing, based on
saleable goods, which at the moment of payment appears expressed in
terms of the standard. By credit devices the actual transfer of the
standard is reduced to an inconsiderable minimum. In reality (as in
foreign trade) goods are exchanged against goods.

8. The effect of credit on prices is to be found mainly in banking
facilities by which goods are coined into means of payment, so that,
expressed in terms of the standard gold, they may be exchanged against
each other. Thus credit devices relieve the standard to an incredibly
great degree from the demand for the use of gold as a medium of
exchange, and thus remove a demand, as trade increases, which would
otherwise have enormously affected the value of gold. Thus the effect of
credit on the general level of prices in considerable periods of time is
shown by a tendency to reduce the demand on the standard gold, and hence
to prevent the tendency toward falling prices.

9. A general proposition is that banks are limited in making loans by
the possession of capital, a bank of large capital and deposits being
able to make large loans, a bank of small capital and deposits, small
loans. A second proposition is that the demand for legitimate loans
varies with the exchanges of goods and collateral and the opportunities
for investment. With an increasing activity in business, however--either
sound or speculative--the expansion of loans is limited by the resources
of the bank. Next, a bank trying to carry a certain amount of loans,
must hold a specified proportion of reserves to demand liabilities under
the rule of banking experience or law. The amount of its capital and the
funds left with it determine the relative size of its loan item; and the
sum of its loans and resultant deposits determine the amount of its
reserves. The reserves of a bank are thus a consequence of the loan
operations. This conclusion, however, as it affects the practical
problem of the present day, is not, in my opinion, invalidated by the
conceivable cases arising, when business tends to outrun banking
facilities, in which anything that makes increasing reserves possible
would increase the power of the banks to lend. When gold becomes
increasingly abundant, the banks having large resources more easily get
the gold reserves needed for their operations. It still remains true
that the fact of an increased supply of gold does not of itself increase
loans, unless conditions of business demand an increase in loans.
Therefore, the expansion of business is not a necessary consequence of
an increasing supply of gold, any more than an expansion of railway
traffic is the necessary consequence of an increasing supply of cars. If
increasing goods are in existence to be transported, then, of course,
there is an increasing demand for cars. Likewise, if there are more bank
resources and loans, there is an increasing demand for that which is
lawful reserve; from which it is claimed that the use of new gold in
bank reserves, under present conditions, is not the significant causal
force which expands business and raises prices (although it may be
contemporary with it).

10. The problem of explaining the general level of prices is one of
arriving at the adjustment between two terms of a ratio (the standard on
the one side, and goods on the other), each of which is influenced by
supply and demand. Gold being one, and goods being many, a cause working
on gold alone, and important enough to show an appreciable effect, might
explain a general movement of prices. In practical operation, however,
because of the large existing stock of gold, very considerable additions
may take place in the supply of gold without materially changing the
world value of gold as related to goods in general. Rapid changes of
prices are hence more likely to be due to influences in the market for
goods, to speculative changes of demand for goods, or to psychological
forces working independently of facts....

In the problem of discovering the causes of changes in the level of
prices, it is necessary first to reach a conclusion as to those causes
which operate on the gold standard in which our prices are expressed. By
so doing we may locate the general level--so far as the standard is
concerned--or the one thing which might work as a cause common to all
goods. The relation between gold and goods might be illustrated by the
familiar mechanical illustration: a rod balanced on a fulcrum, on one
end of which works the forces affecting the value of gold, and on the
other end the forces affecting the value of particular goods. The
relation between goods and gold being a ratio, as one end of the rod
goes up, the other necessarily goes down.

There are, as we all know, various forces at work to produce the
resultant price level. We may here start from a proposition on which we
can all agree. An increase in the quantity of the monetary standard in
the world--such as gold--would tend, _other things being equal_, to
lower its value and thus raise prices. In trying to find the causes in
the price level at any given time (as in 1896-1909) it is necessary,
therefore, after stating the facts as to the increase of gold, to
examine into the influence of "the other things."

To begin, we may take up the demand for gold, which, of course, is both
monetary and non-monetary. First as to the non-monetary uses, such as
abrasion, shipwreck, and disappearance in the arts: The statistics of
consumption in the arts are unsatisfactory; at the best they are only
estimates. Although the total production of the world, 1493-1850, was
$3,158,000,000, there is no evidence as to the available stock in 1850.
My belief is that there was not more than $2,000,000,000.[55] In the
period of 1851-1895, the production was $5,641,000,000, and the
consumption in the arts, at the average rate of $50,000,000 a year
requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The
arts in recent years are estimated to use more than $100,000,000.[56] In
the period, 1896-1905, if $1,000,000,000 be deducted from the production
of $2,899,000,000 we have $1,899,000,000. Thus the total available stock
in 1905 would be about $7,690,000,000. The production of the last four
years, 1906-1910, is about $1,600,000,000, or, less the consumption in
the arts, about $1,200,000,000.

The monetary demand for gold, on the other hand, has shown certain
definite characteristics. Whether it be prejudice, or enlightened
business judgment, the commercial nations of the world have shown a
persistent and continuing disposition to adopt a gold monetary system as
soon as their own means, or the forthcoming supply of gold, has made it
possible. The United States led in 1853, when we declined to change the
ratio in order to bring silver into circulation when only gold was in
use. From 1871-3, Germany, the countries of the Latin Union,
Austria-Hungary, the United States (with the resumption in gold in
1879), and India (in 1893), in response to the preferences of the
commercial world, placed themselves on the gold standard by legal
enactments. The demand for gold all through this period was based upon
considerations independent of the movement of prices. For this was a
time of falling prices when much was heard of the appreciation of gold
and the need of silver. In spite of this tendency toward falling prices,
the movement toward the adoption of gold went on.... It was precisely
this large new supply of gold which enabled the commercial nations to
gratify their desire for what they believed was a more stable standard.

As we enter the present period (1896-1909) we find this momentum towards
the gold standard still in force: and other countries in emulation
planned to put themselves on an equally stable standard with those
whose means had permitted an earlier action--quite irrespective of the
fact that this last was a period of rising prices, while the former was
one of falling prices. In this period, Russia, Japan, various states in
South America, such as Peru, Argentina, and Brazil, and recently Mexico,
have emphasized the movement away from silver to gold. Moreover, as
backward lands, like Turkey, parts of Asia, Egypt, and various districts
of Africa, have developed their resources and increased their trade,
they have taken on gold in their monetary systems. With increasing trade
also there are more exchanges of goods; hence, even in countries (like
Great Britain and the United States) that do not use gold to speak of,
except in reserves, there are increasing loans and deposits and thus a
demand for more gold reserves. Consequently, in countries long ago
established on the gold standard there will be a steadily increasing
demand for gold as exchanges expand. We find thus a special
characteristic of the demand for gold (certainly not existing in the
demand for silver). The power of developing countries to soak up new
gold is as marked a part of present conditions as is the power of a
porous and sandy soil to soak up a heavy rainfall. We must, therefore,
take full account of the noticeable fact that the recent demand for gold
seems about to keep pace with the new supply; that a shipment of gold
from the mines to London is to-day eagerly competed for, not only by
European countries, but by Egypt, India, Turkey, Argentina, and Brazil.

Consequently it may be of interest to see which countries have taken the
largest amounts of gold into their stocks since 1895:

United States $994,000,000
Russia 427,000,000
Germany 419,000,000
South American States 213,000,000
British Empire 194,000,000
Austria-Hungary 163,000,000
Italy 160,000,000

Besides the demand for gold in the arts, and the apparent monetary
demand, as thus already presented, we must not omit to take into account
also the large stocks of gold held by banks and institutions which
publish no statements. In the hands of large private institutions like
those of the Rothschilds, Bleichroders, and others, great amounts of
gold are carried. It is from such stores that the needs of states, such
as Austria-Hungary, France, Italy, and even the United States (in
Cleveland's administration), have been supplied without drawing down
visible reserves.

Thus far, then, we have examined the one factor of demand for gold,
among the "other things" (which were supposed to remain equal). There is
abundant evidence to show that the demand for gold, in this recent
period of rising prices (1896-1909) has been as strong as, or even
stronger than, the demand for gold in the previous period (1873-1896) of
falling prices.

It looks very much as if we must seek for the causes of rising prices
since 1896 in some of the "other things" not yet examined. There is no
time, however, for extended discussion on these points....

The effects of Tariffs and Taxation, Unionism and higher Wages, and
changing Agricultural Conditions in increasing expenses of production in
all industries are so patent as to require no enlargement. Immediately
after the passage of the Dingley Act in 1897, a large list of articles
rose in price precipitously. Moreover, just so far as higher money wages
for the same work, or the same money wages for a reduced number of
hours, have been granted without a corresponding increase in the
efficiency of the labor, the expenses of producing goods in general--and
consequently prices--have risen. But, without doubt, one of the most
important factors in raising prices--directly and indirectly--has been
the increased price of food due to the changing conditions of
agriculture. This most influential cause of higher prices is one of the
"other things" which has been at work quite independent of the quantity
of new gold. Moreover, the indirect effect of high prices of food
produces the most serious practical problem. It wipes out all the gain
of previous increases of wages, and drives laborers to repeat their
demands for higher pay, thus working again to increase expenses of
production. It is not too much to say that the gains of industry, shown
by the fall in prices, as they stood about 1890 have been lost to us by
the high tariffs of 1897 and the wastes of bad farming and the recent
high costs of agriculture.

Our analysis would be inadequate, however, if we stopped here with our
examination of expenses of production. The really practical problem is
still before us in trying to analyze the forces at work fixing prices in
that vague and dangerous margin between actual expenses of production
and the prices in fact paid by the consumer....

The whole _raison d'être_ of monopolistic combinations is to control
prices, and prevent active competition. As every economist knows, in the
conditions under which many industries are to-day organized, expenses of
production have no direct relation to prices. In such conditions, there
is a field in which the policy of charging "what the traffic will bear"
prevails; and this includes industries that are not public utilities.

Furthermore, we must face the fact of increasing riches not only in this
country, but all over the world. New wealth makes a liberal spender. The
retail dealer finding his expenses increasing and--even when they are
not--tries the experiment of charging his richer customers an increasing
price. The newly rich pay and do not feel it. But what can the poorer
unorganized buyer do when retail prices are raised? What can he do if
his meat bill, or his plumbing-repairs bill, rises enormously? The
extravagance of the rich has increased the cost of traveling, the rates
at hotels, the fees, the luxury of steamships and automobiles, the
consumption of fruits and vegetables out of season once never thought
of, and has generally raised the standard of expenditure. Those of
smaller income find they also must pay the higher prices. Thus we have
reached a point where we have to pay almost whatever any one asks.
Organized buyers are the only offset to organized sellers.

Moreover, rising prices due to high expenses of production, or to
combinations of sellers, present a paradise for speculation. A movement
upward based on facts can be easily converted into a further rise based
only on speculative manipulation. A rise of prices which brings large
profits to a combination, thus directly affects earnings and gives
especial opportunity to speculation in the securities of industrials.
Hence, the field of speculation spreads from commodities to securities.
The facts as to the movement of prices of securities are well shown in
Brookmire's Economic Charts since 1885; and, while the presence of gold
serves as a fund of lawful money in reserves, the spread of speculation
has gone on seemingly unaffected by the new supplies of gold. That is,
speculative conditions may arise and disappear antecedent to and
seemingly independent of the gold supplies.

* * * * *

D. F. Houston[57]: The discussion of money and prices to-day reminds one
very strongly of the discussion forty years ago. Now, as then, the
opinion is that prices have risen; but now, as then, there is wide
difference as to the explanation. Now, as then, a highly respectable
body of economists attribute the rise mainly to the new gold; and now,
as then, a number of economists attribute the rise to influences
immediately affecting the cost of production of commodities in general,
instancing such things as labor unions, monopolies, extravagance, the
tariff, general prosperity, etc....

That the tariff has played a part in the situation, I should of course
not deny. By preventing us from securing supplies where they can be more
economically produced, and by making it possible for domestic
manufacturers to monopolize the market, and by tending to compel the
payment for exports in gold, it has unquestionably played a part and is
a notable factor.... In considering the tariff as a factor, however, we
must not forget that we have had the tariff since the beginning, and
that the rates have been nearly as high since the Civil War as they are
to-day; and we must remember, further, that in one of the great
countries which has no protective tariff the tendency of price has been
upward; furthermore, we must not overlook the fact that many of the
tariff rates, which are very high now, are not effective or not nearly
so effective as they were in the earlier period, and also that its
influence is probably greater in things in which the rise of price has
been less marked.

I should not deny that labor unions and monopolies have had an influence
in increasing price. The evidence seems to justify the conclusion that
monopolies have had some effect in increasing price. I am not sure that
there is sufficient evidence in regard to labor unions to enable us to
form a conclusion....

Much has been said in discussion about the influence of extravagance.
This has played a part in similar discussions at all times; every era
has its cry of extravagance, and it is not clear that it has been more
marked in our time than in former times. And one thing is quite clear,
that the extravagance, or economic waste, resulting from the prosecution
of war and its after effects, has been conspicuously absent during the
last fifteen years....

The stock of gold in the leading western commercial nations, with which
we are concerned in discussing prices, probably did not exceed
$5,000,000,000 at the end of 1895. During the next fourteen years there
was added to the stock of gold of these countries an amount nearly equal
to the existing stock. In addition, a number of these countries
enormously developed their credit devices. According to all economic
law, these facts create a strong presumption that gold has been the main
factor affecting price. No sufficient evidence has been presented to
overthrow this presumption.

* * * * *

E. W. Kemmerer[58]: An adequate discussion of the papers presented by
Professors Fisher and Laughlin would require much more time than the few
minutes at my disposal. I shall accordingly limit myself to a few points
and support my conclusions principally by footnote references. This
procedure is perhaps the more justifiable in view of the fact that my
own philosophy of the relationship between money and prices is given in
detail in the book[59] on money and prices to which Professor Fisher has
so generously referred.[60]

I have had the opportunity of reading in manuscript Professor Fisher's
forthcoming book on Price Levels, of which his paper to-day represents
one chapter, and find myself in substantial agreement with his main
contentions. His discussion is a permanent contribution to monetary
science of very great value. To a number of minor points, however, it
seems to me, exception must be taken....

Professor Fisher's formula expressing the relationship between the
circulating media and prices is essentially the same as my own,[61] but
he pays little attention to the factor of business confidence, which is
a most important consideration in the interpretation of the formula. The
ratio of deposit currency to bank reserves is a function of business
confidence.[62]

The distinction Professor Fisher draws between the prices of individual
commodities and the general price level appears to me, as to Professor
Laughlin, to be untenable. It is, moreover, contradictory to his general
philosophy of money. His index numbers recognize no general price level
distinct from individual prices. He illustrates the point that the price
of any individual commodity presupposes a general price level by saying
that "the position of a particular wave in the ocean depends on the
general level of the ocean." I can conceive of no such distinction
between the general price level and individual prices as his statements
seem to imply. General prices "are but a combination, or composite
photograph, as it were, of individual prices."...[63]

Passing to Professor Laughlin's paper, which has been presented to me
merely in the form of an abstract, we find ten propositions, which to a
considerable extent are repetitious. His first five propositions are
rather commonplace generalizations and few economists will be disposed
to dissent from their essential soundness. They place him much closer to
the quantity theory of money than most of us, judging him from his
previous writings, were disposed to think he would go; and in his third
proposition he says, "Probably there is not so much difference of mind
regarding the theory of prices as is sometimes supposed."

With reference to Professor Laughlin's fourth proposition it may be said
that no economist of standing claims that purchasing power is "identical
with the quantity of the media of exchange in circulation." Effective
purchasing power, however, in our modern business communities, does
depend upon the possession of money or of the right to demand money. The
amount of deposit currency which can be used at any time in purchasing
goods is limited by bank reserves because commercial deposits are
payable in money on demand at the order of the depositor. Other assets,
no matter how good, cannot be used for the purpose of meeting deposit
obligations, except when the entire credit machinery breaks down and
suspension is resorted to under the euphemistic name of clearing house
loan certificates.

Professor Laughlin's sixth and seventh points are essentially the same
and may be considered together. He says:

... Price-making generally precedes the demand upon the
media of exchange, and does not at all imply any necessary
demand at the moment upon the standard in which the prices
are expressed.... The offer of money for goods is only a
resultant of price-making forces previously at work, and
does not measure the demand for goods.... That is, the
quantity of the actual media of exchange thus brought into
use is a result and not a cause of the price-making
process....

This contention appears to me to result from a superficial view of the
price-making process. The offer of money for goods and the offer of
goods for money are of course not the first steps. Each person has his
own individual or subjective prices on all sorts of commodities; these
subjective prices represent the valuations which he places upon the
respective commodities in terms of the valuation which he places upon
the money unit. The more of a particular commodity he has the lower his
subjective valuation of a unit of that commodity; the more money he owns
the lower his estimation of a dollar and the higher his subjective
prices; and _vice versa_. Through a process of competition, selection,
and adaptation, some of these subjective prices develop into market
prices, that is, prices at which both buyer and seller benefit, and at
which therefore an exchange takes place. To paraphrase an old adage, the
proof of the market price is in the exchange. It is a common observation
that stock quotations to be of much value must show the number of sales
effected at the prices quoted. A stock for which the maximum bids were
100 and the minimum offers were 110, would not possess a market price
in the strict sense of the word. The fact that sales have recently been
made at a certain price, or are now being so made, is of course
presumptive evidence that intending purchasers can buy at about that
price. A market price, however, is the amount of money paid for a
commodity, not the amount asked, offered, or promised.

Professor Laughlin's ninth proposition I find very difficult to follow.
His premise that reserves are "a consequence of the loan operations" is
a dangerous half truth; they are also a consequence of most other kinds
of banking operations, cash deposits, cash withdrawals and clearing
house balances, foreign and domestic exchange operations, etc. His other
premise, that "the fact of an increased supply of gold does not _of
itself_ [the italics are mine] increase loans, unless the bank possesses
the control of the capital which is a condition precedent to the loans,"
contains an element of truth, but is misleading. While an increased
supply of gold does not of itself increase loans it normally has that
result; and the bank's discount rate and the condition of its reserve
are powerful factors in influencing its loan account. His premises, I
believe, are not sound, and his conclusion, namely, that "the expansion
of business is not a direct consequence of an increasing supply of gold,
any more than an expansion of railway traffic is the direct consequence
of an increasing supply of cars," would not follow from his premises,
even if they were sound. The normal causal chain is more nearly this:
increased gold production results in greatly increased amounts of gold
coming into the monetary uses.[64] This gold comes into the hands of
individuals and is to a large extent deposited in banks; increased money
incomes on the part of individuals lower their estimations of the value
of the money unit, raise subjective prices, and as a consequence market
prices; larger money deposits in banks result in larger reserves, banks
do not make interest on money held in reserves, and accordingly take
measures to invest such surplus money, keeping these reserves as low as
is consistent with law and their ideas of safety;[65] inducements to
borrowers are made in the form of more favorable discount rates;
collateral is not scrutinized so carefully; the speculative market is
stimulated by increasing supplies of call money; confidence everywhere
increases; new enterprises spring up and old ones are expanded; and in a
short time the new gold is absorbed by a higher price level and an
overstimulated business activity. This was the situation after the
Californian and Australian gold discoveries of the last century and it
has been the result of the greatly increased gold production of the last
few years.

Professor Laughlin's final point is that since 1895 the new demand for
gold has roughly equalled the new supply, and that the changes in prices
since 1896 must be sought mainly in the "other things," which have not
remained equal. In support of this conclusion he offers two principal
arguments. The first is as follows:

... Because of the large existing stock of gold, very
considerable changes may take place in the supply of gold
without materially changing the world value of gold as
related to goods in general. Rapid changes of price are
hence more likely to be due to influences in the market for
goods, to speculative changes of demand for goods, or to
psychological forces working independently of facts....

In reply it may be said that the production of gold since 1895
represents a very large percentage of the total supply. The Soetbeer
figures as supplemented by those of the Director of the Mint show that
the world's gold production for the 405 years 1492-1896 inclusive was in
round numbers $8,982,000,000,[66] and that for the eleven years
1897-1907, was $3,513,000,000; in other words, for these eleven years it
was over 39 per cent. of the total for the preceding 405 years. Probably
the effective supply represents a much larger proportion of recent gold
because of (1) the large amount of loss chiefly by abrasion of the gold
produced in the earlier years, and of (2) the greater degree to which
this early gold has assumed specialized forms, such as jewelry, plate,
etc.

Satisfactory index numbers of prices for recent years are not available
for all the principal countries of the world. Such as we have, however,
point to a decided rise of prices in all gold standard countries since
about 1897. Comparing standard price index numbers in six of the chief
countries of the world for the years 1897 and 1907, we find the general
price level to have risen as follows:[67]

United States--Bureau of Labor figures 44.4%
Canada--Coats figures, (weighted) 43.7%
England--Sauerbeck figures 29.0%
France--de Foville, figures for export prices[68] 13.3%
Germany--Hamburg figures 30.8%
Italy--Necco figures for export prices 23.4%

If we average these figures together, assigning the same importance to
the figures of each country, in order to get a _rough_ idea of the
movement of world prices in gold standard countries during the eleven
years in question, we find that the average increase was 30.8 per cent.
If we follow Professor Laughlin and compare the years 1895 and 1907, we
find the average increase in prices to have been 25.8 per cent., and the
world's gold production for the 13 years 1895 to 1907 to have been about
42 per cent. of that for the preceding 404 years. When to this is added
the fact that the evidence points to a smaller percentage of the world's
annual gold production going into the industrial uses than formerly, and
the further fact that during the period in question the increase and
improvements in the world's banking facilities have greatly economized
the uses of money, we see that a very substantial increase in general
prices would be expected, despite a great expansion of business. World
prices in fact have not increased nearly as rapidly as the flow of gold
into monetary uses since 1897, not to mention the enormous development
of deposit currency. The Director of the Mint estimates each year the
amount of the world's new gold used in the industrial arts. Computations
I have made based upon these figures show a tendency for a decreasing
percentage of the annual production to be used in the arts, although
there is considerable irregularity. For the seven years 1895-1901 the
average percentage was 27.1, and for the seven years 1902-1908 it was
25.3.[69]

Professor Laughlin's second argument in favor of the proposition that
the recent rise in prices has not been due primarily to the increased
gold production is one of the most beautiful examples of begging the
question that I have seen in economic literature. He says:

"In recent discussions one of the 'other' factors which has
been slighted is the demand for gold since 1895. The
examination shows that the new demand in countries turning
to the gold standard, and in those already using gold and
extending their demand, amounts in round numbers to about
$3,000,000,000. Hence the new demand has roughly equalled
the new supply, since 1895--a fact which jumps with the
known conditions in the great financial markets like London,
where new arrivals of gold are eagerly competed for by
European banks."

Of course the demand for gold equals the supply, as does the demand for
wheat or any other commodity, when one interprets demand and supply as
one should, in terms of market prices. The general price level is the
very thing which equilibrates the demand for gold and the supply. The
higher price level about which we are talking is an expression of the
absorption of most of this new gold into the world's circulation. Banks
and merchants eagerly compete for it, because higher prices require more
money to do a given amount of exchange work, and rising prices stimulate
business.

* * * * *

Joseph French Johnson[70]: I am glad to observe that there appears to be
a tendency toward agreement with regard to the fact that the value of
money depends upon the demand for it and supply of it. Professor
Laughlin likes the word standard better than I do. It suggests something
permanent and fixed, whereas money is a very changeable thing. While I
am in agreement with Professor Laughlin in the conclusion that the
general level of prices depends upon the demand for and supply of money,
I am unable to give assent to many of the propositions which he puts
forward as links in the chain of reasoning leading to that conclusion.

For example, Professor Laughlin says, "A change of prices may be due to
changes in the demand for and supply of (thus including the expenses of
production) goods as well as to changes in the demand for and supply of
gold." This proposition is true with regard to changes in the prices of
particular commodities. The price of wheat may rise or fall as a result
of a change in the demand for or in the supply of wheat. The
proposition, however, is not true with regard to a change in the general
level of prices. An increase in the supply of goods will lower the level
of prices for the simple reason that it will increase the demand for
gold. I am not certain that I have understood Professor Laughlin's
exposition of his theory, but he certainly seemed to me to argue that
there could be a change in the general level of prices without any
change whatever in the demand for or supply of gold. Such a position, it
seems to me, is absolutely untenable.

That Professor Laughlin seeks to hold this untenable position, it seems
to me, is made evident by the qualification with which he accepts the
statement that a change in the quantity of money, other things being
equal, would be a factor affecting prices. He says, "An increasing
demand for gold, however, would work against the effect of an increasing
supply. If the new demand offset the new supply, then, if changes of
price occurred, their cause must be sought in the influences touching
the producing and marketing of goods." The second conditional clause in
that last sentence introduces an impossible supposition, for if a new
supply of gold is offset by a new demand for it, there could be no
change in the general level of prices, so that no cause for any change
would have to be sought in the "influences touching the producing and
marketing of goods." Professor Laughlin appears to have in mind forces
affecting the general level of prices which are entirely hidden from my
sight. A change in the level of prices means a change in the value of
gold, and how can there be a change in that if the new demand for gold
just offsets the new supply?

Professor Laughlin's analysis of the price-making process is incomplete
and misleading. He is correct when he says that the causes of price
changes must be sought in the forces settling particular prices, but he
is manifestly wrong when he states that the price of wheat is "arrived
at by the higgling of the market, which depends on the buyers' and
sellers' judgment of the demand for and supply of wheat." Such higgling
would determine only the value of wheat. The price of wheat is not fixed
until buyer and seller have reached an agreement in their estimates as
to the value not only of wheat, but also of money. If wheat is
comparatively easy to get, the price falls. If money is easier to get,
the price rises. The demand for and supply of money is evidently just as
important in the determination of the price of wheat as is the demand
for and supply of wheat itself. When Professor Laughlin says that the
offer of money for goods is only a resultant of price-making forces
previously at work, he must have in mind some price-making process and
price-making forces of which I have never heard. I know of no market in
which goods are lowered in price except for the reason that at the
higher price not enough money is offered to absorb the supply; nor of
any market in which goods are raised in price except for the reason that
buyers are willing to offer more money for the goods.

In his analysis of credit and its relation to the value of money,
Professor Laughlin seems to me to have in mind a hypothetical financial
world, the like of which does not and could not exist on earth. He
strives to show that a bank's ability to make loans depends upon the
amount of its capital and deposits, and that therefore any increase in
the supply of gold would not in itself lead to an increase of loans.
"Expansion of business," he remarks, "is not a direct consequence of an
increasing supply of gold any more than an expansion of railway traffic
is the direct consequence of an increasing supply of cars." He is quite
right if he means that an increase in the amount of gold will not
necessarily cause the exchange of more goods. But this does not appear
to be his meaning. He holds that the use of new gold in bank reserves
cannot be a causal force raising prices, for the bankers cannot increase
their loans, in his opinion, unless the condition of business demands
such an increase. In his hypothetical financial world bankers are
willing to carry idle stocks of gold and to wait until business
conditions make necessary an increase in their loans. In the real
financial world, of course, bankers do nothing of the sort. Bankers with
surplus gold immediately tempt borrowers by lowering the rate of
discount and thus increasing the money demand for goods in the markets.
As a result there is an irregular and general rise of prices. More goods
may not be bought and sold and there may be no expansion of business,
but expressed in terms of money the totals are bigger. There is no
analogy between dollars and freight cars. The carrying capacity of a car
is fixed and unchangeable, but the carrying capacity of a dollar is
elastic--so elastic, in fact, that dollars are always fully loaded no
matter how small the supply of goods. As Professor Laughlin points out,
although he apparently does not see its significance, the new demand for
gold since 1895 has "roughly equalled the new supply." Surely it could
not have been otherwise, and no statistics are necessary to prove the
fact.

* * * * *

Murray S. Wildman[71]: My comments on these interesting papers will be
directed upon the methods employed, and certain assumptions involved, in
the arguments of both. Granting that Professor Fisher's analysis shows a
perfect correspondence between the course of prices on the one hand and
the quantity of money and credit instruments on the other hand, I am
still unable to see which magnitudes are properly to be regarded as
causes and which as effects. That variations in the value of gold and in
the price level must be reciprocal, all will admit. If we regard M as
denoting the gold supply for the present, a causal relation between M
and P cannot be denied. But may it not be possible that variations in
M´, or credit, and V and V´, the velocity of circulation of both money
and credit, be simply in consequence of the variation in M and P? Why is
P the only passive term or why is it passive at all?

Suppose that the problem set was to discover the cause of credit
expansion from 1896 to 1910. Would we not seek at once to explain it by
reference to rising prices and greater volume of goods, making a broader
basis for credit, while along with that is a greater gold supply which
promotes the convertibility of an extended credit? Then might we not
invoke Professor Fisher's algebraic formula, with terms rearranged, and
show by this method of reasoning, supported by statistical verification,
that the high prices afford an adequate cause for the present expansion
of credit?

But we are seeking the cause or causes of rise in the price level. This
is equivalent to seeking the cause of decline in the value of gold. Does
the "quantity theory" as newly expounded give us the solution? I think
not. Rather it shows us that as gold has grown in supply, and fallen in
value, credit has grown in magnitude and in rapidity of circulation, and
that these changes in values and volumes have gone hand in hand with
proportional changes in the price level and in the magnitude of
commodity exchanges.

This view of the case brings me to substantial approval of Professor
Laughlin's method of analysis and argument. That is, we must seek the
facts regarding supply and demand as applied to gold, and those which
bear upon supply and demand as touching goods, in so far as the demand
for goods is expressed in offers of gold and gold representatives. Here
the algebraic formula would be invoked to support his reasoning since M´
and V and V´ may be regarded as factors in the demand for gold.

To accept Professor Laughlin's method does not involve the necessity of
his conclusions. The terms, by this method, do not lend themselves to
exact mathematical statement and statistical proof, so conclusions
cannot be exact and definite. This may be illustrated in a consideration
of demand for gold. Some say that demand has grown step by step with
supply and therefore gold has not been cheapened. Others say that supply
has grown more rapidly than demand, and so gold has been cheapened and
to that extent prices are raised.

Either statement may be wrong. I do not believe we have yet any reliable
data regarding the demand for gold in the sense of a value-making
factor. Most efforts to measure demand are based on statistics of gold
in use. If one can show that consumption of gold in the arts, in the
circulation, and in greater bank reserves, has increased _pari passu_
with production, we are told that the value of gold has not been
lowered by the greater supply.

But statistics of consumption give no clue to demand in the
value-determining sense. We have many staple commodities, such as wheat
and cotton, whose price drops sharply when the supply exceeds a certain
normal volume, even though the whole crop is consumed. Statistically
speaking, the demand for a cotton crop always rises as supply rises, and
falls as supply falls, but that is because demand and supply become
equated through a variation in price. Demand, in this sense of quantity
demanded, is in part a result rather than a cause of value.

When we can properly speak of demand as potent for the determination of
value, we are thinking of demand from the point of view of _intensity_
rather than the point of view of _magnitude_. But the demand which makes
for value--demand intensively considered--is only measured by the
purchasing power offered. Applied to gold, I know of no measure of
demand except in the goods and services offered in exchange. To say that
goods and services offered for an ounce of gold in 1910 are less than
are offered for an ounce of gold in 1896, is simply to say that prices
are higher. But it is these prices that we are trying to explain by
giving the effect for the cause, when we say that demand has risen with
supply.

Those staple commodities whose value falls off abruptly with any
increase of supply beyond a customary stock are said to be subject to an
inelastic demand, and those whose value declines uniformly with
excessive supplies are said to have an elastic demand. Is the demand for
gold elastic, or is it inelastic? And is it possible by independent
analysis to construct the curve of elasticity which properly belongs to
gold, and so avoid circular reasoning from the very prices we are trying
to explain?

If the demand for gold is inelastic and the demand curve drops off
abruptly after a certain supply is in evidence, the presumption is that
in the conditions of gold production, rather than in the conditions of
commodity production, lies the cause of our high prices. Moreover, if
this be the case, we can readily see the cause of cheapening of gold,
even though the product of a single year bears a small proportion to
the existing stock.

If on the other hand the demand for gold be very elastic, so that it
expands with growing supplies with no substantial alterations in value,
then we are driven to seek the cause of high prices in influences
directly touching the goods and services rather than in those directly
affecting gold.

It would seem therefore that both methods of treatment have left
something to be desired. The algebraic analysis, even as verified,
presents the relations between magnitudes without showing the cause of
high prices. The argument directed immediately at the value of gold of
necessity involves consideration of the demand for gold, which, as a
price-making factor, remains an unknown quantity.

* * * * *

T. N. Carver[72]: Professor Fisher ... has demonstrated beyond all
question the accuracy of his formula. The question remains, however,
whether his formula supports his own conclusion or Professor Laughlin's.
If, for example, it should be found that P is the cause of M, the
formula would to that extent support Professor Laughlin's position. I
believe that to a certain extent P is actually the cause of M. If the
growing scarcity of agricultural land, or the increase in population and
the increased demand for agricultural products without an increase in
land, should increase the marginal cost of producing agricultural
products to supply this larger demand, that would tend to increase the
exchange value of these products, even according to the formula of
Cairnes as quoted by President Houston.[73] Even without any increase in
the gold supply, this would cause each unit of product to exchange for a
little more gold; then, in order that a given number of exchanges in
agricultural products could be carried on, it would be necessary to have
a larger number of ounces of gold, or a larger number of gold coins, or
some other form of money of given denominations to do the money work.
This, in other words, would necessitate a larger supply of money: and,
if other forms than gold were not forthcoming, it would necessitate that
a larger proportion of the stock of gold should be coined into money in
order to do the work. Thus, without any increase whatever in the world's
total gold supply, there would come to be an increase in the proportion
of that supply used as money, or in the amount of gold coin actually
used in circulation. I believe that this has taken place, and that it is
one of the factors in the problem, although there has also been a very
large increase in the gold supply to still further accentuate the
tendency.

* * * * *

F. W. Taussig[74]: I congratulate Professor Fisher on his admirable
paper. I am in accord with him in his method of reasoning and in all his
essential results. His investigation of this subject adds another to the
brilliant studies with which he has enriched economic science.

It deserves to be said, perhaps, that the term M´ (deposits) in his
equation is not entirely independent, but is in some degree a function
of T. I say to some degree; it is dependent on T in part only, and not
for very long periods. Professor Fisher has here treated it as dependent
simply on M.... He has indicated the qualifications which must be
attached to this dependence of deposits on bank reserves. He has pointed
out that though a general dependence appears over long periods of time,
it is affected by changes in banking ways, and by the tendency to build
up a higher superstructure of deposits in times of active business. But
there is also a connection between T, volume of trade, and M´. That is,
for short periods--nay, for periods of some years--an increasing volume
of trade tends of itself to bring about an increasing volume of
deposits. (I may say, parenthetically, that "volume of trade" does not
seem to me an apt expression; "units of commodities," the other phrase
used by Professor Fisher, is better.) Though I would by no means go the
length of Professor Laughlin's reasoning, which seems to imply that
every act of exchange supplies automatically its own medium of exchange,
it does seem to me that our modern mechanism of deposit banking supplies
an elastic source of deposits, which, for considerable periods, enables
them to run _pari passu_ with the transactions and loans resting on
them. In the end, an increase of deposits finds its limit in the volume
of cash held by the banks. But there is some elasticity of adjustment,
by which loans and deposits increase as fast as transactions or faster;
and this accounts in no small degree for the rise in prices during
periods of activity. The phenomenon shows itself most strikingly in
stock exchange loans, especially in a center like New York. There the
business creates for itself quasi-automatically its own medium of
exchange. I suspect it is undue generalization from operations of this
sort that has led Professor Laughlin to take his extreme position--a
position which I can not but think untenable. Some allowance for the
temporary interaction between M´ and T is necessary for the completeness
of Professor Fisher's reasoning.

* * * * *

Ralph H. Hess[75]: Professor Fisher's formula (MV + M´V´ = PT)
approximately expresses the mathematical equality of purchase and
payment which cannot be questioned. I say _approximately_ because M´
(defined by Professor Fisher as "bank deposits subject to check"), if it
be made to express an accurate measure of circulating credit, should
include not only open bank accounts, but certain other values which
constitute _current means of payment_, such as bankers' bills, trade
bills, cashiers' checks, and certified checks....

The relation which Professor Taussig has pointed out between M´ and T
(the _value of negotiable credit_ and the contemporary _volume of
trade_) is not only possible, but, in any community of modernized
commerce, is actual. Moreover, a knowledge of the process by which
commerce is financed by the existing mechanism of discount, loan,
deposit, and draft justifies the conclusion that, if the volume of trade
(T) be resolved into its factors, namely, _materials of trade_ and their
_frequency of exchange_, the latter factor of T is quite commensurate
with the velocity of credit (V´).

To me it seems incontestable that the volume and velocity of credit
currency, as represented by bank deposits and other circulating media,
vary directly as the volume and value of the materials of trade in the
process of exchange, and are, mathematically speaking, dependent
functions thereof. Granting this relation, an analysis of the equation
of exchange establishes PT as the major determinant of M´V´, and, in so
far as paper money may be authorized and issued upon the security of
commercial assets, of M. That part of the money in circulation which
does not derive its circulating powers from actual and potential
commercial values is itself material of barter incorporating so-called
intrinsic values.

The conclusion is clear that P (price) is independent of all other terms
and factors of Professor Fisher's equation, that V and V´ are determined
by the mechanical circumstances and organization of exchange, and that
the value of M and M´, taken collectively, is a spontaneous derivative
of PT. The fundamental determinants of prices and of "price levels,"
therefore, are to be found outside of monetary and credit agencies _per
se_.

As to the nature and order of the price-making process and the actual
forces behind price movements, I am in substantial accord with Professor
Laughlin. That prices, individually and collectively considered, express
the value-proportion of demand for and supply of goods on the market to
demand for and "visible supply" of the standard commodity is
fundamentally logical. Nor is there occasion to quibble over the paradox
of disturbed equilibrium of demand and supply. Physically considered,
the goods which objectify these terms are, of course, identical; but, in
the valuation process, demand and supply denominate, respectively,
_desire_ and _utility_--the generally acknowledged antecedents of value.
Price is the equalizing factor between the effective demand for gold and
the effective demand for other goods, each taken in conventional units;
and price changes are resultants of, and commensurate with, net
variations in the value-factors of the standard and of the objects of
exchange.

Referring to the nature of credit and the economic qualities of credit
instruments, the somewhat figurative expression "goods coined into a
means of payment" is a striking and accurate characterization. It is
possible that all legitimate market values, under normal trade
conditions, may be liquidized through credit agencies, and the goods in
which they are incorporated be thus rendered immediately and
conveniently exchangeable. This process may be consummated independently
of prices and with slight regard to the actual supply of money. The
truth of this assertion is, in fact, demonstrated daily in the marts of
trade.

* * * * *

J. Laurence Laughlin[76]: There is time to answer briefly only a few of
the points raised by several speakers. First, Professor Fisher's
equation of MV + M´V´ = PT is to my mind not a solution, but only a
statement, of the problem of price levels. It can be read backward as
well as forward. For instance, it does not follow that the level of
prices (P) will rise with an increase of M´, since--as Professor Taussig
has pointed out already--an active development of trade and industry (T)
would itself be a reason for an increase of banking loans and deposits
subject to check (M´), thus equalizing effects on both sides of the
equation without necessarily increasing P. This result is, in fact, one
of the points on which I have steadily insisted in my own exposition of
the theory of prices and credit; and Professor Fisher's equation allows
it to appear distinctly. His equation does not show causes; it states a
static situation, into which various causes may be read. The facts
between 1876 and 1896 disclose an increase of bank deposits of 500 or
600 per cent., and yet that period was distinguished as one of falling
prices. Therefore M´ cannot be regarded as having been proved to be a
cause of higher prices.

Second, Professor Fisher ... seeks to establish a causal relation
between the amount of money in circulation (M) and the amount of
deposits (M´) which, in my judgment, is wholly unfounded. He has
developed this in his paper in the _Royal Statistical Journal_. The
error consists in supposing that a man's deposit account at any time
varies with the amount of money in his possession. Rather, the deposit
account varies with a man's wealth. The rich man does not carry much
more money to pass from hand to hand than the man of moderate means.
Monetary habits in the community require a certain level of circulation
for all persons, but the deposits of an individual may soar above the
common level without regard to the money he keeps in circulation. His
bank deposits are rather a measure of the saleable goods he has sold,
"coined into means of payment."

Third, I well recognize the high position Professor Fisher occupies in
the mathematical school of Walras and others; but has he not made an
error in stating the essence of the price relation in his mathematical
symbols? So far as I understand him, he seems to deny the fundamental
value-concept (on which there has hitherto been general agreement) that
price is a ratio between goods and gold. In furtherance of that idea, he
thinks that, before individual prices can be arrived at, the general
price level must be ascertained. Now, in my exposition using the
ratio-concept, I explained in detail how the general level of prices
might be affected by causes affecting the gold side of the ratio.
Therefore, I did not neglect to account for the general level and that
too without doing violence to the accepted value-concept. But the
ratio-concept (which Professor Fisher seems to deny) allows the forces
acting on goods also to affect the general level of prices as I have
shown. In my opinion, he wrongly works from a general level of prices to
particular prices; while I hold that particular prices, or actual
quotations, are the bases from which all averages, or price levels, are
always and inevitably computed. Moreover, in his diagrams, the level of
prices he used was the one computed from individual quotations. Hence
his whole reasoning on the conformity of the statistics to the terms of
his equation is vitiated. Indeed the better agreement he finds--after
elaborate statistical computations--between the elements and their
result on prices ...--is due, I think, to relying on an equation which
is nothing more than a statement that the whole is equal to the sum of
its parts....

Finally, when Professor Johnson suggests that I am wrong in stating that
forces affecting the goods side of the price ratio have an influence on
prices, he certainly cannot mean that conditions affecting the
producing, marketing, and financing of goods have no effect on prices.
How else, for instance, can we explain the rise of the prices of
agricultural products? The special causes affecting them have little to
do with the quantity of "money." Moreover, the term "money" itself is
used so loosely and vaguely that we can come to agreement on price
theories only by first agreeing upon what we mean by "money." In my
paper, I have discussed the relations of goods, and their prices, to
gold. But, in this country, we use gold little as a medium by which
goods are exchanged. Thus the relation of the prices of goods to our
media of exchange has been practically omitted. And yet the price-making
process generally precedes the creation of the usual banking media of
exchange by which most goods are exchanged.

* * * * *

Irving Fisher[77]: In connection with the statement and explanation of
the equation of exchange it was shown (1) that prices vary directly as
the quantity of money, provided the volume of trade and the velocities
of circulation remain unchanged; (2) that prices vary directly as the
velocities of circulation (if these velocities vary together), provided
the quantity of money and the volume of trade remain unchanged, and (3)
that prices vary inversely as the volume of trade, provided the quantity
of money--and therefore deposits--and their velocities remain unchanged.

Let us now inquire how far these propositions are really _causal_
propositions. An examination of the influence of each of the six
magnitudes on each of the other five will afford answers to the
objections which have been raised to the quantity theory of money.

To set forth all the facts and possibilities as to causation we need to
study the effects of varying, one at a time, the various magnitudes in
the equation of exchange.

Our first question is: given (say) a doubling of the quantity of money
in circulation (_M_) what are the normal or ultimate effects on the
other magnitudes in the equation of exchange, viz.: _M´_, _V_, _V´_, the
_p_'s and the _Q_'s?

We have seen that normally the effect of doubling money in circulation
(_M_) is to double deposits (_M´_) because under any given conditions of
industry and civilization deposits tend to hold a fixed or normal ratio
to money in circulation. Hence the ultimate effect of a doubling in _M_
is the same as that of doubling both _M_ and _M´_. We propose next to
show that this doubling of _M_ and _M´_ does not normally change _V_,
_V´_ or the _Q_'s, but only the _p_'s. The equation of exchange of
itself does not affirm or deny these propositions.

For aught the equation of exchange itself tells us, the quantities of
money and deposits might even vary inversely as their respective
velocities of circulation. Were this true, an increase in the quantity
of money would exhaust all its effects in reducing the velocity of
circulation, and could not produce any effect on prices. If the
opponents of the "quantity theory" could establish such a relationship,
they would have proven their case despite the equation of exchange. But
they have not even attempted to prove such a proposition. As a matter of
fact, the velocities of circulation of money and of deposits depend, as
will be seen, on technical conditions and bear no discoverable relation
to the quantity of money in circulation. Velocity of circulation is the
average rate of "turnover", and depends on countless individual rates of
turnover. These depend on individual habits. Each person regulates his
turnover to suit his convenience. A given rate of turnover for any
person implies a given time of turnover--that is, an average length of
time a dollar remains in his hands. He adjusts this time of turnover by
adjusting his average quantity of pocket money, or till money, to suit
his expenditures. He will try to avoid carrying too little lest, on
occasion, he be unduly embarrassed; and on the other hand to avoid
encumbrance, waste of interest, and risk of robbery, he will avoid
carrying too much. Each man's adjustment is, of course, somewhat rough,
and dependent largely on the accident of the moment; but, in the long
run and for a large number of people, the average rate of turnover, or
what amounts to the same thing, the average time money remains in the
same hands, will be very closely determined. It will depend on density
of population, commercial customs, rapidity of transport, and other
technical conditions, but not on the quantity of money and deposits nor
on the price level. These may change without any effect on velocity. If
the quantities of money and deposits are doubled, there is nothing, so
far as velocity of circulation is concerned, to prevent the price level
from doubling. On the contrary, doubling money, deposits, and prices
would necessarily leave velocity quite unchanged. Each individual would
need to spend more money for the same goods, and to keep more on hand.
The ratio of money expended to money on hand would not vary. If the
number of dollars in circulation and in deposit should be doubled and a
dollar should come to have only half its former purchasing power, the
change would imply merely that twice as many dollars as before were
expended by each person and twice as many kept on hand. The ratio of
expenditure to stock on hand would be unaffected.

If it be objected that this _assumes_ that with the doubling in _M_ and
_M´_ there would be also a doubling of prices, we may meet the objection
by putting the argument in a slightly different form. Suppose, for a
moment, that a doubling in the currency in circulation should not at
once raise prices, but should halve the velocities instead; such a
result would evidently upset for each individual the adjustment which he
had made of cash on hand. Prices being unchanged, he now has double the
amount of money and deposits which his convenience had taught him to
keep on hand. He will then try to get rid of the surplus money and
deposits by buying goods. But as somebody else must be found to take the
money off his hands, its mere transfer will not diminish the amount in
the community. It will simply increase somebody else's surplus.
Everybody has money on his hands beyond what experience and convenience
have shown to be necessary. Everybody will want to exchange this
relatively useless extra money for goods, and the desire so to do must
surely drive up the price of goods. No one can deny that the effect of
every one's desiring to spend more money will be to raise prices.
Obviously this tendency will continue until there is found another
adjustment of quantities to expenditures, and the _V_'s are the same as
originally. That is, if there is no change in the quantities sold (the
_Q_'s), the only possible effect of doubling _M_ and _M´_ will be a
doubling of the _p_'s; for we have just seen that the _V_'s cannot be
permanently reduced without causing people to have surplus money and
deposits, and there cannot be surplus money and deposits without a
desire to spend it, and there cannot be a desire to spend it without a
rise in prices. In short, the only way to get rid of a plethora of money
is to raise prices to correspond.

So far as the surplus deposits are concerned, there might seem to be a
way of getting rid of them by cancelling bank loans, but this would
reduce the normal ratio which _M´_ bears to _M_, which we have seen
tends to be maintained.

We come back to the conclusion that the velocity of circulation either
of money or deposits is independent of the quantity of money or of
deposits. No reason has been, or, so far as is apparent, can be
assigned, to show why the velocity of circulation of money, or deposits,
should be different, when the quantity of money, or deposits, is great,
from what it is when the quantity is small.

There still remains one seeming way of escape from the conclusion that
the sole effect of an increase in the quantity of money in circulation
will be to increase prices. It may be claimed--in fact it has been
claimed--that such an increase results in an increased volume of trade.
We now proceed to show that (except during transition periods) the
volume of trade, like the velocity of circulation of money, is
independent of the quantity of money. An inflation of the currency
cannot increase the product of farms and factories, nor the speed of
freight trains or ships. The stream of business depends on natural
resources and technical conditions, not on the quantity of money. The
whole machinery of production, transportation, and sale is a matter of
physical capacities and technique, none of which depend on the quantity
of money. The only way in which the quantities of trade appear to be
affected by the quantity of money is by influencing trades accessory to
the creation of money and to the money metal. An increase of gold money
will, as has been noted, bring with it an increase in the trade in gold
objects. It will also bring about an increase in the sales of gold
mining machinery, in gold miners' services, in assaying apparatus and
labor. These changes may entail changes in associated trades. Thus if
more gold ornaments are sold, fewer silver ornaments and diamonds may be
sold. Again the issue of paper money may affect the paper and printing
trades, the employment of bank and government clerks, etc. In fact,
there is no end to the minute changes in the _Q_'s which the changes
mentioned, and others, might bring about. But from a practical or
statistical point of view they amount to nothing, for they could not add
to nor subtract one-tenth of 1 per cent. from the general aggregate of
trade. Only a very few _Q_'s would be appreciably affected, and those
few very insignificant.

We conclude, therefore, that a change in the quantity of money will not
appreciably affect the quantities of goods sold for money.

Since, then, a doubling in the quantity of money: (1) will normally
double deposits subject to check in the same ratio, and (2) will not
appreciably affect either the velocity of circulation of money or of
deposits or the volume of trade, it follows necessarily and
mathematically that the level of prices must double. While, therefore,
the equation of exchange, of itself, asserts no causal relations between
quantity of money and price level, any more than it asserts a causal
relation between any other two factors, yet, when we take into account
conditions known quite apart from that equation, viz., that a change in
_M_ produces a proportional change in _M´_, and no changes in _V_, _V´_,
or the _Q_'s, there is no possible escape from the conclusion that a
change in the quantity of money (_M_) must _normally_ cause a
proportional change in the price level (the _p_'s).

While the equation of exchange is, if we choose, a mere "truism," based
on the equivalence, in all purchases, of the money or checks expended,
on the one hand, and what they buy, on the other, yet in view of
supplementary knowledge as to the relation of _M_ to _M´_, and the
non-relation of _M_ to _V_, _V´_, and the _Q_'s, this equation is the
means of demonstrating the fact that normally the _p_'s vary directly as
_M_, that is, demonstrating the quantity theory. To throw away
contemptuously the equation of exchange because it is so obviously true
is to neglect the chance to formulate for economic science some of the
most important and exact laws of which it is capable.

We may now restate, then, in what causal sense the quantity theory is
true. It is true in the sense that one of the _normal effects of an
increase in the quantity of money is an exactly proportional increase in
the general level of prices_.

I have no desire, as some one has humorously suggested, to hide behind
an equation, but I do find it necessary to take refuge behind my book on
the _Purchasing Power of Money_. So many new questions have been asked
that, in the few moments at my disposal, I could not answer them all
satisfactorily. I believe they have all been answered in the book
referred to. For instance, a chapter has been devoted to transition
periods in which it has been shown, as Professor Taussig has suggested,
that during transition periods an increase in _T_ may cause an increase
in _M´_.

THE TESTIMONY OF RICARDO

[78]Let us suppose that the circulation of all countries were carried on
by the precious metals only, and that the proportion which England
possessed were one million; let us further suppose, that, at once, half
of the currencies of all countries, excepting that of England, were
suddenly annihilated, would it be possible for England to continue to
retain the million which she before possessed? Would not her currency
become relatively excessive compared with that of other countries? If a
quarter of wheat, for example, had been both in France and England of
the same value as an ounce of coined gold, would not half an ounce now
purchase it in France, whilst in England it continued of the same value
as one ounce? Could we by any laws, under such circumstances, prevent
wheat or some other commodity (for all would be equally affected) from
being imported into England, and gold coin from being exported? If ...
the exportation of bullion were free, gold might rise 100 per cent.; and
for the same reason, if 35 Flemish schillings in Hamburgh had before
been of equal value with a pound sterling, 17-1/2 schillings would now
attain that value. If the currency of England only had been doubled, the
effects would have been precisely the same.

Suppose, again, the case reversed, and that all other currencies
remained as before, while half that of England was retrenched. If the
coinage of money at the mint was on the present footing, would not the
prices of commodities be so reduced here that cheapness would invite
foreign purchasers, and would not this continue till the relative
proportions in the different currencies were restored?

If such would be the effects of a diminution of money below its natural
level, and that such would be the consequences the most celebrated
writers on political economy are agreed, how can it be justly contended
that the increase or diminution of money has nothing to do either with
the foreign exchanges, or with the price of bullion?

Now, a paper circulation, not convertible into specie, differs in its
effects in no respect from a metallic currency, with the law against
exportation strictly executed.

Supposing, then, the first case to occur whilst our circulation
consisted wholly of paper, would not the exchanges fall, and the price
of bullion rise in the manner which I have been representing; and would
not our currency be depreciated, because it was no longer of the same
value in the markets of the world as the bullion which it professed to
represent? The fact of depreciation could not be denied, however the
Bank Directors might assure the public that they never discounted but
good bills for bona fide transactions; however they might assert that
they never forced a note into circulation; that the quantity of money
was no more than it had always been, and was only adequate to the wants
of commerce, which had increased and not diminished;[79] that the price
of gold, which was here at twice its mint value, was equally high, or
higher, abroad, as might be proved by sending an ounce of bullion to
Hamburgh, and having the produce remitted by bill payable in London
bank notes; and that the increase or diminution of their notes could not
possibly either affect the exchange or the price of bullion. All this,
except the last, might be true, and yet would any man refuse his assent
to the fact of the currency being depreciated?

Could the symptoms which I have been enumerating proceed from any other
cause but a relative excess in our currency? Could our currency be
restored to its bullion value by any other means than by a reduction in
its quantity, which should raise it to the value of the currencies of
other countries; or by the increase of the precious metals, which lower
the value of theirs to the level of ours?

FOOTNOTES:

[43] _The Purchasing Power of Money_, pp. 14-71. The Macmillan Company.
New York. 1911.

[44] This theory, though often crudely formulated, has been accepted by
Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter,
Kemmerer and most writers on the subject. The Roman Julius Paulus, about
200 A. D., stated his belief that the value of money depends on its
quantity. See Zuckerkandl, _Theorie des Preises_: Kemmerer, _Money and
Credit Instruments in their Relation to General Prices_, New York
(Holt), 1909. It is true that many writers still oppose the quantity
theory. See especially, Laughlin, _Principles of Money_, New York
(Scribner). 1903.

[45] See Scott, "It has been a most fruitful source of false doctrines
regarding monetary matters, and is constantly and successfully employed
in defense of harmful legislation and as a means of preventing needed
monetary reforms." _Money and Banking._ New York, 1903, p. 68.

[46] [For a method of determining the velocity of the circulation of
money, see Appendix A.]

[47] It is important to bear in mind that wherever _P_ is used in this
chapter it represents the index number, or scale of prices, at which the
trade, _T_, is conducted.--EDITOR.

[48] An almost opposite view is that of Laughlin that normal credit
cannot affect prices because it is not an offer of standard money and
cannot affect the value of the standard which alone determines general
prices. See the _Principles of Money_, New York (Scribner), 1903, p. 97.
Both views are inconsistent with that upheld ... [here].

[49] This fact is apparently overlooked by Laughlin when he argues that
there is not "any reason for limiting the amount of the deposit
currency, or the assumption of an absolute scarcity of specie reserves."
See _Principles of Money_, p. 127.

[50] Interesting changes in the magnitudes of the equation of exchange
between 1896 and 1914 are given in the appended diagram, which is taken
from a reprint of Professor Fisher's article, _The Equation of Exchange
for 1914, and the War_, the _American Economic Review_, Vol. V, No. 2,
June, 1915.--EDITOR.

[51] Adapted from Irving Fisher. _Recent Changes in Price Levels and
Their Causes_, Bulletin of the American Economic Association. Fourth
Series, No. 2, Papers and Discussions of the Twenty-third Annual
Meeting, December, 1910, pp. 43-44.

[52] Irving Fisher, _The Purchasing Power of Money_, pp. 74-88.

[53] _Ibid._, pp. 149, 150.

[54] _Causes of the Changes in Prices since 1896._ Bulletin of the
American Economic Association, Fourth Series, No. 2, Papers and
Discussions of the Twenty-third Annual Meeting, December, 1910, pp.
27-36.

[55] There is a possible error here of perhaps $500,000,000.

[56] The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director
of Mint, 1909, p. 80.

[57] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.

[58] _Ibid._, pp. 52-61.

[59] _Money and Credit Instruments in their Relation to General Prices_,
2d edition, 1909. New York: Henry Holt & Company.

[60] The passages referred to are omitted.--EDITOR.

[61] Kemmerer, _Money and Credit Instruments_, pp. 9-18, 74-82.

[62] _Ibid._, pp. 82-8, 121-6, 145-8.

[63] _Ibid._, p. 9. [See Fisher: _Purchasing Power of Money_, pp.
175-180.]

[64] The value of gold bullion deposited at the United States mints and
assay offices increased from $87,924,000 for 1897 to $205,036,000 for
1907. Figures furnished by the Director of the Mint.

[65] It is noteworthy that the reserves of the New York associated banks
for example are usually kept very close to the legal reserve
requirements. Cf. Sprague, _Crises under the National Banking System_,
p. 222.

[66] Gold produced before 1492 represents an insignificant part of the
existing supply.

[67] Useful tables summarizing all of these index numbers, except those
of Canada, are given by Achille Necco, in his article on _La curva dei
prezzi delle merci in Italia negli anni 1881-1909_, in _La Riforma
Sociale_, Sept.-Oct., 1910.

[68] Comparison is for 1897 and 1906, figures for 1907 not being
available.

[69] De Launay thinks that the industrial consumption averages somewhere
between 40 and 50 per cent. of the annual output, but believes that for
several years past the industrial uses have been absorbing a decreasing
proportion, though an increasing amount. (_The World's Gold_, pp.
176-7.)

[70] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.

[71] _Ibid._, pp. 61-63.

[72] _Ibid._, p. 64.

[73] The quotation here referred to is omitted.--EDITOR.

[74] _Ibid._, pp. 64-65.

[75] _Ibid._, pp. 65-67.

[76] _Ibid._, pp. 67-69.

[77] Adapted from _The Purchasing Power of Money_, pp. 150-157; and
Bulletin of the American Economic Association, Fourth Series, No. 2.
Papers and Discussions of the Twenty-third Annual Meeting, December,
1910. p. 70.

[78] David Ricardo, _Reply to Mr. Bosanquet's Practical Observations on
the Report of the Bullion Committee_, Works, pp. 326-328. John Murray.
London. 1888.

[79] The Bank could not on their own principles, then urge that most
erroneous opinion, that the rate of interest would be affected in the
money market if their issues were excessive, and would therefore cause
their notes to return to them, because, in the case here supposed, the
actual amount of the money of the world being greatly diminished, they
must contend that the rate of interest would generally rise, and they
might therefore increase their issues. If, after the able exposition of
Dr. Smith, any further argument were necessary to prove that the rate of
interest is governed wholly by the relation of the amount of capital
with the means of employing it, and is entirely independent of the
abundance or scarcity of the circulating medium, this illustration would
I think afford it.

CHAPTER XII

THE GOLD EXCHANGE STANDARD

It is an essential feature of the gold exchange standard as
it exists in the Philippines, for example, that premiums
charged by the Government in Manila for exchange on New
York, and in New York for exchange on Manila are fixed at a
point somewhat below the gold export points in each case.
Thus the would-be exporter of gold in the Philippines never
finds it profitable to ship gold to New York. On the other
hand, international bankers in New York never find it
profitable to ship gold or currency to the Philippines,
because the authorised agent of the Philippine government in
New York always stands ready to sell in exchange for United
States currency, drafts drawn upon Manila at a premium less
than the cost of shipping gold or currency. Through a
regulation of the supply of silver pesos in actual
circulation in the Philippines they are maintained at a
definite ratio to--not gold in the Philippines, but--gold,
or its equivalent, in New York. The way in which the supply
of local currency in the gold-exchange country is regulated
will be made clear in what follows.

The gold exchange standard has not entirely escaped
criticism. Professor J. Shield Nicholson has recently
attacked this standard in India. (_Economic Journal_, June,
1914.) It is his contention that inflation may occur in
India, if it has not already occurred, on account of the
"impeded convertibility of rupees into gold." After a
certain point is reached in the inflation the decline in the
general purchasing power of the rupee must be followed, he
affirms, by a specific depreciation as regards gold; and
then the main object of the plan would be defeated. He
offers no evidence, however, that prices have risen faster
in India than in gold standard countries. With the exception
of Mexico, where currency conditions have become extremely
chaotic, the historical material here reprinted is in accord
with the recent monetary history of the countries under
discussion.

[80]When the Government of British India sought, in 1893, to give a
fixed gold value to about £120,000,000 in rupee silver, it undertook an
experiment of great importance to the financial world, and one which was
naturally viewed in many quarters with grave misgivings. The experience
of fifteen years which have followed that experiment has taught many
lessons in monetary science. It may, indeed, be said to have blazed a
new path in the principles of money--at least, in their practical
application. The effort to raise the coins to a fixed gold value by
scarcity alone was not successful, but it led to other devices, which,
imitated or improved upon in Mexico, the Philippines, and the Straits
Settlements, as well as in India, have created a new type of monetary
system which has come to bear the title of the gold exchange standard.

The gold exchange standard differs in several respects from the limping
standard. It has been the product of definite purpose and plan in the
Philippines and in Mexico and to a certain extent in India. While in
British India it has been, like the limping standard, a compromise with
existing conditions, it has there, as elsewhere, received a definite
form and substance which separated it from the limping standard as
evolved in France and in other countries which found themselves with a
large amount of legal-tender silver on their hands when the metal had
fallen below the official parity. There are two other essential
differences between the limping standard and the gold exchange standard.
One is that the gold exchange standard contemplates a circulation of
token coins of silver without any necessary concurrent circulation of
gold or paper. The other is that the gold exchange standard contemplates
definite and comprehensive measures to maintain the value of token coins
at par with gold instead of relying purely upon custom and scarcity to
give them value.

The essential principle upon which the exchange standard has been
established is that the value of money is governed by the law of supply
and demand. So long as supply was indefinite and excessive, as under the
system of the free coinage of silver, there was no way of preventing
safely and effectively the decline in the gold value of the coins to the
bullion value of their silver contents. The moment, however, that
Government undertook to limit the supply of coins to the demand for
them, it took an important step to separate their value from that of
their bullion contents and to give them a value based upon the demand
for them as money signs required for carrying on exchanges. Strangely
enough, while this principle had been in operation for many years in the
case of subsidiary coins, its bearing upon the use of silver in
countries where the standard had been depreciating was not clearly
comprehended until within recent years. Those who understood the
principle doubted its sufficiency to give a fixed value to silver coins
as the sole medium of exchange, or they distrusted the ability of any
government to judge accurately the number of coins required.

Upon the latter point they would have been correct if dependence had
been placed upon guesswork or any empirical method of determining the
amount needed. It remained to find the true solution of the problem by
so regulating the quantity of the coins that it would respond
automatically to the demands of trade. The correct method of doing this
is through the system of exchange funds. As this system is operated in
the Philippines, it is not possible to obtain gold coin for silver
certificates in small quantities; but it is possible always to obtain
drafts upon New York at par, plus the usual charges for exchange between
gold standard countries. These drafts have to be purchased with actual
silver coin or coin certificates. In either case the coins and
certificates are, by the requirements of the coinage law, held in the
Philippine Treasury. The law does not permit their deposit by the
Treasury in current account at a bank, which would turn them back into
the general circulation.

For practical purposes the volume of currency in circulation is
contracted to the same extent as if a corresponding amount of gold were
taken from the circulation for export. When the current turns and rates
for money become high in the Philippines, Philippine currency can be
released for local circulation by the purchase in New York from the gold
standard fund of bills upon the Philippine Treasury. This rule of
locking up the proceeds of the sale of bills is not rigidly applied to
the funds in New York, because the influence of the Philippine purchases
upon the local circulation there would be insignificant. On the
contrary, the Government obtains a generous interest rate, which has at
times been as high as 4 per cent., upon the deposit of Philippine funds
with New York bankers. During the stress of the autumn of 1907
considerable transfers of capital were made from Manila to New York by
means of the purchase of New York drafts from the Philippine Treasury.
The process, often repeated even under less serious pressure, clearly
shows that the monetary system of the Philippines is linked to gold, and
that capital can be freely transferred upon a gold basis between Manila
and other markets.

The experience of fifteen years since the free coinage of rupees was
first suspended in British India, of five years since the new system was
established in the Philippines, and of nearly four years since it was in
operation in Mexico, have settled most of the doubts which were felt
when the experiment was undertaken in India. In the first place, it has
been made clear that the value of the coins in exchange, as fixed by
law, has not been influenced by variations in the price of silver
bullion. This statement, of course, applies only to one side of the
problem--the fall of the gold value of the silver in the coin below its
face value. It would not be possible under any system yet discovered,
except such uneconomic devices as prohibiting exportation, to prevent
the disappearance of silver coins when the [bullion] value of their
contents rises above the legal value in exchange. Both the Philippines
and Mexico have faced this menace to their monetary circulation since
their systems were inaugurated, but both have succeeded in removing it.
In the Philippines the contents of the silver unit--the peso--was
reduced in 1906 from about 371 grains to 247 grains in pure silver. The
amount fixed by the law of 1903 was practically the same as the contents
of the old Mexican dollar. The adoption of a coin of this weight was
caused partly by the desire to avoid the distrust which some feared
might arise from reducing the weight. At the time of the passage of the
law, moreover, the price of silver was nearly at the lowest point in its
history, having touched the minimum of 21-11/16 pence in January, 1903,
and being at an average price of 22-1/2 pence in March. The adoption of
so heavy a coin, however, was not in accordance with the original
recommendation made by the present writer to the War Department in
November, 1901. The weight then recommended was 385 grains, nine-tenths
fine, or about 347 grains of pure silver.

In Mexico the rise of the silver coins above the legal gold value proved
a blessing in disguise. It enabled Mexico to go almost to an absolute
gold standard by selling her silver at a premium. From May 1st, 1905, to
October 22nd, 1907, the old silver piasters were exported to the amount
of $85,956,202, while gold coinage was executed to the amount of
$71,646,500 (about £7,200,000).[81] The gold has gone chiefly into the
reserves of the banks, which have in circulation about $95,000,000 in
notes. Gold holdings of the banks, which were only $15,832,840 in
January, 1906, were $54,165,483 in October, 1907, while silver holdings
declined over the same period from $49,781,155 to $14,399,924.[82] This
influx of gold came about because silver at 33 pence was above the
Mexican coinage ratio of about 32 to 1, and much of it was sold by the
Commission on Money and Exchange at a direct profit to the Mexican
Treasury. In view of the subsequent fall in silver below 23 pence, at
which rate Mexico is in a position to replenish her supply of subsidiary
coinage, her statesmen may claim the credit of following the great rule
of profit in the commercial world as well as on the stock exchange--to
sell when things are dear and to buy when things are cheap.

The coincidence in the rise of silver and the adoption of the Mexican
monetary reform in 1905 was in some degree accidental. It facilitated
the reform, not only by introducing gold, but by removing the objections
which would otherwise have been heard from the miners of silver to the
rise in gold wages which would have accompanied a fixing of the exchange
at a point above the value of silver bullion. It was the intention of
the Mexican Government, however, to proceed resolutely, though
deliberately, to a fixed exchange, and they would undoubtedly have
accomplished this result, even if they had not been aided by the rise in
the value of silver. Its subsequent fall has in no wise impaired the
stability of the gold standard.

Some fears were expressed in the Philippines as to the willingness of
the natives and of Chinese traders to accept a silver coin at a gold
value fixed by law which was obviously above its value as bullion. This
difficulty has proved almost negligible. Silver within less than three
years has been above 33 pence per ounce and below 23 pence. It is
doubtful if the Government officials in India or the Philippines have so
much as taken note of the daily fluctuations since the price dropped
below the legal parity of the coins, and it is certain that the exchange
value of the coins has been in no wise impaired by their fall in bullion
value. When the last reduction was made in the weight and fineness of
the Philippine coins, lowering by almost 30 per cent. their silver
contents, the precaution was taken of advising the public by means of an
official circular, translated into the various languages and dialects of
the Islands, why the change had been made, and that it would not affect
the exchange value of the coins. Provincial and municipal treasurers
were also directed to carry on a campaign of education among the people
by way of explaining the character and effect of the change. The
greatest menace to the value of the new coins lay with the Chinese, for
in China for many hundreds of years local bankers and merchants have
adhered to the rule that a coin derived no value from the stamp, but was
worth just what it would fetch on the scales. The Chinese traders at
first undertook to discriminate in this manner against the new coins of
the Philippines. In some cases they refused to receive them except at a
discount varying from 20 to 40 per cent. They also offered 105 in the
new coins for 100 in the old, evidently in the hope of exporting the old
at a profit while they continued to be worth as bullion more than their
legal gold value. The success of this discrimination was local and
extremely short-lived. The first consignment of the new coins reached
Manila on May 4, 1907, and when the Treasurer of the Islands prepared
his annual report on October 15th, 1907, he was able to make the
following statement of conditions:

At this time, October 15, the new coin is accepted without
question in every part of the Islands, and no reports or
complaints have been received for the past two months as to
discounting it, and, so far as can be ascertained, no
premium is now paid for the old coin. In fact, the demand
for the new coin for exchange purposes has so far exceeded
the supply that it became necessary to withdraw nearly half
a million of the new pesos from the banks to meet the
requisitions therefor from the provinces.

The hesitation which prevailed, therefore, in many quarters in regard to
the ability of a government to overcome the conservatism of the East in
its preference for coins of full bullion value has not been warranted by
events. This demonstration is of importance if the exchange standard is
to be considered for China. At present the Government of China is not
perhaps strong enough and sufficiently centralised to assure its
subjects that it can give a definite gold value to a token coin and
maintain it honestly and efficiently. The trial of the system, however,
in the Philippines, in British India, and in the Straits Settlements, in
all of which there are many Chinese, has probably so far cleared the air
upon this point that the Chinese Imperial Government would be able to
establish the gold exchange system if it did so under sufficient
guarantees to the financial world that it would be honestly and
intelligently maintained.

Next in importance to the settlement of this question of native
willingness to accept the new system may be considered the degree of
difficulty in maintaining it. It is not surprising, perhaps, that when
it was proposed in an incomplete form for British India, it should have
been denounced as a "fair weather" device--"a leap in the dark," which
would not stand the test of business depression, deficient crops, and an
unfavourable balance of trade.[83]

The most serious difficulty which has been foreseen by critics of the
gold exchange system relates to the sufficiency of the exchange funds.
Up to the period of the general panic of 1907 and the crop failure in
India in the spring of 1908, it might fairly be said, perhaps, that the
system had not been subjected to any but "fair weather" conditions. The
experience of India, however, has thrown striking light upon the
possibilities and limitations of the system in time of stress. The test
in India has been of such magnitude, moreover, that its results are much
more conclusive than any test which might have been afforded in a
smaller country dealing with a less enormous mass of token coins. If the
test had come before the exchange funds had acquired a respectable size,
the system might have been allowed to break down, through timidity and
delay in taking proper measures of protection, and discredit have thus
been cast upon it before it had been fairly tried.

What happened in India was that the failure of the crops deprived the
country of the usual means of compensating by exports the heavy imports
of foreign goods which had been contracted for. It became necessary,
under the settled principles of exchange, to find gold to fill the gap.
Usually the exchange account substantially balanced itself by the sale
in London of Council drafts upon the Indian Government to obtain gold to
pay the interest on the debt held in England. These drafts were
purchased by importers in London, and used to pay for the Indian crops;
but all through the spring of 1908 purchasers for drafts failed to
appear, because there had been no considerable exports of Indian crops
to be paid for. Hence Council drafts were without a market, and for a
moment it seemed that the link which bound the Indian monetary system to
the gold market of London had been severed, and that the silver rupee
might drop as disastrously as the Mexican dollar before its free coinage
was suspended. This would have added the influence of an appalling
disaster to the burden already imposed upon Indian finance by the
failure of the crops, for it would have compelled the Indian importer of
English goods to find a greatly increased number of rupees to meet his
gold obligations in London. Obviously, it was a disaster which, if it
had occurred, would have invited the bankruptcy of the country,
reflected lasting disgrace upon English financial foresight, and perhaps
even have led to organised revolt.

The Indian Government had available for meeting the crisis about
£18,500,000, principally invested in securities in London. This fund,
known as the gold standard reserve, was distinct from the currency
reserve, consisting of gold received for currency notes, which amounted
in the spring of 1908 to about £12,000,000. It was against the former
fund that the Indian Government felt compelled to offer to sell exchange
in India. Such offers were made for a time in limited amounts of
£500,000 each, but they proved substantially adequate for meeting the
demand, and by early summer the demand fell below the supply. The offer
of exchange in this form for rupees maintained the value of the rupee
coinage, contracted the amount of rupees in circulation in India, and
enabled the Indian merchants to meet their obligations without the loss
which they must have suffered if the currency had been allowed to
depreciate in gold value. The actual sales of bills upon the exchange
funds in London reached, between March 26th and August 13th, 1908, the
considerable total of £8,058,000. Of this amount about £2,000,000 was
taken from the currency reserve in gold, which was "earmarked" at the
Bank of England, incidentally affording relief to the London money
market which was keenly appreciated. Most of the remainder was obtained
by the sale of securities to an amount which reduced such holdings from
£14,019,676 on March 31st to £9,415,708 on July 31st.

The test to which the Indian system, as the most important example of
the gold exchange standard, was thus subjected was perhaps of a higher
importance than was realised by those in the thick of the conflict. It
was plainly intimated, however, in the annual report on financial
conditions for 1908 that, if necessary, the Indian Government would have
issued short-dated securities in order to still further replenish the
exchange funds in London. This would have been the true means of meeting
the situation if the existing fund had been unduly impaired. The
argument against it would have been that the demand was indefinite, and
might become so large as to be unmanageable. The fact that the demand
for exchange was met without the issue of new securities and without
trenching upon the reserve funds beyond the amount of £8,000,000 out of
£18,500,000 affords pretty strong evidence that there is a natural limit
to such demands.

It is in this principle, that there is a natural limit to the possible
drain upon the exchange funds, that the security of the new system
lies.... It is only the supply of local currency on the margin of
possible export demands which needs to be safeguarded. The substratum,
which can never leave the country unless under the influence of an
almost inconceivable economic cataclysm, is analogous in some respects
to the "authorised" circulation of the Bank of England. It represents
the irreducible minimum below which the local need for currency can
never fall. If the supply on the margin of the international exchange
movement is adequately guarded, then the whole system is secure. If it
were conceivable that the demand for exchange would equal the whole
amount of the local currency, or even the half of it, then it would be
necessary to maintain exchange funds equal to the whole amount of token
coins or the half of them in order to insure safety. But obviously this
could never be the case.

This argument against the exchange standard is only a repetition of the
dilemma sometimes presented by untrained minds in regard to bank-notes:
what would happen if all the notes should be presented at one time for
redemption? That question has been answered by banking experience; the
question in regard to the gold exchange system has been and must be
answered by experience in substantially the same manner. No country can
be subjected to such stress as to consent to part with its entire
monetary circulation, or even the half of it. On the contrary, every
influence which tends to contract the circulation tends to create a
condition which makes further contraction more difficult. Rates for the
loan of money are affected, prices of imported goods are influenced,
imports fall off and exports increase, and inevitably in the modern
money market local equilibrium is restored, often with considerable
strain, but none the less without pulling down the pillars of the
financial temple.

The experience of last spring in India proves the adequacy of a reserve
of 15 or 20 per cent. of the circulation to maintain the steady parity
of a token coinage. There is apparently no evidence that serious
distrust of the rupee arose, even when the Government was hesitating as
to just what steps should be taken to meet the demand for exchange. Even
if such distrust had arisen, however, it could have expressed itself
through financial channels only by the demand for drafts on London.
These would not have been very valuable to the average local tradesman
except as he was able to sell them back again to the banks for the very
rupees which had aroused his distrust. In this respect the gold exchange
standard may be said to put a brake upon the disposition to export
currency from fear alone, when the exportation is not demanded by the
balance of trade.

If any mistake was made in the management of the Indian currency, it was
in the investment of too large a proportion of the gold standard reserve
in securities. While investment in securities is naturally attractive
because of the income earned, and while it is not subject to just
criticism while kept within certain limits, the possession of actual
gold to a considerable amount is highly desirable. It would not be
necessary, perhaps, that such gold should be "earmarked." If the Indian
Government had a large deposit account in such an institution as the
Union of London and Smith's Bank, or the London City and Midland, it
would possess for the purposes of the Indian Government the character of
gold. Drafts against such a deposit could be sold without the discount
or delay which might be required in disposing of securities. It seems
highly desirable, therefore, in spite of the prudence with which the
recent pressure was met, that at least 30 or 40 per cent. of the gold
standard reserve should in the future be kept either in "earmarked" gold
or in the form of demand deposits.

In the case of the Philippine Islands the reserve is not "earmarked,"
but is at present entirely in the form of deposits with New York
bankers. The problem in the Philippines is really child's play compared
to that in British India. The entire circulation of the Philippine
Islands is about 40,000,000 pesos (£4,000,000), against which a large
reserve has accumulated as the result of the recoinage at a reduced rate
as well as by the profits on the original coinage. It is hardly
conceivable that an emergency would arise which would impair this
reserve; but if this should occur, the scratch of a pen in Washington
would remedy the situation. This would be accomplished by depositing
gold or its equivalent in the exchange fund in New York to the credit of
the war and navy, and placing an equivalent amount of local currency at
the command of the military forces in the Philippines. Such a deposit
would operate to increase the resources at the command of military
disbursing officers in the Islands without increasing the amount
actually in circulation until the occasion arose to disburse it. The
Panama currency has been steadily maintained at par by friendly
interchanges of this sort, even with a very insignificant official
exchange fund. No Governor of the Philippines, therefore, need have any
fear of his ability to maintain the parity of the Philippine coinage.

Whether the exchange standard would stand the strain of a great war is
yet to be subjected to practical test.[84] It may be said, however, that
its capacity to meet such a test would run upon all fours with the
capacity of any monetary system which does not consist exclusively of
gold coin. The experience of France in the war with Prussia seemed to
justify the suspension of specie payments for the purpose of husbanding
the national stock of gold. The history of the Spanish exchange, where
the coins have followed the value of the bank-notes instead of that of
silver bullion, is another case in point. Both Russia and Japan,
however, in the war of 1904-5, succeeded in maintaining complete
convertibility of their bank-notes. There is no reason why the gold
exchange standard should not be successfully maintained so long as the
country where it was established retained its national independence and
pursued a sound financial policy. The issue of large amounts of debt
would not in itself impair the stability of the standard, unless the
Government, in order to obtain gold, ravished the exchange funds in
financial centres. The questions involved would be substantially the
same as those involved in maintaining the parity of bank-notes or paper
money: first, the disposition of the Government to maintain its credit;
secondly, the resources which the Government was able to command.
Without either good intentions or monetary resources, the monetary
system, along with the fiscal system, would break down. It is not
apparent, however, that a country operating upon the gold exchange
system would find any greater difficulty in maintaining the system than
the Bank of Japan had in maintaining the convertibility of its notes
during the war with Russia.

If there were a disposition in time of war to transfer capital abroad by
excessive demands upon the exchange funds, it could be counteracted in
three ways. One would be the automatic influence of the deficiency of
currency which would arise at home. Another would be the issue of loans
abroad, from which exchange demands could be met. A third would be the
deliberate elevation by a small percentage of the charge for exchange.
This would amount to a slight depreciation in the currency, but if kept
within prudent bounds, it would probably permit the maintenance of an
adequate circulation without disturbance to local prices and without
even a theoretical depression below the 2 or 2-1/2 per cent. which
affected the notes of the Bank of France in the war of 1870.

The gold exchange system may indeed be said to be an extension of the
bank-note system to token coins. The token coin is, in effect, a
metallic bank-note, whose maintenance at gold par is subject to the
rules of sound banking. Its advantages over the bank-note in undeveloped
countries are that it conforms to a strong prejudice in favour of "hard
money," not subject to the vicissitudes of tropical climes, and that the
output can be more safely regulated, where new coins are issued only for
gold, than where a bank may increase its note issues to take over assets
of speculative or doubtful character. In the advanced countries, with a
highly organised credit system, gold, and gold alone, is the proper form
of full legal-tender coin; but in the less advanced countries of the
Orient silver token coins have the advantage that they conform in size
and denominations to the small scale of local transactions, that they
are not so rapidly absorbed by hoarding, and that their very
non-exportability enables the Government to keep in circulation a
quantity of currency which might under a different system be drained
away to richer countries, and leave the community denuded of an adequate
medium for carrying on exchanges.

OBJECTIONS TO THE GOLD-EXCHANGE STANDARD FOR THE STRAITS SETTLEMENTS
ANSWERED

[85]... the establishment of the gold standard in the Straits
Settlements ... in the spring of 1903 ... provided for the recoinage of
the British and Mexican dollars then circulating in the Malay Peninsula
into new Straits Settlements dollars ... of the same weight and fineness
as the British dollar, and for the subsequent raising of the value of
these new dollars to an unannounced gold par by means of limiting the
supply, in accordance with the principle by which India raised the gold
value of the rupee....

The objections urged to the adoption of the gold-exchange standard are
[were]: (1) That it would unduly interfere with the [foreign exchange]
business of the banks. (2) That it would encourage banks to work on
dangerously low cash balances, knowing as they would that they could
obtain dollars of the Government on a moment's notice by the purchase of
cable transfers on Singapore from the crown agents for the colonies in
London. (3) That there would be danger of the Government's notes [a part
of the circulating medium] depreciating unless they were redeemable in
gold in the country itself. (4) That the monetary circulation of the
Straits Settlements was too small to make the plan feasible there. (5)
That the plan would require a larger reserve fund than would otherwise
be necessary, because the Government would be compelled to keep a
reserve both in London and Singapore; and that in each place the reserve
would have to be large, because drafts on the fund through the sale of
telegraphic transfers would not give the Government any such warning in
advance of the demands liable to be made as would enable it to replenish
the reserve.

The above arguments, all of which were urged upon the writer either by
officials or business men in the Straits Settlements, do not appear to
be conclusive for the following reasons, which may conveniently be
stated in the same order as the objections.[86] (1) If the rates for the
sale of government drafts were fixed at the "gold points," as they
presumably would be under the gold-exchange standard, and if only drafts
of large amounts were to be sold by the Government, redemption by the
sale of drafts would not interfere appreciably more with the business of
the banks than would redemption in coin. Under these circumstances the
banks themselves would be the principal purchasers of government drafts,
and such drafts would be purchased and forwarded merely in lieu of the
shipment of sovereigns. (2) The sale of telegraphic transfers, while
desirable in the interest of currency elasticity, is by no means a
necessary feature of the gold-exchange standard. If the Government were
opposed to making a minimum legal reserve requirement of banks, it could
limit its sales of drafts to demand drafts or even, if need be, to
short-time drafts. (3) If government notes were redeemable in silver
dollars on demand, and if the silver dollars were redeemable in gold
exchange on demand, depreciation would be impossible in a country where
the people have the confidence in the Government which they have in the
Straits Settlements. (4) The system of the gold-exchange standard is
better suited to a country with a small circulation than to one with a
large circulation. It is evidently easier to maintain a small reserve
abroad than a large one and the operations with a small reserve are less
disturbing to the money market of the financial center in which the
reserve is located. (5) It is not probable that the Straits Settlements
would require so large a reserve under the gold-exchange standard as it
will under the system to be adopted. Under either system it would need a
sovereign reserve and a dollar reserve. Under the system to be adopted
both reserves will be located in Singapore; under the gold-exchange
standard the dollar reserve would be located in Singapore and the
sovereign reserve in London. The sale of cable transfers is not a
necessary part of the system, as above pointed out; and, even if it
were, the movement of market rates of exchange would ordinarily give
ample warning of a demand for dollar drafts or sovereign drafts.
Emergency cases, if such should arise, could be met through the
temporary transfer of funds to the gold reserve from the security
portion of the note guarantee fund, or through the transfer of dollars
to the credit of the home government in Singapore in exchange for an
equivalent amount of sovereigns placed to the credit of the Straits
government in London.... A prolonged and severe drain upon the reserve
fund, which in a country like the Straits Settlements would be an
extremely improbable contingency if the Government withdrew from
circulation dollars presented in the purchase of government drafts,
could of course always be met by the forward sale on the London silver
market of the redundant dollars piling up in the Government's dollar
reserve in Singapore. The gold-exchange standard would probably enable
the country to get along with a smaller gold reserve than will the
system to be adopted, inasmuch as it would keep gold coins out of
circulation and the demands upon it would be limited to the requirements
of meeting foreign trade balances--the only monetary use to which the
dollars could not be applied. The Straits Settlements, inasmuch as it is
a country for whose trade requirements silver coins are better adapted
than gold, and a country which is anxious to maintain its reserve at as
small an expense as possible, would in fact seem to be a place
peculiarly adapted to the gold-exchange standard. The premiums which the
Government would realize on its sale of exchange, together with the
interest it would obtain on that part of its reserve deposited abroad,
would doubtless yield sufficient profit, as in the Philippines, to pay
the expenses of administering the currency system and to provide in
addition a substantial annual increment to the gold reserve.

FOOTNOTES:

[80] Charles A. Conant, _The Gold Exchange Standard in the Light of
Experience, The Economic Journal_, Vol. 19, June, 1909, pp. 190-200.

[81] _Le Marché Financier en 1907-8_, p. 711.

[82] These figures are from the annual budget statements of the Minister
of Finance.

[83] For some of these doubts see _London Bankers' Magazine_, October,
1908, LXXXVI, p. 435.

[84] Throughout August, 1914, while sterling rates in other countries
rose to unprecedented heights, India succeeded in maintaining rates on
London in the neighborhood of the gold export point--a striking
testimony to the soundness of the Indian arrangements.--EDITOR.

[85] E. W. Kemmerer, _A Gold Standard for the Straits Settlements II.,
Political Science Quarterly_, Vol. XXI, No. 4, p. 663, 678-680.

[86] The answers given to the objections just stated have been confirmed
and strengthened by the actual operation of the gold-exchange standard
as later adopted by the Straits Settlements.--EDITOR.

CHAPTER XIII

A PLAN FOR A COMPENSATED DOLLAR

[87]In the _Purchasing Power of Money_ (1911) I sketched a plan for
controlling the price level, _i. e._, standardizing the purchasing power
of monetary units. This plan was presented more briefly, but in more
popular language, before the International Congress of Chambers of
Commerce, at Boston, September, 1912. The details were most fully
elaborated in the _Quarterly Journal of Economics_, February, 1913.
Following these and various other presentations of the subject,
especially the discussion at the meeting of the American Economic
Association in December, 1912, the plan was widely criticized by
economists, both favorably and unfavorably, as well as by the general
public.

On the whole the plan has been received with far more favor than I had
dared to hope and even the adverse criticism has usually been tempered
by a certain degree of approval.

The object of the present paper is briefly to state the plan and to
answer the more important and technical objections which have been
raised. Answers to the more popular objections, omitted from this
article through lack of space, will appear in a book, _Standardising the
Dollar_, which I hope to publish in 1915.

I shall begin with a skeleton statement of the plan; space is lacking
for more. In brief, the plan is _virtually_ to vary each month the
weight of the gold dollar, or other unit, and to vary it in such a way
as to enable it always to have substantially the same general purchasing
power. The word "virtually" is emphasized, lest, as has frequently
happened, any one should imagine that the actual gold coins were to be
recoined at a new weight each month. The simplest disposition of
existing gold coins would be to call them in and issue paper
certificates therefor. The virtual gold dollar would then be that
varying quantum of gold _bullion_ in which each dollar of these
certificates could be redeemed. The situation would be only slightly
different from that at present, since very little actual gold now
circulates; instead, the public uses gold certificates, obtained on the
deposit of gold bullion at the Treasury, and redeemable in gold bullion
at the Treasury at the rate of 25.8 grains, nine-tenths fine, per
dollar. The only important change which would be introduced by the plan
is in the redemption bullion; we would substitute for 25.8 a new figure
each month. The gold miner, or other owners of bullion, would, just as
now, deposit gold at the United States Mint or Treasury and receive
paper representatives, while the jeweler, exporter, and other holders of
these certificates would, just as now, present them to the Treasury when
gold bullion was desired.

There would also be a small fee or "brassage," of, say, 1 per cent. for
"coinage," _i. e._, for depositing the bullion and obtaining its paper
circulating representative. In other words, the Government would buy
gold bullion at 1 per cent less than it sold it. This pair of prices,
for buying and selling, would be shifted in unison, both up or both
down, from month to month, it being provided, however, that no single
shift should exceed 1 per cent., a figure equal to the amount by which
the two differ. The object of this proviso is to prevent speculation in
gold.

To determine each month what the pair of prices should be, or, what is
practically the same thing, to determine what amount of gold bullion
should be received and paid out in exchange for paper, recourse would be
had to an official index number of prices. If, in any month, the index
number is found to deviate from the initial par, the weight of bullion
in which it shall be redeemable the next month is to be corrected in
proportion to this deviation. Thus, the depreciation of gold would lead
to a heavier virtual dollar; and an appreciation, to a lighter virtual
dollar.

There are, of course, other details and possible variants of the plan,
some of which will be referred to later when necessary. The objections
to the plan are classified under the following heads:

1. "_The plan assumes the truth of the quantity theory of money._" There
is nothing whatever in the plan itself which could not be accepted by
those who reject the quantity theory altogether. On the contrary, the
plan will seem simpler, I think, to those who believe a direct
relationship exists between the purchasing power of the dollar and the
bullion from which it is made--without any intermediation of the
quantity of money--than it will seem to quantity theorists.

2. "_It contradicts the quantity theory._" This objection, the opposite
of that above, is raised by some, who, like Professor Boissevain,
believe in the quantity theory, but imagine that the operation of the
plan could not affect the quantity of money at all (or would not affect
it to the degree needed). But evidently an increase in the weight of the
virtual dollar, _i. e._, a reduction in the price of gold bullion, would
tend to contract the currency, by diverting gold from the mint into the
arts; because its reduced price would cause an increased demand and
consumption. A decrease, of course, would have the opposite effect.

3. "_It might aggravate the evils it seeks to remedy._" This objection,
raised by Professor Taussig and a few others, is based on the preceding.
It is claimed that an increase in coined money may take place for years
"without visible effect on prices; then comes a flare-up, so to speak."
I doubt if Professor Taussig meant the first half of this statement to
be quite so strong. The evidence only justifies the statement that the
rise is slow at first and rapid later while similarly the effect of a
scarcity of money is slow at first and rapid later. Professor Taussig
then proceeds to apply the same idea to my plan:

The cumulative consequence would be like the cumulative
consequence of a long continued decline in gold production.
After a season or two of declining bank reserves, tight
money, and so on, a sudden collapse might be occasioned, and
apparently caused, by the announcement of some particular
seigniorage adjustment. Then there might be a decline in
prices much greater than in proportion to the bullion
change.

But the working of the compensated dollar would not be in the least
analogous to the operation of gold inflation or contraction, even as
Professor Taussig supposes it. The plan always works cumulatively
_toward_ par, never cumulatively _away from_ par. One often sees a wagon
with its wheels on a street-railway track having some difficulty getting
off; the front wheels have to be turned at a large angle before they are
forced out of their grooves; then of a sudden they jump away. This is
analogous to the delayed "flare-up" of prices which Professor Taussig
supposes under the influence of a long continued decline or increase in
the gold supply. But if the driver instead of trying to turn out is
trying to keep the wagon on the track he will pull the horse back at
every tendency to turn to the right or left. The more the horse turns to
the right the harder will the driver endeavor to turn him to the left.
Clearly the effect of the driver's efforts will be to avert or delay,
not to aggravate or hasten, any jumping out of the grooves which other
causes may tend to produce.

In other words, if it takes as much time as Professor Taussig fears for
a pressure on prices to move them, then so much the more certain is it
that, under the plan, deviations from par, though they may be
persistent, cannot be either rapid or wide. A long continued small
deviation gives plenty of time for the counter pressure exerted by the
compensating device to accumulate and head off any wide deviation.

Suppose that, following Professor Taussig's ideas, some cause such as an
increase of gold production would, in the absence of the compensated
dollar plan, gradually lift the price level as follows: during the first
year, not at all; during the second year, 1 per cent.; during the third
year, 2 per cent.; after which would come a "flare-up" of 10 per cent.
We may suppose then that, if the plan were in operation during the first
year, there being no deviation visible, there would be no change in the
weight of the dollar. After the first month of the second year when
prices were 1 per cent. above par, the weight of the dollar would
according to the plan be raised 1 per cent. If this were unavailing, so
that in the second month the deviation were still 1 per cent., the
weight of the dollar would be again increased 1 per cent. Every month,
as long as the deviation of 1 per cent. lasts, the weight of the dollar
would receive an _additional_ 1 per cent. Unless some effect were
produced on the supposed original schedule of deviations, the weight of
the dollar of the second year would be increased 12 per cent., and by
the end of the third year by 24 per cent. more, or 36 per cent. in all.
But it is clear that by this time, with so swollen a dollar, the
"flare-up" scheduled for the fourth year could not occur, but that a
counter movement would set in--in fact, would have set in long before
the dollar became so heavily counterpoised. Nor could the result of the
counterpoise, even if so heavy, be to swing suddenly prices far below
par. Prices would, by hypothesis, yield slowly and again give time for
taking the counterpoise off. If the price level sank, say to 1 per cent.
below par for six months, then to 2 per cent. for another six months and
to 3 per cent. in the next six months, evidently the entire 36 per cent.
would be taken off in eighteen months (since 1 × 6 + 2 × 6 + 3 × 6 =
36). The compensating device is thus similar to the governor on a steam
engine. It is the balance wheel that is largest and hardest to move
which is the most easily controlled by the governor. So if the
"flare-up" theory is true, the system will work more perfectly than if
it were not true.

4. "_It would not work unless every single mint in the world employed
it._" This is an error. Although it could be easily shown to be
politically inadvisable for one nation alone to operate the plan, this
would not be economically impossible. Those who hold the contrary are
deceived by the term "mint price." They reason that our mint price
($18.60 an ounce of gold, 9/10 fine) and England's mint price (£3 17_s._
10-1/2_d._ for gold 11/12 fine) are now "the same," and that,
consequently, if our price were lowered 1 per cent., _i. e._, to $18.41,
while the English price remained unchanged, _all_ our gold would be
taken to England to take advantage of the "higher" price there. But
these comparisons between English and American prices are based on the
present "par of exchange" ($4.866 of American money for the English
sovereign): which par of exchange is in turn based on the relative
weights of the dollar and the sovereign. As soon as our dollar were made
1 per cent. heavier, not only would the new American mint price go down
1 per cent., but the par of exchange would also go down 1 per cent., to
$4.82. Consequently, the new mint price of $18.41, although in figures
it is lower than the old, yet, being in heavier dollars, would still be
"the same" as the English mint price of £3 17_s._ 10-1/2_d._ This
sameness of mint price as between the two countries means at bottom
merely that an ounce of gold in America is equivalent to an ounce of
gold in England.

It is true that each increase in the weight of the virtual dollar in
America--in other words, each fall in the official American price of
gold--would at first discourage the minting of gold in America. The
miner would _at first_ send his gold to London, where the mint price was
the same as formerly, and realize by selling exchange on the London
credit thus obtained. But the rate of exchange would soon be affected
through these very operations, by which he attempted to profit, and his
profit would soon be reduced to zero; the export of gold to England
would increase the supply of bills of exchange in America drawn on
London and lower the rate of exchange until there would be no longer any
profit in sending gold from the United States to England and selling
exchange against it. When this happened it would be as profitable to
sell gold to American mints at $18.41 per ounce as to ship it abroad;
and $18.41 in America would be the exact equivalent at the new par of
exchange ($4.82) of the English mint price of £3 17_s._ 10-1/2_d._

5. "_The system would be destroyed by war._" Professor Taussig fears
that if money were stabilized, the system would itself be upset by war.
"Any war would put an end to it." To this I would reply: first, that if
war did put an end to it the system would do good so long as it lasted
and its discontinuance would do no more harm than the existence of our
present unscientific system is doing at all times; secondly I do not see
any reason for thinking that war would put an end to it.

Possibly Professor Taussig has in mind the first form in which I
explained the plan, _viz._, in my book, _The Purchasing Power of Money_.
In that form one country was to serve as a centre and all other
countries were to have the gold exchange standard in terms of gold
reserves in the central country, just as now the Philippines have a gold
exchange standard with reference to the United States and India with
reference to England. Professor Taussig's objection would undoubtedly
apply, to some extent, in cases where the plan was carried out through
the gold exchange mechanism. But where the system was independently
established in each country simply parallel to the systems in other
countries, there would be no more need for its abandonment in case of
war than for the abandonment now by Germany of the gold standard because
England, its enemy, has the gold standard also. We know, of course, that
in time of war, the gold standard is often temporarily abandoned in
favor of a paper standard; and the new proposal would not escape such a
difficulty. This, however, would not be due to the international
character of the plan, but to the exigencies of war.

6. "_The multiple standard is not ideal. Especially is it faulty when
the cause of price movements is entirely a matter of the abundance or
scarcity of goods in general._" Those who hold this objection point out
that an ideal standard would not be one which always smooths out the
price level but one which discriminates and leaves unchanged such rises
and falls as are due to general scarcity and abundance of goods. There
is much to be said in favor of such discrimination as an ideal. It must
be admitted that the compensated dollar plan would not discriminate
between changes in the price level due to the scarcity or abundance of
goods in general and those due to changes in money and credit. It must
be further admitted that a theoretically ideal standard would take some
account of this distinction. But the compensated dollar plan does not
claim to be ideal. The plan would simply correct the gold standard to
make it conform to a multiple commodity standard. It does not pretend to
correct the multiple commodity standard to make it conform to some
"absolute" standard of value.

Such an ideal standard is as unattainable as is absolute space. Changes
in relative value indicate change in absolute value, either of goods or
of money; but it is not possible for us to know, except in a general
way, how much of the absolute change is in goods and how much in the
dollar. On general principles we may be assured that the absolute change
is wholly or mostly in the dollar. We economists in our measurements of
value are in much the same predicament as the astronomers. Our
economical "fixed stars" are fixed only in a relative sense. We cannot
measure the empty spaces of absolute value, but can only express values
in terms of visible goods, the general average of which is the nearest
approach to absolute invariability we can, in practice, reach.

But if it were possible to measure absolute values to our universal
satisfaction, in terms, say, of "marginal utility," or of "disutility of
labor," or of anything else, there are no statistics by which we can
realize such a standard in practice. The only readily available
statistics by which we can correct our present standard are price
statistics from the great markets. We can, by index numbers based on
these price statistics, translate from gold into commodities, but as yet
we cannot translate from commodities into any ideal or absolute
standard.

If I were treating of the problem of an ideal standard of value, I think
I should be inclined to agree with Professor Marshall that a standard
that represents a gradually descending scale of prices to keep pace with
the "real" cheapening improvements in industrial processes is better
than one which represents an absolute constancy of prices. But it would
be quite impracticable to discover the exact rate of fall of prices
which would correctly register the improvement going on in industry,
and, moreover, it would, I believe, be so small as not to depart much
from the mutiple standard. This I infer is also the opinion of Professor
Marshall.

Professor Kinley makes the very interesting suggestion that we can
suppose a more ideal standard than the tabular by making our unit a
definite percentage of the national annual dividend. This appeals to me
as a rough and ready way of fixing a unit more nearly ideal than that
fixed by the tabular standard. But it would certainly not be
practicable. It would not even be quite ideal. But if Professor Kinley
will measure his standard, the compensated dollar plan will be able to
take care of it.

In fact, if we could find a more absolute standard than the tabular
standard and could accurately measure it in statistics, precisely the
same method of compensating the dollar could be employed to keep the
dollar in tune with that standard as with the tabular standard. The only
difference would be that the guiding index would be different. The plan
for compensating the dollar does not in essence consist in selecting the
multiple or any other standard. It consists in a method of making the
monetary unit conform to any standard chosen. But there is convincing
evidence that the multiple standard is usually near enough to the ideal
for all practical purposes and infinitely nearer than the gold standard.
_While individual goods may vary greatly in absolute value, the general
mass of goods will vary comparatively little and seldom._ There may be
some absolute change in the general mass of commodities, but it must
usually be extremely small in comparison with changes in any one
commodity like gold. It is clear from the theory of chances that this
must be the case. The odds are hundreds to one that the variations in
absolute value in several hundred commodities will offset each other to
a large degree. We very seldom have world feasts or world famines. If
the corn crop is short in some places it is abundant in others. If it is
short everywhere the crop of wheat or barley or something else is
practically certain not to be. We cannot expect that everything will
usually move in one and the same direction. If there is a war in Japan,
it is not likely that there will also be a war in India. A world war or
even anything as near to a world war as the present conflict in Europe
is a most unusual thing.

A standard composed of several hundred commodities must therefore be, in
all human probability, more stable than a standard based, as is our
present gold standard, on one commodity. Bimetallists made much of this
point when claiming that two metals joined together were steadier than
one, just as two tipsy men walk more steadily arm in arm than
separately. Still more steady is the average of a hundred commodities
just as a line of a hundred tipsy men abreast and holding each other's
arms will march even more steadily than two. This is because it is
wholly unlikely that every man in the line will lurch in the same
direction at the same instant. The lurching of some in one direction
can always be depended on to offset almost entirely the lurching of
others in the other direction. This theory of probabilities in its
application to the present rise of prices is, I believe, borne out by
the facts.

After a careful study of all available evidence, I am convinced that the
present general rise in prices beginning in 1896, cannot be traced to
any simultaneous scarcity of goods. I refer the reader to _Why Is the
Dollar Shrinking?_ where I have given the summary of the evidence. I
think the facts are equally clear that the great fall in prices from
1873 to 1896 can not be laid, wholly at least, to the increasing
plentifulness of goods.

Finally, even if we could measure and apply an absolute standard, it is
doubtful if, in practice, it would be of any more service in regulating
contracts, than a multiple standard. For after all, as I have tried to
show in _Appreciation and Interest_ what we want in a contract is
something that is _dependable_ rather than something that is absolutely
constant; and the multiple standard gives dependability in terms of the
ordinary staple necessities of life. If we could know that the dollar
always means a definite collection of goods, we could know that the
bondholder or the salaried man who gets a stated income of $100 a month,
would have the same command over actual goods, and such knowledge would
be of great service. This whole subject I have discussed in Chapter X of
my _Purchasing Power of Money_.

7. "_It would be inadequate to check rapid and large changes of the
price level._" Owing to the narrow limits, _e. g._, 1 per cent. as
stated, imposed on the monthly adjustments, it is quite true that a
sudden and strong tendency of prices to rise or fall could not be
completely checked. If prices were to rise 8 per cent. per annum and the
plan permitted no more rapid shift than 6 per cent. per annum, this
would leave only 2 per cent. per annum uncorrected, or only one-fourth
the rate at which prices would rise if wholly uncorrected. But half (or
in this illustration three-quarters of) a loaf is better than no bread.
Moreover, such extreme cases are rare and when they occur there is all
the keener need for mitigation even if it be somewhat inadequate.
Ultimately, of course, after the rapid spurt has abated, the
counterpoise, in its relentless pursuit, would overtake the escaped
price level and bring it back to par.

8. "_The correction always comes too late._" It is objected that the
plan does not make any correction until actual deviation has occurred,
and so the remedy always lags behind the disease. It is true that the
corrections follow the deviations. They could not precede them unless we
foreknew what the deviations were to be; and we could not afford to
entrust the work of guessing to government officials. In this respect,
as in others, the plan does not attain perfection; yet it is infinitely
better than the present plan, which leaves the standard haphazard. It is
also pointed out that after the correction is applied it may happen that
prices will take the opposite turn, in which case the remedy actually
aggravates the disease. But, taking the extremely fitful course of
prices since 1896 and correcting it according to the plan, month by
month, as shown in the _Quarterly Journal of Economics_ diagram, we find
that in nine cases out of ten the opposite is true. Even in the few
remaining cases the deflections were very slight and were, of course,
soon corrected immediately after the following adjustments. If the
corrections are sufficiently frequent, it is impossible not to maintain,
in general, an extremely steady adjustment.

When steering an automobile the chauffeur can only correct the deviation
from its intended course _after_ the deviation has occurred; yet, by
making these corrections sufficiently frequent, he can keep his course
so steady that the aberrations are scarcely perceptible. There seems no
reason why the monetary automobile cannot be driven almost equally
straight.

9. "_The plan assumes that a 1 per cent. fluctuation can be exactly
corrected by a 1 per cent. adjustment of the dollar's weight._" Owing, I
fear, to my own fault of phrasing, I have found that several people have
acquired the mistaken impression that the plan requires, to be made at
each adjustment, an increase of 1 per cent. in the weight of the dollar
for every 1 per cent. _increase_ of the index number since the last
adjustment; whereas actually the plan requires, to be made at each
adjustment, an increase of 1 per cent. in the weight of the dollar for
every 1 per cent. excess of the index _above par_ then outstanding.

From this mistaken premise it has naturally been inferred that, in order
that the plan should work correctly, a 1 per cent. loading of the dollar
would always have to exactly correct a 1 per cent. change in the index
number, and, very properly, the critics doubted the truth of this. But
since the premise was mistaken the objection based on it disappears.

10. "_The plan would be sure to create dissatisfaction and
quarrelling._" This fear is, I believe, wholly imaginary. There would be
some ground for it if the proposal were to adopt the old "tabular
standard" by correcting money payments through the addition to or
subtraction from the debt of a certain number of dollars. Under these
circumstances the extra dollars paid or the dollars from which the
debtors were excused would stand out definitely and would be a subject
for debate and dispute, but if the tabular standard were merged in the
actual money of the country the ordinary debtor and creditor would be as
unaware of how his interests had been affected as he is now unaware of
how his interests are affected by gold appreciation. It would still be
true that to the ordinary man "a dollar is a dollar."

If we cannot get the ordinary man to-day really excited over the fact
that his monetary standard has affected him to the tune of some 50 per
cent. of his principal of fifteen years ago, it does not seem likely
that he could get excited because some one tells him that the index
number used in the "compensated dollar" plan robbed him of 1 or 5 per
cent. as compared with some other possible system.

The debtor class favored in large measure bimetallism, or free silver,
as a means of helping them pay debts, while the creditor class opposed
it. But this was a question of changing the standard, not of keeping it
unchanged. If it were proposed to shorten the yardstick, undoubtedly
many who would profit in the outstanding contracts would and ought to
oppose it. But there is and can be no contest over efforts to keep the
yardstick from changing.

11. "_It has never been tried._" True; but the proposal is, in
mechanism, almost identical with the gold exchange device introduced by
Great Britain to maintain the Indian currency at par with gold. The
system here proposed would really be to-day less of an innovation in
principle than was the Indian system when introduced and developed
between 1893 and 1900, while the evils it would correct are similar to,
but vastly greater than, the evils for which the Indian system was
devised.

The truth is, unless I am greatly mistaken, that the last named is the
only strong objection to the plan in the minds of most of its critics;
it is the constitutional objection to any change of the _status quo_. It
is simply the temperamental opposition to anything new. As Bunty well
says in the play, "anything new is scandalous." The conservative
temperament dislikes experiment because it is experiment. Accordingly it
is not surprising that we find many of the objectors saying, "let well
enough alone," "let us 'rather bear those ills we have than fly to
others that we know not of.'" These people seldom give assent to untried
experiments; yet after the new plan has been tried and established they
invariably turn about and become its most staunch supporters. This fact
has been often illustrated in our monetary and banking system. Nothing
short of the shock of civil war was required to divert us from a state
system of banking to a national one. In spite of the intolerable evils
of the former, it was easy to find many arguments in its favor. After
the change these arguments never reappeared. The same was true of
slavery.

But conservatism always yields gradually to pressure. Its resistance is
strong but has no resiliency. It is not like the resistance of a steel
spring (which, when pushed in one direction, will bend back), but a mass
of dough or putty which, though it resists impact strongly, yet when it
is moved stays inert and does not return. Under these circumstances,
even if progress is made an inch at a time, it seems to me worth while
to try to make it. The two steps first necessary have been taken,
namely, the perfecting of the plan and the running the gauntlet of
criticism.

It is not impossible, judging from the many and authoritative
endorsements of the plan, that it may be pushed rapidly toward
realization. All depends on the opening up of opportunities. After the
present war, for instance, it may be that "internationalism" will come
into a new vogue and that some special opportunity will be afforded to
bring the plan with its endorsements to the serious attention of the
world's administrative officials.

* * * * *

[88]It must be admitted at the outset that the plan, if carried out with
iron consistency for a considerable stretch of time, would achieve the
result mainly had in view--the prevention of a long-continued and
considerable rise in prices. It might not achieve that result as
smoothly and evenly as its proposer expects; and the qualifications just
stated--that it must be carried out unflinchingly for a long
period--should be borne in mind. No one who holds to the doctrine that
the general range of prices is determined by the relation between the
quantity of commodities and the volume of the circulating medium, and
that the volume of the circulating medium in the end depends, _ceteris
paribus_, on the amount of coined money, can do otherwise than admit the
logical soundness of the scheme. He who maintains that the rise in
prices during the last fifteen years is due to the greater gold supply
must admit that a restriction of the monetary supply of gold will check
the rise. The plan proposed is in essence one for a regulation in the
monetary supply of gold. Its effects must be the same in kind as those
of a cessation of free coinage, with an apportioned limited coinage....

The question arises whether it would be feasible for one country alone
to adopt the plan. It would be feasible, in the same sense that it would
be feasible for all countries together to adopt it. One country alone,
carrying it out with unflinching consistency, might secure the desired
result, subject to the qualifications which have already been indicated.
But that any one country would in fact adopt it alone seems to me in the
highest degree improbable.

Consider for a moment the mode in which the scheme would work in detail
if adopted by a single country. Though the immediate effect upon general
prices within the country would be unpredictable, the effect upon
certain kinds of prices would be certain, predictable, almost
instantaneous. Exported commodities would feel the effect at once. Their
prices are determined, to use the current expression, by the foreign
market. It would be more accurate to say that their prices are
determined by the total market, domestic as well as foreign. But it is
clear that their prices must be the same (due allowance being made for
transportation charges and the like) within the country as without. Now
the immediate effect of a seigniorage would be, as Professor Fisher
points out, a readjustment of the par of foreign exchange. The exporter
would find the par of exchange lessened, and in terms of domestic money
(compensated dollars) he would receive less than he got before. All
commodities of export would fall in price at once, or fail to rise, to
the extent of the seigniorage. Other commodities probably would be
unaffected for the moment. In the long run, no doubt, these other
commodities (we may call them domestic commodities) would also be
affected. But, to repeat, the rapidity and extent of the change in
general prices is impossible of prediction. The exporters, none the
less, would feel an immediate and unmistakable effect. Beyond question
they would be as hotly indignant with the plan as if an excise tax had
been imposed on their commodities without any possibility of their
raising the price of their products. Consider for a moment what would be
the state of mind in our cotton-exporting South. Is it to be supposed
that any set of legislators could resist the political pressure from the
various exporting sections, and carry out the scheme unflinchingly? Can
we imagine a Congressman telling his constituents that they need only
wait a while, until all money incomes and all prices had adjusted
themselves to the new conditions? that then nobody would be worse off or
better off than before? To ask this sort of question is to answer it.
The very proposal of the scheme in the halls of Congress would invite
the hot opposition of the exporting sections and industries. Its
immediate consequences for them would be seen quickly enough, and no
promise of ultimate adjustment would lessen their hostility....

Professor Fisher has predicted that prices will rise further. He is
disposed to believe that there will be not only a rise, but that there
will be a considerable rise. I hesitate very greatly to enter the domain
of prediction. I am inclined to believe that the rise in prices will not
cease for the next decade; but whether it will be considerable or
moderate or negligible in extent, I should not venture to say.
Predictions concerning the output from the mines are to be taken with
the greatest caution. We all recall the predictions which Suess made in
1892. The distinguished geologist believed that the prospects of an
increased production of gold were of the slightest, and that the world
must fall back on the use of both metals. How different the course of
events has been from that which he predicted! There are those who
believe that the output of gold, so far from continuing to increase, has
reached, or is approaching, its maximum. For myself, I should not be
surprised if there were a cessation in growth, and should certainly be
surprised if there were not a relaxation in the rate of growth.

Further: it deserves to be borne in mind that the total supply of the
precious metals is now so much greater than it was twenty years ago that
the same annual increment will have much less effect on prices. This is
the familiar consequence of the durability of the precious metals....

Finally, a circumstance should be borne in mind which bears not only
upon the intrinsic desirability of a regulative plan, but also upon the
attitude of the general public and the consequent political and
industrial possibilities. Economists are familiar with the difference
between the phrase which they use in describing the new conditions, and
that which is current in popular discussion. The economists speak of the
"rise in prices"; the general public speaks of the "high cost of
living." The difference in phraseology is not due simply to variation of
the point of view. It results from the fact that very different
phenomena are had in mind by the two sets of persons. The economist is
thinking and reasoning about the change which has been of special
interest for him--the general rise in prices. The man on the street is
thinking about the exceptional rise in the prices of one important set
of commodities. Any one who will examine with care the index numbers of
our Bureau of Labor will see what a marked rise, much beyond that of the
general index number, has appeared in the prices of farm products, and
especially in the prices of meat. That special advance has taken place
within the last three or four years. It is precisely within this period
that general attention has been turned to rising prices. What the public
has had chiefly in mind has been the commodities of wide consumption.
This, I believe, is the main cause of labor unrest....

Whatever be the particular causes that have led to the high prices of
food, economists agree that these causes will operate irrespective of
any compensated dollar plan. This would simply serve, at its best, to
keep general prices where they are, leaving each particular group of
commodities subject to its own particular set of causes. If the
compensated dollar plan were to be adopted, and if the prices of food
should continue to mount, there would be disappointment for the general
public, but nothing to surprise the economist. And conversely, it is
entirely possible that the rise in the cost of living, that is, the
special rise in the prices of foodstuffs, will reach its end
irrespective of any monetary change whatever. The general rise in prices
and money incomes ... is not unwelcome to the great majority of people.
Its incidental consequences are perceived and debated chiefly by the
economists; such as the effects on the creditor class and the slowness
of so-called fixed incomes to rise correspondingly. The general public
is concerned chiefly with the conspicuous rise in the prices of
foodstuffs, which is ascribable to causes very different from those that
bring the general rise, and can be reached only by remedies very
different....

FOOTNOTES:

[87] Adapted from Irving Fisher, _Objections to a Compensated Dollar
Answered_, reprint from _The American Economic Review_, Vol. IV, No. 4,
December, 1914.

[88] F. W. Taussig, _The Plan for a Compensated Dollar_, _The Quarterly
Journal of Economics_, Vol. 27, May, 1913, pp. 401-416.

CHAPTER XIV

MONETARY SYSTEMS OF FOREIGN COUNTRIES

ENGLAND[89]

[90]The monetary unit is the _pound_, or _sovereign_, equal to $4.8665,
divided into 20 _shillings_ of 12 _pence_ each, each penny equal to 4
_farthings_. Originally the pound was a Troy pound of silver, .925 fine.
Under the law of 1816 gold was made the standard and silver subsidiary.
The coinage of gold is free, and to avoid delay the Bank of England is
required to buy all gold and pay for the same at once at the [minimum]
rate of £3 17_s._ 9_d._ per ounce, a [maximum] charge of 1-1/2_d._ being
imposed for the accommodation. Silver is only coined on government
account and the coinage ratio is 14.29 to one.

They have the gold _sovereign_ (containing 113.001 grains pure gold),
the unit of their currency, also _half-sovereigns_, _crowns_ (5_s._),
_double florins_, (4_s._), _half-crowns_, _florins_, _shillings_, _six_
and _three pence_ pieces, _four pence_ (groat), _two pence_ and _penny_,
all in silver, also _penny_, _half-penny_, and _farthing_ in bronze. A
few English banks, operating under old charters, issue notes to a
limited extent, which circulate as money. Otherwise the paper currency
of England and Wales consists wholly of notes of the Bank of England....

Extraordinary measures were resorted to by the British government in the
early stages of the European war of 1914; with the close of the war
currency conditions will doubtless go back to normal, as described
above.

The Government, also, under date of August 6, authorized an issue of
currency notes, in denominations of £1 and 10 shillings....

These notes, which were first issued to the public August 7, were
deposited with the Bank of England for account of the British
government, as the practical way of getting them into use; they were
used for various purposes, including advances to banks at 5 per cent.
per annum, up to 20 per cent. of their deposits; the volume outstanding
December 30, 1914, was £38,478,164; the amount outstanding on June 23,
1915, was £46,199,705. These notes were protected in part by securities
and by an increasingly large gold reserve, exceeding 75 per cent. in
March, 1915.

Postal orders were made legal tender and so remained until February 4,
1915....

CANADA

In 1857 the legislature of Upper and Lower Canada formally adopted
dollars and cents as the money in which public accounts should be kept.
The Confederation in 1867 adopted the same for the Dominion, retaining,
however, the sovereign.

In 1871 the Currency Act prescribed the same for all accounts, providing
also that the gold coins of the United States of America should be legal
tender along with British sovereigns, the latter at a rating of $4.86
2/3.

The silver and bronze tokens (including pieces of 50, 25, 20, 10, 5, and
1 cents) had been supplied from the London Mint, or from Birmingham on
its behalf, from 1856 to 1907. After the Confederation no more coins
were issued for the separate Provinces. The twenty-cent piece (though
still retained by Newfoundland) has not been struck for Canada since
1864.

From January 2, 1908, the whole supply of British and Canadian coins was
undertaken by the Ottawa Mint. By the Ottawa Mint Act the Dominion
Parliament undertook the support of a branch of the Royal Mint in
Ottawa, the administration to be in the hands of the British Treasury.
This system (the same as that of the Australian Branch Mints, Sydney,
Melbourne, Perth) was preferred to the plan of an independent Dominion
Mint because that was the only way of procuring the privilege of coining
British sovereigns.

A royal proclamation published on November 2, 1907, duly established a
branch of the Royal Mint at Ottawa, and authorized the coinage of
British sterling gold coins from dies prepared in England, such coins to
rank with those struck in London. The depositor of gold bullion has the
right to demand British sovereigns in exchange....

The British sovereign (or pound) is legal tender in Canada at $4.8666.
The American gold coins are also legal tender. Canadian silver coins are
925 parts fine, and have a slightly less amount of fine silver than
United States of America silver coins of similar circulating values. The
dollar, though sanctioned, has not yet been struck.

Paper currency consists of legal-tender Dominion notes and bank-notes
issued against the credit of the banks; there were at the end of 1914,
22 banks, with 3,130 branches in the Dominion, 20 in Newfoundland and 72
in the United States and other foreign countries....

On July 31, 1914, just before the war, Dominion notes were issuable
without limit, providing the amount over $30,000,000 was covered by
gold. The volume at that time was $112,821,618.53 and the gold held
amounted to $90,292,833.28. As a consequence of the war the limit beyond
which Dominion notes may not ordinarily be issued without being entirely
covered by gold was by an Act passed in August increased from
$30,000,000 to $50,000,000....

BRITISH COLONIES

The British West Indies, as also Guiana, make British gold legal tender.
United States gold also circulates freely. There are a few banks with
limited note-issuing power, and minor coins are similar to those of
England. There is a growing use of United States currency.

British Honduras has a dollar unit, identical with that of the United
States.

British India has ... adopted the gold [-exchange] standard and India
has for some years been largely absorbing gold; the _pound_ is the
unit--the metallic currency, mainly silver, is maintained at parity with
gold by an arbitrary valuation or rate of exchange. The principal coin
is the _rupee_, equal to $0.3244; by a fixed government rating 15 rupees
equal £1. There is a gold [-exchange] standard reserve for India,
amounting, March 13, 1915, to £25,627,393, about one-half held in India
and one-half in London; it consists of gold and investments.... Paper
money is issued only by the Government and is covered by gold, silver
largely, and securities to some extent.

The Straits Settlements have a _dollar_ currency, divided into 100
_cents_; the value of the dollar was fixed by the Government at 2_s._
4_d._, on January 29, 1909, and has since been maintained at
approximately that rate, a gold [-exchange] standard reserve being
accumulated for that purpose. The system is copied after that of India.

Hong Kong, silver standard, is the exchange point between gold and
silver countries, and hence important. The British _dollar_ of 416
grains is the principal coin. It fluctuates in value with the value of
silver bullion.

Australia and New Zealand have the British system of banking. There are
many banks, some with British charters, and many branches; they issue
notes covered by gold. Gold in large quantities has been produced in
these states since 1851.

British Africa and other minor Eastern possessions have the British
system, modified in various respects.

Egypt having recently been formally annexed by Great Britain, her
monetary system will naturally be closely identified with that of
England in the future. The English sovereign has been for many years the
gold coin of common use.

LATIN UNION

The Latin Union consists of France, Italy, Belgium, Switzerland and
Greece; they are bimetallic, both gold and silver being full legal
tender, and the coinage ratio being 15-1/2 to 1; they have identical
systems, and formed a union to maintain the parity of silver and gold,
at the above ratio, by accepting each other's silver coins; while their
systems are bimetallic in law, silver is now coined only in small
denominations and on government account. The general adoption of the
gold standard by other countries has embarrassed the efforts of the
Union to preserve the parity and also the interchangeability of silver
coins between these nations.

FRANCE

France has the _franc_, equal to $0.193, as the monetary unit; the
principal gold coin is the _louis_, equal to 20 francs. The paper
currency of France is issued wholly by the Bank of France, a private
corporation, privately owned, but whose chief officers are appointed by
the Government, which thereby obtains a general control of policy and
administration; the maximum amount of note-issue is fixed by law,
arbitrarily, and by occasional increase is kept well ahead of the
country's necessities; no fixed legal reserve is required, but the total
note-issue must be covered by gold, silver, securities, and commercial
paper; as a matter of fact it carries very large metallic reserves, and
since it may lawfully pay its obligations in either gold or silver, it
can always conserve its gold holdings by requiring a premium for the
same, or withhold gold payment altogether.

It has over 400 branches and the same rate of discount obtains in all
branches on the same day; it thus regulates and controls the interest
rate throughout France, in the interest of uniformity and fairness; it
may do business with banks or individuals and has many very small loans;
its notes are a legal tender; the power to issue currency is one of its
chief elements of banking power....

BELGIUM

Belgium is bimetallic and its coins are the same as those of France and
have unlimited lawful currency; bank-notes are issued only by one bank,
privately owned; the Government receives a share of the dividends in
excess of 6 per cent., and imposes a tax upon the note-issues; demand
liabilities, including notes, must be protected by a coin reserve of
33-1/3 per cent. and the notes must be covered by cash, commercial paper
and securities.

ITALY

Italy has the _lira_, equal to $0.193, and divided into 100 _centesimi_;
her coins correspond to those of France; the Bank of Italy largely, and
two other banks to a lesser extent, issue notes against their credit,
limited, however, to three times their capital, unless covered by gold;
the issue may be increased, but comes in for a tax of 1 per cent. per
annum and must be protected by a 33-1/3 per cent. reserve in coin and
foreign exchange....

SWITZERLAND

Switzerland's coinage system duplicates that of France, and her Federal
Bank is very similar to the Bank of France....

GREECE

Greece ... has for its monetary unit the _drachma_, equal to $0.193. Her
coinage follows the Latin Union agreement. Paper currency is issued both
by the Government and by banks, and both are depreciated. Greece had to
resort to emergency measures during the Balkan War, which may have an
influence upon her currency for some time.

SPAIN

Spain ... has the _peseta_, equal to $0.193 United States, as her unit.
The Bank of Spain has the sole right to issue notes, which may equal
five times its capital and must be protected by a 25 per cent. coin
reserve. Gold commands a premium. Silver is coined only on Government
account....

GERMANY

Germany, gold standard, has for her currency unit the _mark_, of 100
_pfennig_, equal to $0.238; the 5-mark piece contains the same amount of
pure silver as the 5-franc piece and two United States half-dollars....
Silver is legal tender to the amount of 20 marks. The coins for her
colonies are varied to suit local needs.

AUSTRIA-HUNGARY

Austria-Hungary, gold standard, has as its unit the _krone_, equal to
$0.2026; 20-krone and 10-krone pieces are coined in gold, also gold
ducats, worth $2.288; silver coins are of various fineness....

PORTUGAL

The Portuguese Government, by decree of May 22, 1911, adopted a new
monetary system and the coins will be placed in circulation as soon as
possible. The unit of the system, excepting for her possessions in
India, is the gold _escudo_,... equal to $1.08 American gold. The escudo
is divided into 100 equal parts called _centavos_.... Multiples are 2,
5, and 10 escudos. Divisions of the escudo are of silver, with values of
50, 20, and 10 centavos; subsidiary coins consist of bronze and nickel
pieces. Her currency is not maintained at a parity with gold.

NETHERLANDS

... The unit is the _florin_ or _guilder_ of 100 cents, equal to $0.402.
The 10-florin piece is the principal gold coin; the _ryksdaalder_ (2-1/2
florins), the florin and half-florin in silver are legal tender, as well
as all gold coins; silver is maintained at parity with gold by law;
coinage of silver is only on Government account; paper money is issued
by a central bank and 40 per cent. metallic (gold and silver) reserve is
required against deposits as well as notes; the balance of the notes are
covered by negotiable instruments. The central bank was organized in
1814. Banking in the Netherlands is excellently managed.

SWEDEN--NORWAY--DENMARK (SCANDINAVIAN UNION)

These have the gold standard and have for their unit the _krone_, equal
to $0.268 United States currency; their subsidiary silver has various
fineness; paper currency of Sweden is issued by the Royal Bank, owned by
the Government; notes are legal tender and may be issued to a fixed
amount in excess of gold on hand or in foreign banks, but must at all
times have gold to the extent of at least 10,000,000 _kroner_.

Norway has a single bank of issue, controlled by the State, which owns a
majority of the stock; notes are legal tender and may be issued to twice
the amount of gold on hand and in foreign banks.

Denmark's paper money is issued by a privately owned bank, but under
strict control by the Government; the notes are legal tender and may be
issued to a sum 30,000,000 kroner in excess of the gold on hand.

RUSSIA

Russia is on a gold basis and has for its unit the _ruble_, of 100
_kopecks_, equal to $0.51456 in United States currency; the silver coins
in common use are the ruble, one-half and one-fourth ruble; paper money
is issued by the Imperial Bank, which is owned by the Government and
managed as part of its finance department; the law requires the coin
reserve to equal two-thirds of the note issue....

JAPAN

Japan maintains the gold standard and its unit is the _yen_, equal to
$0.498; the yen is divided into 100 _sen_, the sen into 10 _rin_. The
yen equals 11.574 grains of pure gold.

The Bank of Japan may issue notes to the extent of $120,000,000 upon
securities, any amount upon specie, and also may issue further sums in
excess of specie, subject to a tax of 5 per cent. The stock of the bank
is all privately owned. Japan first copied the national banking system
of the United States and after trial abandoned the same for a central
bank. She has managed her finances and her banking with wonderful
ability and great success. Besides the Bank of Japan, there are many
strong private banks, notably the Yokohama Specie Bank.

CHINA

China, silver basis, had for its unit the _tael_, divided into 1000
_cash_; there are said to be sixteen different kinds of tael in the
different states of China; the most valuable is the "Haikwan," or
"_customs tael_," the one in which customs dues are reckoned, and this
equalled $0.664 United States currency, October 1, 1914. The cash is of
base metal, with a square hole punched in the centre and is worth less
than a mill in our currency.

In the last years of the Empire a new system of coinage was established
and since continued by the Republic. The unit is the _yuan_ of silver,
worth $0.477, but varies with the price of silver; one-half, one-fifth,
and one-tenth yuan are also coined in silver and smaller coins in copper
and brass....

PHILIPPINES

The unit of value is the _peso_, equal to $0.50 in United States
currency. The fiscal affairs are administered by the United States and
the currency is safe and maintained on [essentially] a gold basis.

ARGENTINA

At a time when the cultivation and development of trade relations with
South America seem most alluring, we find a principal embarrassment in
the currency and credit conditions which obtain in most South American
States, but Argentina, one of the most favored of South American States,
has a stable and sound currency system. Her unit is the _peso_, of 100
_centavos_. The gold peso is equal to $0.9647 in United States money. In
1889 the Government took measures to acquire gold and fixed the relation
of paper to gold at 227.27 per cent., and it has since been maintained
at that level without fluctuation. This made the paper peso equal to
about $0.44 gold. They have a very large gold reserve in their _caja de
conversion_, 262,000,000 pesos gold, which protects the paper money and
gives it stability. Gold payments were suspended temporarily at the
commencement of the European war (1914), but paper money seems to have
remained at par....

BRAZIL

Brazil was formerly a colony of Portugal, and naturally copies the
parent country in her currency system. Her unit is the _milreis_, of
1000 _reis_. Nominally the gold standard prevails, but depreciated paper
is the currency of her commerce. The milreis contains 12.686 grains of
pure gold and is worth in United States currency $0.546.

In 1898 the Government assumed the sole power to issue paper money, and
strove to bring the same to a parity with gold; the arbitrary valuation
put upon the milreis by the Government was 15_d._ or $0.30.

On December 20, 1910, the value of a milreis was raised to 16_d._ The
Government accumulated a conversion fund, understood to be $60,000,000
to $70,000,000, but owing to crises at home and abroad it has not yet
been able to make gold and paper notes interconvertible.

Brazil possesses an enormous area, and is wonderfully rich in
undeveloped resources. Her coffee and rubber are especially valuable and
should take care of her international trade balances. In the near future
her currency should become stable and free from fluctuation. Brazilians
receive important service from foreign banks and bankers.

CHILI

Chili has the gold standard, but her paper currency is not maintained at
a parity with gold; her unit is the _peso_, of 100 _centavos_, of the
value of 18_d._...

FOOTNOTES:

[89] The following table, from _The Monetary Systems of the Principal
Countries of the World_, compiled in the office of the Director of the
Mint, Washington, 1912, gives the weight, fineness, etc., of the coins
of Great Britain:

GOLD
-----------------+-------+------------+-------+--------+--------+--------
| | | | | Pure |Value in
Denominations. |Weight.| Fineness. | Fine | Weight.|gold or | United
| | |weight.| |silver. |States
|Grams. |Thousandths.|Grams. |Grains. |Grains. | money.
-----------------+-------+------------+-------+--------+--------+--------
5 pounds |39.9410| 916-2/3 |36.6125|616.3720|565.0080|$24.3325
2 pounds |15.9764| 916-2/3 |14.6450|246.5488|226.0032| 9.7330
Sovereign | 7.9881| 916-2/3 | 7.3225|123.2744|113.0016| 4.8665
Half sovereign | 3.9941| 916-2/3 | 3.6612| 61.6372| 56.5008| 2.4332
-----------------+-------+------------+-------+--------+--------+--------
SILVER
-----------------+-------+------------+-------+--------+--------+--------
Half crown |14.1379| 925 |13.0775|218.1760|201.8119| $0.6083
Florin |11.3103| 925 |10.4620|174.5405|161.4495| .4866
Shilling | 5.6551| 925 | 5.2309| 87.2695| 80.7232| .2433
Sixpence | 2.8275| 925 | 2.6154| 43.6339| 40.3008| .1216
Fourpence (groat)| 1.8850| 925 | 1.7436| 29.0893| 26.9071| .0811
Threepence | 1.4137| 925 | 1.3076| 21.8162| 20.1788| .0608
Twopence | .9425| 925 | .8718| 14.5446| 13.4536| .0405
Penny | .4712| 925 | .4358| 7.2715| 6.7252| .0202
-----------------+-------+------------+-------+--------+--------+--------

[90] A. Barton Hepburn, _A History of Currency in the United States_,
pp. 450-473. The Macmillan Company. New York. 1915.

CHAPTER XV

THE NATURE AND FUNCTIONS OF TRUST COMPANIES

[91]The trust company supplements the bank. Through a long process of
evolution the bank has developed as a means of facilitating the exchange
of commodities. The trust company is a still further step in the same
process, and, in a highly organized society, it meets needs which the
bank is not able to supply.

In a new community the general store forms the centre of the business
life of the place. With growth and increasing trade, the private banker
sees room for the profitable employment of his funds. The state or
national bank meets the needs of further growth. Success and the
accumulation of wealth pave the way for the trust company. The bank is
organized primarily to serve the needs of active commercial life; the
trust company handles funds in less active circulation.

It is customary for the courts to designate or approve certain trust
companies as depositories for funds paid into court, and the effect of
such designation or approval would be to relieve executors, trustees, or
others acting in a fiduciary capacity and depositing with these
companies from liability for loss through their failure. A person
charged with due care in the selection of a depository could not be held
to have been wanting in such care in choosing as a depository a trust
company which the court has itself approved.

The powers of trust companies vary in different states, and when they
are created by special legislation, local companies are found with
different charter privileges. The capital and surplus of these
institutions are liable for their acts in fiduciary capacities, and in
some states they are required to deposit with one of the state
departments a fund as a special guarantee. The liability assumed is
generally accepted by the courts in lieu of the bonds which individuals
acting in similar capacities are required to give.

The development of trust companies in the United States has been
remarkably rapid. Since 1882, when the first legal authority was given
for the exercise by corporations of fiduciary powers, they have steadily
grown in number until there are now more than fifteen hundred,
distributed as follows:

Alabama 30
Arizona 9
Arkansas 38
California 24
Colorado 16
Connecticut 31
Delaware 12
District of Columbia 5
Florida 9
Georgia 25
Idaho 10
Illinois 75
Indiana 108
Iowa 29
Kansas 4
Kentucky 42
Louisiana 22
Maine 39
Maryland 21
Massachusetts 56
Michigan 6
Minnesota 4
Mississippi 19
Missouri 49
Montana 7
Nebraska 13
Nevada 1
New Hampshire 4
New Jersey 86
New Mexico 10
New York 78
North Carolina 38
North Dakota 5
Ohio 60
Oklahoma 10
Oregon 20
Pennsylvania 260
Rhode Island 11
South Carolina 17
South Dakota 12
Tennessee 73
Texas 52
Utah 9
Vermont 26
Virginia 19
Washington 20
West Virginia 22
Wisconsin 9
Wyoming 5
Hawaii 5
----
Total 1555

Their business in all departments has shown a steady increase, and the
trust companies of the United States to-day carry deposits amounting to
over $3,858,300,000. Net deposits in the 7397 national banks aggregate
$5,891,670,000.

In some states commercial banking and trust powers are exercised by the
same companies. In such cases, separate departments are maintained for
the various classes of business. Another method is for the same
individuals to organize a national bank and a trust company, the former
under national and the latter under state laws.

The securities company or trust company organized under state laws and
controlled by a national bank with the stock interest in the former
distributed among the owners of the stock of the bank and evidenced by
indorsement on its certificates is still another expedient which has
been resorted to in order to enable a closely affiliated and controlled
organization to exercise legitimate functions which are, however,
outside the province of a national bank.

The earning power of trust companies has equalled and even exceeded that
of the banks, and the stock of those companies which are well
established and doing a flourishing business sells at such a premium
that investment in it at its market value gives a very low return.

Trust company failures have been few and far between, and where they
have occurred they can be traced to a disregard of sound banking
principles and to the assumption of unwarranted risks. Even in the case
of companies which have failed there is no record of any impairment of
trust funds, whatever loss there was having been borne by the
stockholders and, to a less degree, by the depositors. This fact, the
result of the absolute separation of trust assets from assets belonging
to the company, is the strongest argument for the employment of trust
companies in fiduciary capacities, and explains their rapid growth in
popular favor.

The literature put out by these institutions invariably recites the
advantages to be gained by dealing with them instead of with
individuals. The following is a good example of such reasoning:

THE ADVANTAGES OF A TRUST COMPANY AS TRUSTEE

A trust company is preferable to individual trustees, because it
possesses every quality of desirability which the individual lacks, to
wit:--

(1) Its permanency: it does not die.

(2) It does not go abroad.

(3) It does not become insane.

(4) It does not imperil the trust by failure or dishonesty.

(5) Its experience and judgment in trust matters are beyond
dispute.

(6) It never neglects its work or hands it over to
untrustworthy people.

(7) It does not refuse to act from caprice or on the ground
of inexperience.

(8) It is invariably on hand during business hours and can
be consulted at all times.

(9) Its wide experience of trust business and trust
securities is invaluable to the estate.

(10) It is absolutely confidential.

(11) It has no sympathies or antipathies and no politics.

(12) It can be relied upon to act up to its instructions.

(13) It does not resign.

(14) All new investments of value suitable for trust estates
are offered in the first instance to trust companies, and in
that way it has a choice of valuable security; and as its
purchases are on a scale of magnitude, it can usually buy at
a rate which is lower than that at which the individual
trustee can purchase.

The most common objection to the appointment of corporate trustees is
thus stated by Augustus Peabody Loring, Esq.:

The trust companies, which have of late years become so
numerous, to a considerable extent do away with the element
of personal risk attaching to an individual trustee; but
they lack the advantages of personal management. These
companies sometimes fail from improper management as utterly
as individuals do, and as a rule the lack of personal
management results in securing the minimum return only on
the amount invested, and lacks the great advantages often
secured by the able personal oversight of individual
trustees.

The question, after all, comes back to the personal qualifications of
corporate officers and individuals. If the former are less capable than
the latter, the fault is with the particular company--not the system,
and if interest returns are sometimes less under corporate management,
this fact is more than equalized by the added safety to the corpus of
the estate.

A "Trustee Company" has been suggested as a proper title for the company
doing a legitimate trust business, and is the name used in Australia and
in New Zealand. In some states the use of the word "trust" in corporate
titles is now regulated by law. Confusion has arisen in the popular mind
between the trust company and the trusts or industrial combinations.

The usual functions of a trust company are: banking in a more or less
limited form, execution of corporate trusts, execution of individual
trusts, care of securities and valuables. In addition, other functions
are sometimes exercised, such as life, title, and fidelity insurance,
and the business of becoming surety. The earlier companies in the United
States were chartered to manage individual estates only and to act in
certain fiduciary capacities; the recent development of the trust
company has been in the direction of banking functions and corporate
trust business.

It is worthy to note that the life insurance companies which originally
secured trust powers have, with but few exceptions, given up their life
insurance business, and that most of the fidelity insurance and surety
business is given over to companies which now make a specialty of such
risks. The fact is being recognized that the assumption of vast risks
contingent on future occurrences is not compatible with the absolute
security which is essential in the transaction of legitimate trust
business.

BANKING

The banking functions of trust companies may include any or all of the
following:

The receipt of money deposits payable on demand and subject to check, or
payable at a fixed date, or according to special agreement. Interest is
usually allowed on all deposits above a fixed maximum amount or on the
total sum.

Money advances secured by the hypothecation of stocks, bonds, life
insurance policies, bonds and mortgages, or other personal property.

Real estate loans, secured by bond and mortgage. It is customary to loan
not over two-thirds of the value of improved property; when the property
is unimproved, not more than half.

Discounting paper is engaged in principally by companies transacting a
commercial banking business. The purchase of unsecured paper is
permitted in some states where discounting is not allowed.

The purchase and sale of securities.

Trust companies sometimes guarantee issues of bonds, or at least set
their stamp of approval upon them.

The issue or guarantee of letters of credit, and the transaction of a
foreign exchange business.

The care of savings deposits. For this purpose a separate department is
usually maintained.

CORPORATE TRUSTS

Among the most important functions of a trust company are those relative
to the business of other corporations:

Of late years the trust companies in the Eastern cities have
been selected as trustees instead of individuals whenever
the law of the State where the property was situated allowed
such selection. Trust companies have manifold advantages
over individuals in such a relationship; they do not die;
the large amount of financial business which they daily
transact provides them with the machinery for such purposes;
while their well-known names stand as evidence to the
purchasing public that at least the necessary formalities
have been complied with. Beyond that responsibility the
trustees of corporation mortgages usually assume none.

In recent years the trust companies have shown a tendency,
when acting as mortgage trustees, to recognize a greater
moral responsibility than they at first were willing to
bear. Trust companies did not, of course, intend to appear
as in any way guaranteeing the bonds to which they
certified, though that seems often to have been the
erroneous opinion of the unthinking; but trustees now
acknowledge themselves bound within the limits of the
mortgage to use their influence to protect the interest of
the bondholders. A trust company which should now allow the
issue of unsecured bonds because of some glaring defect in
the language of the mortgage, would not longer be morally
excused by financial opinion, though perhaps held
technically innocent.[92]

As trustee under corporate mortgages and trust deeds, the trust company
acts for the bondholders. It is customary for it to authenticate each
bond issued subject to the provisions of the mortgage, to represent the
bondholders in case of default, and to exercise such other functions as
may be provided in the mortgage.

A generation ago it was customary for a railroad to name one or more
individuals as trustees of the mortgages executed to secure bond issues.
The development of trust companies and their manifest advantages over
individuals in such a capacity has resulted in their absorbing almost
all this business. Trust companies are now generally appointed as
trustees in corporation mortgages, and are also often named to succeed
individuals who have died or resigned. The appointment is one of the
most important and far reaching which the trust company can accept. Its
name and reputation serve as an assurance that the transaction is a
regular one, and entered into in good faith. Although the modern
corporation mortgage is usually explicit in its terms to the effect that
the trustee in no way guarantees the value of the security and assumes
no liability except for its own negligence, yet the intimate connection
between the trustee and the borrowing corporation in the minds of
investors makes it necessary that care be taken not to assume
trusteeships which may lead to a wrong use of the name and credit of the
trust company.

As trustee under mortgages securing bond issues, the title to the
mortgaged property is vested in the trust company for the benefit of the
security holders. The corporation owning the mortgaged property retains
physical possession of it so long as the terms of the obligation are
complied with, except in the case of securities pledged, which are
usually lodged with the trustee. In case of default, however, it
devolves upon the trustee to protect the interests of the bondholders,
and this may necessitate the foreclosure of the mortgage and sale of the
property.

As fiscal agent it dispenses coupon and interest payments on bond
issues, and dividends on stock. It receives sums set aside as sinking
funds to provide for the retirement of obligations at maturity, or when
bonds are subject to redemption, draws the specified amount by lot and
pays the principal.

As registrar the trust company authenticates certificates of stock and
bonds in order to prevent an over-issue, and to reduce the chance of
loss or theft. As transfer agent, the company attends to perfecting
transfers of ownership for stock and bond issues or parts thereof.

The New York Stock Exchange, like most other stock exchanges, in its
constitution requires that all active listed stocks must be registered.
This Exchange also requires that a trust company or other agency shall
not at the same time act as registrar and transfer agent of the same
corporation. In the popular mind, and even in the minds of some trust
company officers, the difference between the duties of the two positions
has been more or less confused. Both have been created to safeguard and
facilitate the passing of title to shares of stock, but the duties of a
transfer agent and a registrar are not synonymous; they are distinctive.
One is called upon to examine and give clear titles to property
transfers, and the other is merely to record such transfers.

As manager of underwriting syndicates, the trust company issues the
prospectus and markets the securities of corporations which are being
launched, or of established companies which are putting out new
securities.

In railroad and other reorganizations, the trust company takes a
prominent part, acting both as a depositary for, and as a representative
of, the committees which formulate and execute the plans of
reorganization. Its officers often have a large share in the preparation
of such plans.

As assignee and receiver, the trust company acts in the same capacity
for corporations as for individuals and firms or partnerships, assisting
in winding up insolvent businesses and in conducting embarrassed ones.

INDIVIDUAL TRUSTS

The execution of individual trusts is the function originally assumed by
trust companies. The various other forms of business which are now
engaged in, have, with the exception of life insurance, been later
developments of the trust company idea. The earliest power granted these
companies was to receive moneys or other property, real or personal, in
trust. The trust company now also acts as executor and administrator of
the estates of decedents.

As executor appointed by the will of a decedent, it takes out letters
testamentary upon probate of the will, advertises, files inventory and
appraisement, pays debts, collects claims, makes the requisite
accounting to the probate or orphans' court, and makes distribution of
the estate in accordance with the terms of the will and the court's
decree.

As administrator acting under appointment of the register of wills or
probate court, it performs similar duties, distributing the estate in
accordance with decedent's will if there is one, or if there is none, in
accordance with the intestate laws of the state, which specify the
order of succession and distributive shares in the case of estates of
decedents leaving no wills. There are different kinds of administrators,
in any of which capacities a trust company may be called upon to act.

As trustee under will, the trust company carries out the provisions of
the will, investing and managing the estate or particular fund in
accordance with the directions of the testator. As such it may hold real
and personal property.

As trustee under deed or private agreement, a contract is entered into
between the company and the owner of the property, by which the title to
the property is vested in the corporation subject to the terms recited
in the instrument. Such deeds of trust may be revocable or irrevocable.
Marriage settlements are frequently made in this way.

The trustee's duty in investing the funds is a double one; namely, to
invest them securely so that the principal shall be preserved intact,
and to invest them as productively as possible under his powers, so that
they shall yield the best rate of interest obtainable for the benefit of
the person or persons entitled to the income. He must hold the scales
evenly, regarding scrupulously his duties to all beneficiaries. The
popular idea that security is the only consideration is erroneous, as
the trustee is equally bound to invest the funds as profitably as
possible and cannot neglect one duty more than the other. The mistaken
impression that the corporate trustee, even more than the individual, is
mindful only of the safety of the principal and entirely loses sight of
the question of income, has arisen from the restrictions as to
investments imposed by law, and frequently also by the will or trust
deed, and from the fact that the individual executor or trustee, rightly
or wrongly, sometimes assumes risks and personal liability which the
proper rules of a trust company would not permit it to assume.

The executor or trustee is governed, as to the kinds of investments, by
the directions of the will or deed of trust. This may require the
purchase of "legal investments" only, or state that the trustee is not
to be confined to securities prescribed by law, or give specific
directions as to the classes of securities which are to be bought. The
terms of such documents are always strictly construed by the courts; if
no directions are given, the trustee is expected to buy only "legal"
securities, and when he exceeds his powers he is held responsible for
any loss. Administrators and guardians without broader powers given by
will are obliged to invest, except at their personal risk, in such
securities as are sanctioned by law or directed by the court.

Some states prescribe by statute the securities in which a trustee may
invest. "Where there is no statute or decision of the highest court
fixing the class of securities in which a trustee may invest, he can
safely follow the rule prescribed for the investment of the funds of
savings banks." In general, city, State, and United States bonds, first
mortgages secured on improved real estate with ample margin, are among
the investments sanctioned by law. As to real estate, stocks, and first
mortgage bonds of railroad, manufacturing, and other corporations, the
practice varies in the different states. Loans on personal property,
second mortgages, and other investments subject to prior liens or of a
speculative character are excluded. All investments must possess
"intrinsic" value; the courts hold trustees liable for any losses from
speculative risks--but any gains accrue to the trust estate.

OTHER FUNCTIONS

The trust company acts as guardian, curator, or committee of the
estates, and in some states, of the persons of minors, those who are
insane or mentally incompetent, spendthrifts, drunkards, and any other
persons not legally qualified to take charge of their own affairs. In
the case of a minor, the trust terminates on the ward's becoming of age;
in other cases, when the disability is removed, or in accordance with a
decree of court. These appointments are frequently made by order of
court, and to it accounting must be made. In some states the company is
styled "conservator" when caring for the estates of persons of unsound
mind.

When acting as attorney in fact, the company obtains its authority by
virtue of a letter of attorney which usually is or can be recorded,
conveying certain definitely specified powers. This may be either to
perform a single act--such as to satisfy a mortgage--or may be broader
and continuing, granting authority to sell and transfer securities and
collect income. A general power of attorney, as the term indicates, is a
delegation to another of the general powers of the person appointing--as
to payments, collections, transfers of property, and all transactions of
a business nature.

As agent merely, the company takes charge of property, real or personal,
for its owner, but such agency does not imply nor ordinarily include
authority to sell or convey title. Moreover, trust companies as agent
often take up lines of business which they either cannot or would not
engage in on their own account. Thus, a trust company can act as agent
for fire or life insurance companies, for water, gas, and other public
service corporations. In new communities and where it is difficult to
find responsible representatives, the trust company can often render
efficient service and secure a steady income without risk by assuming
agencies of various sorts.

As assignee the trust company takes possession of the property assigned
for the purpose of carrying out the terms of the deed of assignment in
the interest both of the assignor and the creditors of the assignor. The
deed of assignment is an acknowledgment of an embarrassed or insolvent
condition, and the efforts of the assignee are directed to realizing as
much as possible from the assets intrusted to its management.

As receiver, the duties may be very similar to those of assignee,
although they are usually broader in scope. The business may not be
insolvent, and the application for the appointment of a receiver may be
due to temporary difficulties only. By such an appointment the property
is preserved intact and equal treatment is afforded creditors. An able
receivership often results in the adjustment of difficulties and the
return of the property to its owners on a paying basis. While in the
case of assignee the appointment is by the individual, partnership, or
corporation executing the deed of assignment which specifies the powers
and duties of the assignee, in the case of receiver the appointment is
by a court and the company so appointed acts as an appointee or
ministerial officer of the court, and as such is directly subject to the
court's orders.

A trust company acting as receiver is better able than an individual to
furnish additional capital, if amply secured, and thus successfully to
meet the difficulties which withdrawal of credit and restricted capital
have temporarily brought upon an otherwise prosperous business. The
courts authorize the issue of receivers' certificates to provide funds
for purchase of equipment and the proper maintenance of the property and
conduct of the business when the creditors are benefited by such
expenditures. Such certificates may be made a first lien on all assets,
taking precedence even of mortgages and other secured obligations. The
receiver thus secures the capital necessary to make the property more
productive and to secure the largest return from the business.

As custodian or depositary, the trust company sometimes holds property
the title to which is in dispute, delivering the same when the ownership
is legally determined.

In taking charge of escrows or conditional instruments or deeds
delivered to a third party until the condition is performed, the trust
company acts in a similar capacity, as the joint representative of both
parties.

The trust company acts as the representative of both the living and the
dead in practically every legal relation in which an individual is
qualified to act. Its function is not only to keep intact the estate of
which it has charge, but to look to and safeguard the interest of every
beneficiary.

CARE OF SECURITIES AND VALUABLES

The functions already recited have resulted in the assumption of the
duty of caring for property other than that of the estates held in the
trust department. In the safe deposit department, individual safes are
rented, bulky packages--not containing stocks or bonds--are received on
storage, certificates of deposit covering securities are issued, and
provision is made for access to, and examination of, the property so
deposited. For personal property received on storage, the charges are
either according to bulk or value. Wills are usually receipted for and
kept without charge.

INSURANCE

The examination and insurance of real estate titles is a later
development often found in connection with the usual trust functions.

Fidelity insurance and suretyship providing against loss by reason of
the dishonesty of individuals and the non-performance of obligations,
contracts, etc., have often been combined with the various forms of
trust company activity. They are, however, largely passing into the
hands of corporations especially organized for the transaction of such
business.

COMPENSATION

When acting as trustee under corporation mortgages, a definite charge
may be made for accepting the trust, and a fixed amount per annum
thereafter for paying coupons and performing other duties. For the
certification of bonds it is usual to charge fifty cents per bond in the
case of large issues, and one dollar for small issues. The figures,
however, vary in different places. The charge for certifying the bonds
may be the only one, although an additional charge is usually made for
counsel fees. In case of default and consequent foreclosure of the
mortgage, extra payment is made to the trustee covering all services
incident to the foreclosure.

For the disbursement of sinking funds, interest, or coupons, the
temporary use of the money may be considered adequate compensation, if
the amount involved is large. A commission on the sum distributed or a
fixed amount is charged when acting as fiscal agent, apart from duties
in other capacities. For acting as registrar or as transfer agent it is
usual to make a fixed charge per annum, based on the amount of labor
involved. The transfer agent is usually paid about twice as much as the
registrar. Compensation for acting as manager of an underwriting
syndicate may be a fixed sum or a commission, according to the
provisions of the underwriting agreement. For acting as depositary under
plans of reorganization, assignee, or receiver, a lump sum is usually
paid covering all services. Agency work of various sorts is paid for in
accordance with the usual practice in the business which is undertaken;
a fixed sum, or a fixed sum and a commission, or a commission only, may
be received.

The trust company is in a position to render valuable, and often
indispensable, aid to its corporate clients. Large amounts being
involved, the great railroad and industrial corporations are willing to
pay well for such services. Corporate trust business has, consequently,
been a profitable field for the trust companies.

GOVERNMENT REGULATION

An examination of the laws of the various states is interesting as
showing the attempts which are being made at regulation. Most of these
laws have been enacted within recent years and to-day there are but few
States which do not have such statutes on their books.

The step which Massachusetts first took in requiring a legal reserve to
secure deposits has been followed by similar action in other states. In
general, the wisdom of prohibiting companies which engage in the care of
estates from assuming excessive risks is becoming better recognized. The
promotion and underwriting of commercial ventures and the assumption of
unknown risks are functions not compatible with the proper exercise of
the duties of trustee or executor.

The supervision of trust companies by the separate states provides an
elastic system to supplement the rigidly guarded powers of the national
banks, and can adapt itself to changing conditions and enlarging needs,
leaving for solution according to the requirements of each section of
the country such questions as proper functions, reserves, and the
authority to establish branch offices.

FOOTNOTES:

[91] Adapted from Kirkbride and Sterrett, _The Modern Trust Company_,
pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company.
1913.

[92] Thomas L. Greene, _Corporation Finance_, p. 59.

CHAPTER XVI

SAVINGS BANKS

[93]The savings bank works with those unacquainted with the ways of
business and who could not single handed take good care of their money,
or invest it safely or profitably. The bank of discount is generally
managed by business men versed in the ways of business, acquainted with
monetary affairs, and able to conduct financial operations with
intelligence. They combine their _capital_ in order to make it
effective; the savings bank combines _savings_ in order to make them
_capital_, and as such to acquire a power impossible to the scattered
savings.

The savings bank is for the saver; its funds are invested permanently,
while the business bank opens its doors to business men and loans rather
than invests its funds, and for a short time only. The latter deals with
borrowers rather than savers, and serves for hire. The one serves best
by keeping--the other by lending. One _aims_ at profit, while the other
_never_ makes (or should make) profit an end. The savings bank is the
receiving reservoir for the little springs, the bank of discount is the
distributing reservoir for accumulated capital.

We must get the last idea clearly in mind or we get a misconception of
the savings bank. However much the element of interest may figure in the
management, and whether we pay depositors 4 per cent. or 3 per cent., or
no interest at all, the accumulation of interest is not to be compared
in importance with the _accumulation of principal_.

No man ever acquired riches at 4 per cent. In fact, 4 per cent. upon
small deposits is so trifling a matter that it may be ignored in
considering the greater value of the increase of capital. However
desirable the accumulation of interest may be (and this in the course
of years is considerable), the chief end and aim of the savings bank
should be the _accumulation of principal_.

CLASSIFICATION OF SAVINGS BANKS

We may roughly classify savings institutions into: First, mutual
(trustee), or philanthropic; second, stock (including "savings and trust
companies"); third, co-operative, or democratic, as exemplified in the
co-operative banks of Europe. The first are usually managed by a
self-perpetuating body of trustees, who do not share the earnings; the
second are managed by the directors elected by the stockholders; the
third are managed by officials elected by the members.

A second classification may be made into public and private
institutions; the first includes the postal and municipal banks; the
private embraces the mutual, stock, and co-operative. A third
classification may still be made into the "unit" and the chain system.
In the unit system the bank is an independent entity and has no
connection (aside from a managerial standpoint) with any other bank. The
banks of the United States are all, excepting the Postal Savings Banks
and a few branch savings banks, of this character. In the second, the
bank is but a part of a chain, as in the postal system, the municipal
banks of Germany, and the co-operative credit banks of Europe. We shall
briefly review each system.

TRUSTEE SAVINGS BANKS

The _original_ savings bank is the trustee bank. As Hamilton says, "It
stands for the attempt on the part of the well-to-do to improve the
condition of the poorer classes, and involves a self-sacrificing service
on the part of a few in the interest of the many." While many of the
early savings banks partook of this character, others were organised
from purely selfish motives and were characterised by bad management and
bad faith from the start. A study of savings bank frauds will amply bear
out this statement.

The "spirit of commercialism" hereafter spoken of has invaded the
domain of the mutual savings bank and it cannot in truth be said that
some of the newer banks were organised from any spirit of philanthropy,
although the management as a whole may be above suspicion and honorable
in the highest degree.

But, however this may be, the mutual savings bank is a product of the
East and promises to remain so in spite of the fact that some of the
Western states have very good, if not excellent, savings bank laws.

The distinguishing characteristic of the trustee savings bank is
_mutuality_. _All_ the earnings of the bank, less reasonable
administrative expenses and the apportionment to surplus or guaranty
fund, are divided among the depositors in the form of interest.

One or two features of the mutual bank may be mentioned. First, the
investments of such institutions are usually carefully restricted,
looking primarily to the element of safety; and as long as the trustees
keep their funds so invested they cannot be held, either in law or
morals, responsible for losses. Second, the predominancy of the mortgage
loan. The nature of the deposits being more or less permanent,
investments of a permanent character may be made without fear of a
sudden demand for their return on the part of depositors; and to
safeguard the banks from such unexpected calls, quite generally trustee
banks are permitted by law to require notice, the usual time being
either sixty or ninety days. The third distinguishing feature is the
self-perpetuation of the board of managers. No amount of money can _buy_
a man's way into a mutual savings bank. He cannot, as in stock concerns,
buy enough stock to _vote himself_ into office--he can only gain office
as the other men advocate his cause. And, on the contrary, he cannot be
voted _out_ of office. Only an act, such as bankruptcy (which voids his
office), can affect him, and, like a Supreme Court judge, he is
appointed during good behavior.

The greatest weakness of the trustee bank is this: Lacking the
"essential element" that prompts men to undertake such ventures
(profit), it does not appeal to the average man of means unless he is
sentimentally inclined; and not being indispensable to trade and
commerce, like a bank of discount, it does not come to be a commercial
necessity. Even in a great State like New York we find twenty-eight
counties with no savings banks. And in many of these counties there are
large and thriving towns and cities. Thus the city of Jamestown, with
over 30,000 population, has no savings banks; while Elmira, with over
35,000 population, has but one, and that with but half a million assets.

From the viewpoint of intensive results, as tested by the volume of
patronage accorded these institutions, a perusal of the statistics will
demonstrate that in some places the trustee bank has had a remarkable
record. For instance, in Maine, a sparsely-settled State, and largely of
a rural nature, we find one savings account to every 3 of the
population. More remarkable is Vermont, the "Green Mountain State,"
where natural conditions would seem to be much more hostile to such
development, we find 30 per cent. of the population having savings bank
accounts. New Hampshire has an account for every 2-1/2 of the
population, while Massachusetts heads the list, with seventy-five out of
every hundred. New York has one to every three.

"In seeking an explanation of this remarkable success of the trustee
system," says Hamilton, "we are reminded that New England is singularly
separate and distinct in its customs, habits and ideals from the rest of
the country. Notwithstanding the large foreign population, the dominant
type is more homogeneous and more Anglo-Saxon than it is in any other
section, and therefore fixed customs have been more rigid and
controlling. Among the ideals behind the customs and institutions must
be noted a stern, Puritanical sense of simple living, industry and
providence, and this spirit is so strong as to be well calculated to
give color and direction to the philanthropic impulse. There is also an
unusual amount of public spirit, of collective rather than a neighborly
character, as seen in the institution of the town meeting."

STOCK SAVINGS BANKS

The stock savings bank, where it is a savings bank, and not a bank of
discount under a savings title, differs in no essential degree from the
mutual institution. The mutual bank belongs to the depositors; the stock
bank to the stockholders. The mutual bank pays dividends to depositors
only; the stock bank pays dividends to both stockholders and depositors.
The stock bank does not pretend to be philanthropic in its management.
It is purely a business proposition, and where the investments are of
the accepted savings bank type, it can justly claim to be on a par with
its mutual friends, provided, of course, that it measures up to the
standard in its management.

As is implied in the term "stock," it issues capital shares and pays
dividends thereon. It has, therefore, the added protection of the
stockholder's liability, which, together with the accumulated surplus,
affords the element of strength so necessary in all financial concerns.
It usually pays the depositors a stipulated rate of interest, and the
profits beyond this belong to and are distributed to the stockholders as
dividends. The partnership idea is entirely lacking, and the depositors
get what they bargain for, while the surplus goes to those who invest,
not necessarily their savings, but their _capital_, and assume all risks
of the business. It could not in law or equity "scale down" its deposits
to make good any losses--a feature peculiar to the mutual institution.

In this respect one thing is certain: In so far as safety is concerned,
especially in a young bank, the stock bank with the stockholders'
liability is surely superior to the mutual, unless the trustees of the
latter are of such high order and of such financial worth as to be able
and _willing_ to assume the burden of any losses that may accrue until
the surplus or guaranty fund affords ample protection. This was the
trouble in the early days of the mutual savings banks in England.

GUARANTY SAVINGS BANKS

New Hampshire is the only state in which "guaranty savings banks" are
found. These are a combination of mutual and stock--a cross between the
two. They do not transact a commercial business, being strictly savings
banks in their functions, yet having "special deposits," which to all
intents and purposes are capital stock. "The guaranty savings bank
differs from the ordinary mutual savings bank in that it has capital
stock or _special deposits_, as they are called. It pays a certain
stipulated rate of interest to its _general_ depositors and _any surplus
of earnings above this dividend is available for dividends on the
capital stock or special deposits. These special deposits constitute a
guaranty fund for the general depositors, and the charter ordinarily
stipulates that the special deposits shall always equal 10 per cent. of
the deposits._"

Such institutions are savings banks in every sense of the word, but the
strictly mutual feature is lacking in the specialising of part of the
deposits and paying a higher rate of interest on these deposits. In New
York State savings banks cannot take a "special deposit," but in New
Hampshire, in return for the higher interest rate, the special
depositors assume all the risk of loss or depreciation, and, as in the
case of stock concerns, they would be the first to suffer in the event
of insolvency.

MUNICIPAL SAVINGS BANKS

This form of savings banks properly belongs to a strong class of
municipalities. They can only thrive in places where the local spirit is
strong, the local government pure, and where the local officials are
accustomed to wield a large measure of authority. Accordingly, they have
come into being and met with success in those countries where the early
history of the town made a large measure of local autonomy a necessity.
Towns of this class possess the public spirit and the intelligent
administration required for the success of such a public venture. They
also possess a fund of gratuitous public service among the citizens
which may be drawn upon when occasion requires.

Such banks are found in Austria, France, Italy, Denmark, Sweden, and
Japan. The best examples are to be found in Germany, where they have
been in operation for a long period of years. Savings institutions exist
here at present in great variety and number, including State or Province
Savings Banks, City Savings Banks, Township Savings Banks, County
Savings Banks, _Bezirk_ (District) Savings Banks, Private Savings Banks,
and Co-operative Savings Banks.

These banks have some 19,000,000 pass books out and their deposits
amount to 13,500,000,000 marks ($3,213,000,000). These deposits are
practically all guaranteed by the various municipalities of the Empire,
which condition forms a bulwark of confidence in the security of private
wealth and earnings that cannot be shaken by hard times, panics, bank
failures, etc.

PEOPLE'S BANKS

The co-operative banks of Europe, otherwise called "People's Banks," are
essentially savings banks, in that they depend for their working capital
upon the accumulated savings of their members. The aims of these banks
are first _economic_, to enable the economically weak to make themselves
financially strong by the power of combination; second, _moral_, to
bring the members together in a unity of interests and to develop
character by making thrift and good habits the groundwork of their
operations; third, educational, to train in business methods and in the
handling of money those whose scope has been narrow and whose
experiences have been few in this regard.

In the establishment of these banks, the cardinal rules have been:
Maximum of responsibility, minimum of risk, maximum of publicity. To
secure the maximum of responsibility, unlimited liability has been
accepted by the members in many cases; that is, each one pledging his
all for the good of all; and, second, to secure the minimum of risk,
character is made the basis of membership and good habits the prime
requisite for membership. No investments are made in speculative
enterprises, and the purposes for which the money is borrowed are
closely inquired into and due care taken that the funds shall be applied
for such purposes only. To secure the maximum of publicity the action of
the bank in all matters is given the widest publicity possible in order
that the work may have public inspection.

The result of these simple rules has been that the poor have proven as
good, if not better, creditors than the rich; for once losing credit
they can never regain it except by the slow process of years of good
behavior.

The great pioneers in the "People's Banks" were Raiffeisen and
Schulze-Delitzsch. They fully appreciated that any system that would
succeed must descend to the level of its beneficiaries and they have
admirably adapted the co-operative idea of banking.

THE LOCALIZATION OF SAVINGS BANKS IN THE UNITED STATES

The home of the mutual savings bank is in the East, where it began
operations in 1816, and may even be said to be in the Eastern States;
for west of Buffalo and south of Baltimore, we find only 21 savings
banks of the mutual character. Out of 647 savings banks of the mutual
type found in the United States, 593 are found in New England, New York,
and New Jersey; and over one-half, or 334, are found in the two States
of New York and Massachusetts. Maine, Vermont, Connecticut and New
Hampshire have 215, the total of which accounts for all but 100 of the
mutual savings banks in this country.

The dearth of savings banks in Pennsylvania is notable. It would seem
strange that in a state of such character, where the mutual savings bank
had its first test, and where in individual instances it has been
extremely popular and successful, the failure of such an institution has
been so pronounced; but Pennsylvania is the home of the building and
loan association (there are over 1,400 in operation), which seems in a
measure at least, to fulfill the same purpose. From a pamphlet issued by
the Dollar Savings Bank of Pittsburgh in 1905, the striking sentence is
gathered, that to-day at the end of half a century the Dollar Savings
Bank stands as the _only_ institution of its kind in Western
Pennsylvania.

As we go south and west the banks take on a more commercial aspect, and
the savings bank as we know it in the East is a rarity, and the word
"savings" in their title is a misnomer. This is particularly true of
Iowa, where we find practically all state banks using this word, and yet
very few of them are other than banks of discount. The reason for the
large number may be in the economic conditions of that State, and also
the fact that banks may organise with as low as $10,000 in capital,
making it possible to establish a bank in even the smallest place.

In Illinois, for instance, we find no distinctively savings banks, and
in a city like Chicago, where if the same success had attended the
savings banks as it has in New York, upwards of a billion dollars would
be on deposit, we find no strictly savings institution other than banks
of discount and trust companies operating savings departments.

The reasons for the absence of mutual savings banks in the West and
South lie, no doubt, as Hamilton suggests, in the fact that these
sections were not settled from religious, but commercial motives; and
the "spirit of New England" being lacking, the savings bank which
requires a peculiar spirit of philanthropy, and age, as well, has not
become a factor in the development of the country. In fact, the
eleemosynary institution, such as the college, the hospital, or the
savings bank, the former requiring endowments of money to become
successful, and the latter the endowment of gratuitous management to
become possible, is last to follow in the economic development of a
community. Another reason may be in the pre-ponderance of agriculture
among the employments, which does not, until the country becomes highly
prosperous, afford much in the way of idle funds which would go into the
savings banks. The mutual savings bank is a product of the East and
promises to remain so in spite of the fact that some of the Western
states have very good, if not excellent, savings banks laws.

The dearth of savings banks in the South is, no doubt, due to the
prostration following the Civil War, which left the country drained of
its resources; the general ignorance of banking functions, and the
improvidence of the Negro.

POSTAL SAVINGS BANKS

The postal savings bank is not a bank, or a banking system, so much as
it is an adjunct of the Government; for the fundamental idea is that
through the post office the Government holds itself out as willing to
accept the savings deposits of the people, invest them in its own
securities and become absolutely responsible for the safe return of the
funds when called for, with a nominal rate of interest. All the leading
countries of the world except Germany and Switzerland now operate the
postal savings banks. While the rules may differ in the details, the
general scheme is the same, and a review in brief of the system of Great
Britain will serve to illustrate the methods of operation of such an
institution.

The present system was established in England in 1861. The deposits, at
whatever office they may be made, can be withdrawn from any other office
which transacts a savings bank business. The accounts are kept in London
and all moneys are remitted to the headquarters, where it is handed over
to the Commissioners for the Reduction of the National Debt, who invest
the funds in public securities.

Deposits may be made as low as one shilling or multiples thereof, and
the limit of deposits for an individual is $150 during one year or $650
in all. Charitable societies may deposit without limit. For the benefit
of youthful depositors, who have not a shilling to deposit, cards are
issued upon which stamps are placed as purchased, and when filled
represent one shilling, and may be turned in as cash. School managers
are urged to bring this plan to the attention of the pupils, and it has
been productive of good results, over 5,000 schools having adopted this
system. The interest rate is fixed at 2-1/2 per cent. and never varies.

AMERICAN POSTAL SAVINGS BANKS

ARGUMENTS FOR AND AGAINST THE ESTABLISHMENT OF POSTAL SAVINGS BANKS IN
THE UNITED STATES.

[94]In spite of the numerous differences in the postal savings bank
system of the forty-odd countries possessing them, there are certain
fundamental features common to all. Whatever else a postal savings bank
may be, it is without exception an institution working principally
through the post offices, and its primary object is the encouragement of
thrift among the poorer classes by providing safe and convenient places
for the deposit of savings at a comparatively low rate of interest. In
the discussion of the postal savings bank proposition in this country,
no one questioned the desirability of encouraging habits of economy and
thrift on the part of the public, nor was there any question that
adequate savings bank facilities should be provided for this purpose;
the debate hinged very largely upon the question whether adequate
facilities of this character were not already provided by private
initiative.

The advocates of a postal savings bank claimed that adequate savings
facilities were not and could not be provided by private enterprise,
because of the expense of conducting savings banks in small communities,
and also in larger communities where the people were not yet educated to
the saving habit; and they pointed particularly to the lack of savings
facilities in the southern and western states....

... The country is not nearly so well provided with banks receiving
savings accounts as with post offices. In the United States there are
270 square miles of territory to each bank carrying savings accounts and
50 square miles to each post office; there is a population of 8,370 to
each such bank and of 1,542 to each post office; and there are 5.4 post
offices to each bank carrying savings accounts. A comparison of the
figures for the different sections and states shows that it is in the
southern, western, and Pacific states that savings bank facilities are
most lacking.... The New England, eastern, and middle western states are
much better provided with banking facilities than are the other
sections; but even in these states post office facilities are much more
ample than savings bank facilities....

An objection repeatedly urged against the establishment of a postal
savings bank was that it would prove a competitor to existing banks. The
fear of such competition appears to have been the chief cause of the
opposition of most members of the banking fraternity to all postal
savings banks proposals. Senator Cummins of Iowa said in the Senate:

The banks of the United States are opposed unanimously to
the institution of a postal savings system.... I venture the
assertion that during the nearly two years that I have been
a member of this body ... I have received the protests of
nearly every bank in my state against any such scheme, and
those protests have usually been accompanied by a very
large number of petitions, secured, I have no doubt, through
the industry and energy of the bank officers.

It was argued that postal savings banks would have an undue advantage
over private institutions because of the great confidence in the
Government entertained by working people; and it was asserted that funds
would be withdrawn from existing banks and deposited in the postal
savings banks.... In reply, the advocates of postal savings banks
claimed that existing banks had nothing to fear from governmental
competition; that they had the advantages of an established clientele,
higher interest rates, higher limits, if any, in the amounts that could
be kept on deposit, and of the close personal and advisory relation
which so often exists between a bank and its customers. They further
argued that postal savings banks would be a help rather than a hindrance
to other banks. They would educate the people to habits of thrift and
would draw money out of hoards; and the deposits which they received
would for the most part be transferred to other banks as soon as the
limit fixed for postal savings banks deposits should be reached, or even
before, as the depositor began to appreciate the safety of other banks
and the advantage of their higher rate of interest....

The immediate occasion of the last active movement for a postal savings
bank system in the United States was ... the losses and inconveniences
arising from bank failures and from the suspension of cash payments in
the panic of 1907. Naturally, therefore, the demand for great safety of
savings deposits played an important part in the discussion.

The advocates of postal savings banks cited figures showing the number
of national bank failures and the losses involved, and similar figures
for savings bank failures in certain states. They made much of the large
amounts involved and of the hardships in individual cases. On the other
hand, the opponents of the postal savings bank scheme quite generally
dealt with percentage figures rather than with absolute amounts and
showed that for recent years the average losses, in terms of percentage
of the amounts on deposit, were almost infinitesimal.

The figures cited for bank failures, so far as they relate to savings
deposits, are so incomplete as to be of doubtful value in measuring the
extent of the losses....

After all, such figures give us no adequate measure for losses of this
kind. "Among the experiences of working people none is more demoralizing
and few are more cruel than loss of savings through failure of banks or
absconding of individuals intrusted with funds." To such people there is
cold comfort in the assurance that the average loss of savings bank
depositors over a long period of years is but a fraction of a mill on a
dollar. The loss is theirs: it is not distributed among all depositors.

In urging that a postal savings bank would draw money from hoards into
circulation, the advocates of the scheme claimed also that such a bank
would keep in the United States money that would otherwise be sent
abroad by foreigners.... Much was made of the fact that every year many
millions of dollars in money orders payable to self are bought for
savings purposes.... In such cases the purchaser not only failed to
receive any interest on his savings but was required to pay the money
order fee. Many immigrants, moreover, distrust American banks, and,
being familiar with postal savings banks in their home countries and
having great confidence in government institutions, remit their savings
to these home banks. How extensively this is done we have no figures to
show....

THE MAIN FEATURES OF THE SYSTEM

[95]The Postal Savings Bank System of the United States, which began
operations January 3, 1911, by the opening of a postal savings bank in
each state, is under the control of a board of trustees, consisting of
the Postmaster-General, the Secretary of the Treasury, and the
Attorney-General.

Depositories for the receipt of such moneys are designated by the Board.
An initial appropriation of $100,000 was made to cover the cost of
putting the law in operation, which was supplemented by another
appropriation of $500,000 in the session of 1911.

Any person over ten years of age may deposit, but no person shall have
more than one postal savings bank account in his or her own right. Upon
making the first deposit, a _certificate of deposit_ is issued, which is
to be surrendered when paid, and cancelled; or in the event of making a
subsequent deposit is to be surrendered for one calling for a higher
amount. The lowest deposit permitted is one dollar, the limit being $100
in a calendar month; but to provide for small deposits, a postal savings
card is issued for ten cents, to which may be attached postal savings
stamps, which when filled will be accepted in lieu of one dollar.

The interest rate allowed is 2 per cent., credited once a year, and the
highest balance permitted is $500 to one person. Withdrawals may be made
on demand.

The funds so received are to be deposited in national and state banks at
2-1/4 per cent. interest. Five per cent. of these deposits may be
withdrawn and kept in the Treasury of the United States as reserve.
Before becoming a depository, the bank must furnish as security
government, state, or municipal bonds, the limit of deposits being an
amount equal to the paid-up capital and one-half the surplus.... Not
over 30 per cent. of the amount of such funds may be withdrawn by the
trustees for investment in United States bonds, and it is the intent of
the act that the residue of such funds amounting to 65 per cent., shall
remain on deposit in the banks in each state and territory willing to
receive the same under the terms of the act, but may be withdrawn for
investment in bonds under the direction of the President, "when in his
judgment, the general welfare and interests of the United States so
require." Provision is also made for the conversion of savings bank
deposits into United States bonds, at the request of depositors.

"POSTAL SAVINGS BEHIND THE SCENES"

Speech of Hon. Carter B. Keene, Director of the United
States Postal Savings System at the Banquet of the
Investment Bankers Association of America at Denver,
Colorado, Tuesday evening, September 21, 1915.

_Mr. Toastmaster and Gentlemen:_

I appreciate very highly your invitation to speak here to-night, also
the words of commendation from your presiding officer. I have often
wondered whether the fact that I am the only director of a big savings
institution has anything to do with the ability of that institution to
pay every depositor his money on demand. (Laughter and applause.)...

The toastmaster was wrong when he said that postal savings has nothing
to do with investment bankers. We have a great deal to do with them.
Indirectly, we are one of their best customers. More than ninety-four
million dollars in bonds are now with the Treasurer of the United States
as security for postal savings funds, and you gentlemen have largely
supplied the banks with these bonds. Sixteen million dollars are in
State and Territory bonds; city, town, and village bonds amount to
forty-six millions; county bonds nine; miscellaneous bonds ten; and
bonds of the United States Government and its dependencies thirteen....

Since I have been here this week I have heard billions and billions
talked about.... I can hardly comprehend what a million is. But I want
to tell you that in four and a half years the postal savings system of
the United States has become custodian of sixty-eight million dollars,
in cash, of the people's savings. Let me lay emphasis on the _cash_,
because big figures do not always mean cash. Sixty-five million dollars
of this money is on deposit in six thousand banks scattered throughout
the country. In other words, practically all of the money we have
collected has been released through the banks to channels of trade in
the very localities where it originated. I am sure you will agree with
me that this is a very creditable showing so far as dollars and cents
are concerned.

The Federal Reserve Act, which went into effect on the 16th of November
last, provided that postal savings funds should not be deposited in
non-member banks. The Attorney General for the United States has held
that the prohibition relates to funds received on and after November
16th. Therefore, postal savings on deposit in state institutions when
the act became effective have been allowed to remain, except as it has
been necessary to withdraw it to pay depositors.

The Post Office Department has made frequent investigations to determine
where postal savings deposits come from; with the invariable result that
they are found to come from chimney corners, mattresses, bootlegs,
etc., but until very recently no effort has been made to ascertain where
postal savings go when withdrawn. And this recent inquiry has been both
gratifying and entertaining. It was found that in a vast majority of
cases savings were withdrawn for very substantial reasons, prominent
among them being payments on homes and the launching of small business
enterprises. Occasionally a hospital bill was paid. Some depositors sent
money to the old country to bring over a parent or a brother; a wedding
trousseau here and there; and in Colorado we have record of a withdrawal
to buy an automobile. (Laughter.)

I am glad to say that there has been a very great change in the attitude
of the banks toward postal savings in the last few years. At the outset,
many bankers thought that postal savings was an unwarranted invasion of
the domain of private enterprise and that the service would prove a
severe drain on their established business. The opposite has been the
result. The tarnished coins and soiled currency that come into our
postal depositories represent hidden savings--money that is beyond the
reach of any corporate banking institution no matter how sound it may be
or how conservatively managed. This newly discovered money has been made
available for commercial purposes in the very cities and localities from
which it was withdrawn, so instead of being a drain on corporate banking
institutions postal savings has added to the deposits of some six
thousand banks more than sixty-five millions. The bankers now freely
admit that postal savings has been a help to them, and it is no uncommon
thing for banks, especially in the mining regions of the West, to urge
the Post Office Department to extend postal savings facilities in order
that more money may be made available for local uses.

Among our 540,000 depositors every nation on the face of the earth is
represented, also every conceivable occupation. The fisherman, the
miner, the shoemaker, the preacher, the bank teller, the butcher, the
baker, the candle-stick maker, all have accounts, but the great bulk of
our deposits come from the men and women who work with their hands for a
daily wage.

The foreign born are our most numerous and liberal patrons. An
interesting poll of depositors has just been made by the Post Office
Department and it was found that 59 per cent. of all postal savings
depositors were born outside the United States, while the American born
comprise 41 per cent. A still more surprising fact is that the foreign
born own 72 per cent. of all the deposits. The Russians lead with
$14,000,000 to their credit, or 20.7 per cent. Then follow the Italians
with $9,650,000, or 14.2 per cent.; natives of Great Britain and her
colonies with $6,000,000, or 8.8 per cent.; the Austrians with
$5,900,000, or 8.7 per cent.; Hungarians, $2,900,000, or 4.3 per cent.;
Germans, $2,800,000, or 4.1 per cent.; Swedes, $1,500,000, or 2.2 per
cent.; and Greeks, $1,200,000, or 1.8 per cent.

What a splendid vote of confidence on the part of our foreign-born
citizens in the good faith of the United States. And in these figures
also is a high testimonial to the industry and frugality of our newly
acquired citizens. That they should take most kindly to postal savings
is not remarkable when we consider that they were accustomed to a
similar service in their native countries....

Another thing that has induced foreigners to become postal savings
depositors is the disastrous experiences many of them have had with
so-called "private banks," usually operated by people of their own
tongue. It is difficult to conceive of a more heinous crime than some of
these so-called "bankers"--slick and persuasive--have committed in
alluring credulous, hard-working men and women, to entrust their humble
savings with them for the deliberate purpose of theft. I am glad to see
that prosecuting officers have recently been aroused to the "private
bank swindle" and that their promoters are getting the punishment they
deserve.

When Europe got on fire last year, our postal savings receipts began to
increase by leaps and bounds. During the fiscal year 1915, the deposits
jumped from $43,440,000 to $65,680,000 and more than 140,000 new
accounts were opened. The war still has an influence upon postal savings
deposits, but the more immediate cause of large deposits at this time is
the remarkable revival of commercial activities. Seven cities now have
more than a million dollars on deposit, namely. New York, Brooklyn,
Chicago, Boston, Detroit, San Francisco, and Portland, Oregon. Greater
New York, including Brooklyn and several other offices in the
municipality, now have over one-fourth of all the money in the Postal
Savings System. During the past fiscal year New York City gained 200 per
cent.; Bridgeport, Connecticut, 188 per cent.; Brooklyn, New York, 167
per cent.; Paterson, New Jersey, 162 per cent.; Jersey City, New Jersey,
122 per cent.; Detroit, Michigan, 112 per cent.; Newark, New Jersey, 100
per cent.; Akron, Ohio, 77 per cent.; Gary, Indiana, 66 per cent.;
Pueblo, Colorado, 52 per cent.

Now, my friends, I come to a point that I hope will make an impression
on your minds--a lasting impression--and that point is that the Postal
Savings System from the first has been seriously handicapped by
statutory restrictions on the amount that may be accepted. The law
permits the acceptance of only one hundred dollars a month and five
hundred dollars in all from a depositor. It has been shown that the
foreign born are the largest patrons of our savings service and if this
service is to reach its full measure of success we must recognize and
respect the habits of the foreigner, and one of his habits is to save
his money until he gets several hundred dollars together and then take
the entire amount to the post office, just as he did in the old country.
Because the postmaster cannot accept all that is offered, the intending
depositor very frequently goes away in resentment and disappointment
without depositing a dollar....

It is the testimony of postmasters from all over the country that they
are rejecting about as much money as they are taking in. The Postmaster
General last year recommended to Congress that one thousand dollars be
accepted with interest and that another thousand dollars be accepted
without interest, but for safekeeping. That was a practical and
reasonable recommendation--one which would meet all requirements in
ninety-five per cent. of the cases. Unfortunately the recommendation
failed.... The Postmaster General has indicated that he will repeat the
recommendation in his forthcoming annual report and I sincerely hope
that Congress will promptly recognize the urgent need of the
legislation. Millions of dollars, my friends, are spent every year by
uplift societies for the betterment of the foreigners. These foreigners,
these begrimed, hard-working foreigners, come to our post offices and
ask us to take their humble savings. How unfortunate that we cannot
accept what they offer, within reasonable bounds. What an effective
agency this would be in bettering in a most practical and permanent way
the conditions of the very people we want to Americanize as speedily as
possible.

... We have five hundred and forty thousand depositors in the United
States to-day and postal savings has a new and different story for each
of them. It is not always the big things in life that change or fix our
course. Can't you remember when a few dollars or the want of a few
dollars tipped you one way or the other in some important matter. Who
can estimate the happiness and prosperity that the starting of a postal
savings account may lead to. It is a step, and an important one, in the
right direction. Some one has well said that the immigrant who opens a
postal savings account steps unconsciously on a moving platform; one
thing leads to another, and his deposit might lead him into local
investment and investment into business and into citizenship.

There is a very interesting human-interest side to postal savings in
which every phase of good fortune and disaster is reflected. An aged
couple at Norfolk without the knowledge of each other had been carrying
$100 on their persons as a guaranty of respectable burial. They are now
postal savings depositors. Two sisters died in each other's arms in the
_Eastland_ disaster in Chicago a few weeks ago--two working girls--and
they had postal savings accounts for like amounts. Their savings went to
pay for their burial. One of Uncle Sam's bluejackets who went down on
the ill-fated submarine _F-4_ was the owner of a substantial postal
savings account. Gentlemen, the Postal Savings System means something
more than a cold array of assets and liabilities, a balance sheet. Way
off in an isolated spot in Russia a money order went not long ago to the
home of a humble peasant. That money order represented the savings of a
son who was drowned in the Susquehanna River. A few weeks back, a
thrifty Mexican girl withdrew her savings from the post office at San
Diego, California, to buy a trousseau. After the honeymoon she returned
to the office with her new husband and both opened postal savings
accounts.

Last year Leadville, Colorado, struck a thrift note that was new in this
country, so far as I know, and reference to it is particularly timely as
Christmas is approaching. A mining company in that city struck the note
and I hope it will be heard from one end of this country to the other.
It was this: Last December an officer of the company went to the post
office and opened a postal savings account for every employee--ninety in
all--as a Christmas present. He placed to the credit of each 2 per cent.
of what he had earned during the year. These Christmas remembrances
amounted to over fifteen hundred dollars. Out of the ninety employees
only five had previously opened postal savings accounts. Now, I count
that substantial charity; I call that well-directed charity. We have
kept track of these particular deposits and the workmen who get their
start through that Christmas bounty are adding to their savings weekly
by their own personal efforts. (Applause.)

Gentlemen, as a rule, we in official life swing back and forth in a
measured arc, and the little one can do is so small when compared with
the mass of Government activity that we feel insignificant and lost. But
I feel, my friends, that in the Postal Savings System my associates and
I are doing a positive good for humanity. I believe that we are making
people better and happier because postal savings points the way from the
sweat shop to the school--it stands for clean homes and empty alleys.
Each of you is a stockholder in the Postal Savings System and its
success is your success. Your dividends are in the better and happier
American citizenship which it encourages and promotes. (Applause.)

FOOTNOTES:

[93] Adapted from W. H. Kniffin, _The Savings Bank and Its Practical
Work_, pp. 54-75. The Bankers Publishing Company. New York, 1912.

[94] E. W. Kemmerer, _The United States Postal Savings Bank_, _Political
Science Quarterly_, Vol. XXVI, No. 3, September, 1911, pp. 465-77.

[95] W. H. Kniffin, _The Savings Bank and Its Practical Work_, pp. 75,
76. The Bankers Publishing Company, New York. 1912.

CHAPTER XVII

DOMESTIC EXCHANGE

[96]The banker has become the bookkeeper and settling agent of the
business world. The products of a locality, let us say the State of
Georgia, move out to the markets of the world and create credits in
favor of that locality on the books of banking institutions in the
commercial centers, while at the same time a counter movement of
commodities is under way from other localities into Georgia, in like
manner creating credits for those localities which are debits against
Georgia. The practical effect is that the commodities moving between
these communities are exchanged and pay for themselves, the running
accounts being kept and settlements effected in the banks.

To illustrate the details: A dealer in cotton in Atlanta makes a sale to
a mill in Fall River and receives in payment a check or draft drawn on a
New York bank, which he deposits for the credit of his account in an
Atlanta bank, and which the latter forwards for the credit of its bank
account in New York. Meanwhile an Atlanta merchant has bought goods in
New York and in order to pay for them buys from the Atlanta bank an
order for the New York credit, and this when forwarded completes the
circle of payments for cotton and goods.

If we would extend the investigation to include the bank accounts of the
Fall River mill and the Atlanta dealer we would find, first, that the
mill account was built up constantly by deposits of checks and drafts
received in payment for goods sold in all parts of the country and
perhaps all over the world, with almost no deposits of cash, and that it
was drawn down by checks for raw cotton, and supplies and large amounts
of cash for the pay-rolls; second, that the cotton dealer's account was
built up entirely by deposits of checks or drafts received for cotton
shipments and drawn down by checks and cash payments to farmers for
cotton.

For payments at a distance bank credit in the form of a check or draft
is [commonly] used....

The foregoing illustrates the movement of the exchanges constantly
proceeding ... between ... different communities.... There is a network
of relationship between banks through which each local community and
market is connected with all other communities and markets.... No
locality is so remote as to be outside of the circle and no community's
sales and purchases are so scattered but that they can be brought
together in the settlements. Each bank is the center of a circle of
which it is the clearing agent; all payments between its own customers
may be made by a transfer of credit upon its books. If there are two
banks or more banks in a town, all payments between their customers are
resolved into offsets between these banks, and in like manner all
payments between localities are resolved into offsets between banks, and
if not settled in local centers are passed up to larger and larger
clearing centers....

But while the cross-payments of trade may be depended upon in the long
run to balance and settle themselves, it does not follow that they will
do so from day to day, or that they coincide so closely that payments in
money are never required. An individual's sales and purchases are seldom
made at the same time, and the sales and purchases of communities are
not constantly balanced. The trade of a one-crop farming district will
not be so evenly balanced as one of a district in which mixed farming
prevails, and in every industry there are periods, usually recurring
every year, when the payments exceed the current income, and
corresponding periods when income exceeds outgo....

A region like the cotton states, whose products move quickly to market,
may have large credit balances at one season and at another be wanting
to borrow....

The banker is an equalizing agency in the situation. He stands in the
breach: he must either supply the missing offsets of credit, or, as a
last resort, make the payments in money....

The entire system of settlements, with transfers and offsets and
advances and interchange of capital and credit, is exceedingly
interesting and wonderfully simple and effective, but depends for its
effectiveness upon a scrupulous observance of the principle upon which
it is based. That principle is the natural reciprocity of trade....

While there are balances from time to time in the exchanges ... between
different localities ... which cannot be settled without shipments of
money, they are usually met without inconvenience unless there is a
disturbance of credit.

EXCHANGE RELATIONS BETWEEN CHICAGO AND NEW YORK

[97]... It should always be borne in mind that the fact that New York
City is the country's dominating financial market results in making New
York funds acceptable everywhere as a means of payment, and in making a
ready market for New York exchange throughout the country for a large
part of the year.

Throughout January money in Chicago relative to that in New York City is
cheap. Exchange rates on New York are high and there is a considerable
movement of cash from Chicago to the Eastern States--particularly to New
York City....

Just prior to January 1 there is normally a large demand in Chicago for
New York exchange with which to meet dividend and interest payments due
in New York, and the high rates thus created continue somewhat into the
new year. The crop-moving and holiday demand, however, being over, money
becomes relatively cheap in Chicago and flows to New York City, where it
can at least earn the 2 per cent. paid by banks on bankers' balances,
and where it is absorbed somewhat in speculative activity and in the
higher security prices, which normally rule the latter part of January
and the fore part of February.

From the last of January to the fore part of March the demand for money
in Chicago relative to that in New York rapidly rises. Exchange rates on
New York fall to a low point, and shipments of cash to the Eastern
States are very small....

... There is, however, no evidence of a movement of cash from the East
to Chicago in February, although there is something of a westward
movement in March.

During this period the relative demand for money in Chicago is increased
by the anticipated opening of navigation on the Great Lakes, for the
opening of navigation gives rise to a large amount of New York exchange
received in payment of grain bills. There is also a demand on the part
of western bankers for currency to meet the spring needs of the western
farmers. The first of March in many sections of the Middle West is the
commonest time for making settlements of interest and principal on farm
mortgages. It is also a common date for paying farm rents.

This spring advance in the value of money in Chicago as compared with
New York reaches its maximum early in March. The demand then falls off
rapidly and with only temporary interruptions (the most noteworthy being
about the first of May) until it reaches the low level of the early
summer, the latter part of May. It continues at a low level until early
in July, when the crop-moving advance begins....

About the first of July the relative demand for money in Chicago and
vicinity begins to increase, advancing rapidly, with minor
interruptions, until early in September, and then maintaining a high
level until the fore part of November. During this period exchange rates
rule low and money moves in large quantities from the Eastern States to
Chicago....

The primary cause for this increasing and large demand for money in
Chicago is of course the anticipated and actual crop-moving demand,
there being no sufficiently strong Eastern demand for money at the time
to hold it back....

It has been found ... that during the last six to eight weeks of the
year, after the crop-moving demand has to a large extent subsided, the
relative demand for moneyed capital in both New York City and Chicago is
maintained until the time of January settlements at nearly the high
level of the crop-moving period. A study of domestic exchange rates and
of currency shipments shows that the relative demand for money is
stronger during this period in New York City than in Chicago, that
exchange rates in Chicago on New York rise, and that cash moves
eastward....

Money becomes relatively cheap in Chicago and vicinity during these last
six to eight weeks of the year, principally because of the return flow
of currency previously shipped to the country districts for crop-moving
purposes. There is also considerable demand at this time for New York
exchange to meet payments in certain lines of goods, such as hardware
and dry goods, that are due New York and New England houses by Western
establishments, and to make purchases for the holiday trade....
Comparatively high exchange rates... [near] the end of the year are
largely due to preparations for the January disbursements, which Western
concerns are called upon to make in New York City....[98]

EXCHANGE RELATIONS BETWEEN ST. LOUIS AND NEW YORK

[99]... General seasonal movements in the relative demand for money in
St. Louis (as compared with New York City), ... are fairly regular in
their occurrence.

From the beginning of the year until the fore part of May the demand
appears to be moderate, exchange rates rule near par, and there is a
moderate tendency for cash to move from St. Louis to the Eastern States,
with almost no tendency to move in the opposite direction....

The first eighteen weeks of the year, St. Louis bankers say, are a
period of comparative inactivity in the local money market. Concerning
this period, a prominent St. Louis banker writes: "For the first
eighteen weeks in the year... there is comparatively no New York
exchange making and also a nominal demand for it, and likewise an easy,
quiet money market."...

The second noticeable movement in the St. Louis money market is the
sharp decline in the relative demand for money from the fore part of May
to about the first of June. Exchange on New York rises rapidly at this
time, and May is the month of heaviest shipments of cash to the East....

The high exchange rates in May, and the resulting eastward movement of
money, are due largely to the fact that at about this time in St. Louis
the bills of boot, shoe, hardware, and dry goods merchants mature, and
as their paper is held largely in the East, exchange is required in
large amounts. The result is large payments to St. Louis banks, the
building up of their reserves, and resulting reduction of their credit
balances in New York City.

From the first of June to the first of November the demand for money in
St. Louis relative to that in New York City increases rapidly, advancing
from the cheapest money in the year (twenty-first week) to the dearest
money (forty-fourth week)....

This greatly increasing relative demand for money in St. Louis is, of
course, attributable to the crop-moving requirements.... The cashier of
a St. Louis bank writes: "New York exchange... always goes to a discount
here in the fall of the year, and this is caused by the large cotton
drafts drawn in payment of cotton shipped out from the Southwest. The
banks down there either send us drafts drawn on New England points or
New York, or else they send drafts drawn on the two large cotton buyers
here, who, in turn, draw their drafts on Eastern points. The result is a
great deal of exchange comes in, for which there is a demand for
currency." The resulting low rates of exchange continue as long as the
cotton season lasts. During this crop-moving season there are heavy
shipments of cash from St. Louis to the Southern States....

After about the first week in November the relative demand for money in
St. Louis falls off rapidly until about the first of December, and then
fluctuates at a moderate level until the end of the year....

The rise in exchange and easing up of the St. Louis money market in the
latter part of November and in December is due to the decline in the
crop-moving demand for cash, particularly in the South, and the return
movement of cash from that section,... which begins the latter part of
November. Southern banks in settling their St. Louis bills first use
their eastern exchange and then ship currency. The upward movement of
exchange is hastened shortly after the first of November by heavy
purchases, for about four weeks, of New York exchange by dry goods,
hardware, and boot-and-shoe houses for the purpose of settling their
eastern accounts....

DOMESTIC EXCHANGE IN SAN FRANCISCO ON NEW YORK CITY

[100]... Before taking up the subject of seasonal variations in San
Francisco domestic exchange rates on New York City, it may be well to
observe that in a number of respects the San Francisco domestic exchange
market is a peculiar one.

In the first place the principal kind of money in circulation is gold
coin and this fact materially influences the range of domestic exchange
fluctuations, _i. e._, the shipping points. Concerning this matter I can
do no better than quote from letters of Mr. F. L. Lipman of the Wells
Fargo Nevada National Bank. Mr. Lipman writes (under date of February 7,
1908): "In the East the medium of exchange is paper or new gold by
weight. In California it is current gold coin by tale, with a mingling
of paper and new gold. The first effect of an upward movement of
exchange, there, is that at about 40 cents per $1,000 the currency
shipping point is reached, which in due course, drains off our paper
money. At approximately $1.10 per $1,000 the gold shipping point is
reached. Of course the only gold that can be economically shipped is new
gold. Now it not infrequently happens that the demand for remittance
will be so great as to exhaust (1st) the currency and (2d) the new
gold, leaving only our current gold, for which there is practically no
shipping point, the discount on worn coin being practically
prohibitory."

A second peculiarity of the San Francisco exchange market arises from
the fact that San Francisco, being the chief port city of the Pacific
coast and the seat of one of the United States mints and subtreasury
offices, is the recipient of large quantities of gold from
gold-producing regions, _i. e._, California, Alaska, and Australia. The
United States mint will issue without any charge its transfer drafts on
the subtreasury in New York in return for deposits of gold, the new
product of mines, or for deposits of imported gold. "Frequently," writes
Mr. Lipman, "this usage is without influence on our local market, as
when large importations of Australian gold are received for New York on
London account. At other times this practice of the Treasury has a
decided effect on our exchange market as, for instance, when the early
gold shipments come down from Alaska. These shipments command the
service of the Treasury Department to the full amount thereof, while a
portion at least of the proceeds is used in payment of local bills for
supplies to Alaska from this city. This throws on the market an
additional supply of exchange when such exchange is desired. The owners
of the gold, however, have the privilege of taking gold coin instead of
eastern exchange from the Treasury, and this alternative tends to bring
exchange to about par. The Government also influences exchange from the
other side, by its willingness to transmit money by telegraph from New
York and Chicago to this city."...

Professor Carl C. Plehn of the University of California, suggests three
other characteristics of the San Francisco domestic exchange market, _i.
e._, (1) the close exchange relations with the Orient, (2) the fact that
in San Francisco, New York bills very frequently represent merely steps
in a general arbitrage transaction, and (3) the appreciable interest
element involved in demand transactions because of the distance between
San Francisco and New York....

From the beginning of January to about the first of March there is a
rapid decline in the relative demand for money in San Francisco,
resulting in the lowest level of the year during February.

The average rate of exchange rose from 30 cents discount in the first
week to $1.05 premium in the seventh....

... Among the principal factors cheapening money in San Francisco at
this time and forcing up exchange may be mentioned: (1) the fact that
advances which have been made for the movement of general crops up and
down the Pacific coast are being repaid very rapidly; (2) the demand for
eastern exchange with which to pay bills incurred for holiday purchases;
and, finally (3), the latter part of February, the desire of taxpayers
to discharge eastern obligations and get movable funds out of the State
before the tax returns of the first Monday in March are made to the
assessor.

From the fore part of March to the fore part of June the demand for
money in San Francisco relative to New York City tends to increase....

Among the causes at work in reducing exchange rates at this time may be
mentioned: (1) the readjustment after the heavy demands for exchange
which were made anticipatory of assessment day: (2) preparation for the
second installment of taxes which become delinquent the last Monday in
April; (3) demand for funds by the large fruit canneries with which to
buy sugar and tin in preparation for the annual fruit pack which begins
in May; (4) by May the shipping trade in green fruits has begun, giving
rise to many eastern bills; (5) demand for funds for equipping fishing
companies going on long trips....

From about the 1st of July to the fore part of September there is an
almost continuous increase in the relative demand for money in San
Francisco....

... During August and September, particularly the latter month,
substantial transfers of cash [are made] to San Francisco by the United
States subtreasury at New York.

This decline in exchange is principally due to the large amount of
eastern credits available locally at this time from the shipment of
California products, especially green fruits, to eastern points; the
returns for such shipments being usually available in either Chicago or
New York exchange.... The California hay and grain harvests cause
considerable demand for funds by the middle of July, while the ships
returning from the fisheries in August and September require large sums
with which to pay their crews.

From about the middle of September (thirty-fourth week) to the latter
part of October (thirty-ninth week) New York exchange tends to rule at
near par....

During these weeks the outward movements of grain, green fruit, and fish
tend to force exchange down, while the fact that this is the quarter of
large receipts of gold ... from Alaska, making it a period of large
receipts of gold bullion at the Mint, and that the San Francisco Mint
makes returns for this gold in gold coin or New York exchange, at the
option of the owner of the bullion, tends to keep New York exchange at
par.

The demand for money in San Francisco relative to New York City
increases rapidly from the latter part of October to about the 1st of
December when it reaches its highest point in the year.... November and
December are the months of largest transfers of cash to San Francisco by
the United States subtreasury in New York. The fall in exchange during
this period appears to be due primarily to the outward movement of dried
fruits, such as raisins, prunes, and apricots. The banks pay out large
amounts of actual coin which goes to the country, and receive in return
drafts on eastern points which build up their eastern balances. This
also represents the most active part of the northern grain season. The
low point of the year for exchange is about the last week in November
when the tax collector for the city and county of San Francisco
withdraws large sums of actual coin from circulation and locks much of
it up in the vaults of the city hall.

December is a month in which the relative demand for money in San
Francisco lightens considerably as the result of the rapid falling off
of the crop-moving demand.... The demand for remittances to the East for
January 1st settlements tends to force up exchange rates at the end of
the year....

CURRENCY MOVEMENTS BETWEEN NEW ENGLAND AND THE EASTERN STATES

[101]... The distance between New York City and the principal New
England cities is very small, and there is a great community of
financial interest among these cities and New York. Between New York
City and Boston the currency shipping points are only about 25 cents
premium and 25 cents discount. Single financial deals between New York
City and Boston are frequently of sufficient moment to lead to
considerable shipments of currency, although exchange rates previously
were only moderate. The relations among the clearing-house banks of
Boston and among those of other New England cities are close, so that
when one bank is in need of New York funds it is liable to obtain them
from another which may have more than it needs. For this reason, it is
said, much less money is now received from New York City and shipped
there than was the case a few years ago....

THE DOMESTIC EXCHANGES DURING THE CRISIS OF 1907[102]

There is no part of our banking machinery which has received so little
elucidation as that of the domestic exchanges. Even for normal times the
subject is obscure, and the writer therefore ventures upon an
explanation of its course during a period of crisis with hesitation, and
he is by no means confident that important considerations may not have
been overlooked.

As in the case of foreign exchange, domestic exchange rates fluctuate
within limits fixed by the cost of shipping money, and also, in the case
of cities distant from New York, by the loss of interest while currency
is in transit. The quoted rates apply principally to business between
banks, the rates being determined by demand and supply. A Boston bank,
for example, receives from its customers New York drafts and also checks
drawn on banks in New York and its vicinity. All these items will serve
to build up its balances in that city. On the other hand, its depositors
have been sending out checks, many of which will in the course of time
reach New York and reduce its balances there. The Boston bank will also
have received from banks of New York and from banks elsewhere items for
collection in its vicinity, and remittance in ordinary course will be
made by it in New York funds. Similarly it has sent away items for
collection to banks in other cities upon which it expects a like
remittance. As a result of all these various influences the balances of
the Boston bank may either increase or decrease. If they increase it may
be ready to sell exchange to other Boston banks whose balances are
running low. It may also happen that the bank is desirous of reducing
its New York balances, and in that case it will also appear as a seller
of exchange in the market.

Now, if in the course of a crisis clearing-house loan certificates
become the principal or sole medium of payment between banks, it may
well happen that a bank will be unwilling to sell exchange unless it is
unusually well supplied with New York funds. By the sale of exchange it
can at best only secure a favorable clearing-house balance, which will
be settled in loan certificates, and if this balance should be
unfavorable it can meet it by taking out certificates on its own
account. Each bank, therefore, to a greater extent than in normal times,
is obliged to rely upon itself for means of payment in New York. The
loan certificate does indeed yield a return or involve an expense of 6
or 7 per cent., while the return on New York balances is only 2 per
cent. This advantage does not, however, seem to have induced the banks
to sell exchange as freely as in normal times.

This is, however, not the only disturbing influence. The Boston bank may
have remitted to New York upon items collected by it for other
banks--let us say those of Philadelphia--but it may happen that the
Philadelphia banks delay or even discontinue remitting to New York upon
items sent to them for collection by banks of Boston and other cities.
The Boston bank can then no longer rely upon what would normally serve
to build up its own New York balances. It will be simply acquiring a
mass of unavailable credits at scattered points throughout the country.
The supply of New York exchange which it might have been willing to sell
is consequently diminished, and the premium on exchange must rise to a
point at which it will tempt some of the banks to sell exchange, even
though it intrenches upon their balances with agents which are available
for reserve.

The premium would naturally be especially high in those cities where the
banks were most unwilling to reduce their New York balances.
Philadelphia seems a case in point, as its deposits with reserve agents,
which were $30,995,000 on August 22, were reduced to only $29,389,000 on
December 3. At that time the premium on currency in Philadelphia ranged
from $1.50 to $3 per $1,000. It is, therefore, a reasonable conclusion
that the banks were strongly disinclined to make use of their New York
balances. In a few cities it is probable that the premium reached a high
level because the banks had exhausted their New York balances. St. Louis
may be mentioned as a probable example. Being a central reserve city,
its banks would naturally have only such balances in New York as normal
business requirements made necessary. The dislocation of exchange
elsewhere or the course of payments between New York and St. Louis may
have combined to produce such a balance of payments as would have
required currency shipments if the St. Louis banks had remitted promptly
to New York.

The extent to which banks in different cities delayed or refused to
remit to New York on items collected by them for other banks cannot be
determined. Banks in one city, very naturally and honestly, were
inclined to lay the blame upon banks elsewhere. The banks in other
places, however, may not have been able to secure payment of the items
sent to them for collection from other banks in their locality with the
usual promptness. When every allowance has been made, however, there can
be no question that banks in certain cities, in these as well as in
other matters, adopted a policy wholly designed to strengthen themselves
regardless of consequences.

The general prevalence of the premium on New York exchange is, as we
have seen, accounted for in part by the use of clearing-house loan
certificates in settling balances between banks and by the delay in
remitting in New York funds upon items collected for other banks. It
seems probable, however, that, taking the country as a whole, the course
of payments was favorable to the New York banks. At the beginning of
November withdrawals for crop-moving purposes have in recent years begun
to diminish, except to the South, and movements of money from eastern
centers are distinctly in favor of New York at that season of the year.
If this were indeed the case in 1907, it affords still another reason
for thinking that the New York banks might have met the crisis
successfully without restricting payments. They would probably have been
obliged to meet only withdrawals arising from lack of confidence and not
real needs for crop-moving purposes, such as would have increased the
difficulties of the situation had the crisis begun at the beginning of
September.

Finally, it should be noted that the restriction of cash payments to
depositors and the currency premium seem to have increased the demand
for New York exchange. Only in that city was it possible to buy any
considerable quantity of money. Many banks in various parts of the
country purchased gold and currency at a premium in New York and,
instead of drawing on their own balances, then entered their home market
as purchasers of exchange which was remitted in payment.

In the few instances where exchange was below par the currency premium
was a more direct influence; but exchange could not have dropped to the
low figures recorded in 1893 in the case of Chicago [$30 discount per
$1,000], because the Chicago banks in 1907 did not maintain payments
among themselves as they had done on previous occasions. Exchange was at
a discount only in those cities where the course of payments was so
strongly against New York that practically all the banks found their
balances in that city increasing. Chicago might have been expected to
belong to this group, but its banks made extensive use of bills derived
from grain exports to secure gold which was shipped directly to them. In
general, exchange was at a discount, or at par only, in the Southern
States, the banks of which, by means of cotton sales, are normally in
position to draw money from the northeastern part of the country during
the late autumn.

In conclusion, it should perhaps be pointed out that the quoted rates of
exchange were often without much significance. The ordinary course of
dealings was so completely disorganized in many places that the rates
were purely nominal, representing little or no actual transactions.

FOOTNOTES:

[96] Frank A. Vanderlip, _Modern Banking_, Three Addresses delivered at
Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank.
New York. 1911 [?].

[97] E. W. Kemmerer, _Seasonal Variations in the Relative Demand for
Money and Capital in the United States_. Publication of the National
Monetary Commission, Senate Document No. 588, 61st Congress, _2d
Session_, pp. 96-100.

[98] [Owing to the growth of deposit banking among the farming classes,
the increasing diversification of industry in the agricultural States,
_Sub-treasury operations_, and the offer of remunerative rates of
interest on loans in New York during the fall, the net autumnal currency
movement since 1907 has frequently been to New York. See E. M.
Patterson, _Certain Changes in New York's Position as a Financial
Center_, _Journal of Political Economy_. Vol. XXI, June, 1913, pp.
523-539.]

[99] E. W. Kemmerer, _op. cit._, pp. 101-105.

[100] _Ibid._, pp. 118-121.

[101] _Ibid._, 54. 55.

[102] O. M. W. Sprague, _History of Crises under the National Banking
System_, Publications of the National Monetary Commission, Senate
Document No. 538, 61st Congress, _2d Session_, pp. 293-297.

CHAPTER XVIII

FOREIGN EXCHANGE

THE NATURE OF FOREIGN EXCHANGE

[103]The bill, or order to pay money in a foreign centre, is the
commodity that is actually bought and sold by dealers in foreign
exchange, but it is better for the moment to leave bills out of
consideration. They are only the tangible expression of the claim for
money in another centre, and at this early stage of our inquiry it is
better to keep our minds fixed on what is at the back of the bill,
namely, the money in a foreign centre to which it gives its holder a
claim. The French buyer of a bill on London buys it, as a rule, because
by sending it to his English correspondent he can discharge a debt to
him in English money. What he really buys with his francs is so many
English pounds, and the labyrinth of the foreign exchanges is much
easier to thread if, before we complicate the question by talking about
bills, we keep our eye on the comparatively simple problem which is the
key to the puzzle, namely, the exchange of one country's money for
another's.

Thus stripped to its naked simplicity, the problem begins to look as if
it were not a problem at all, and a critical inquirer may be excused for
thinking that at least in the case of countries that use currencies
based on the same metal, there ought to be no need for daily quotations
of rates of exchange, because the relative value of their moneys ought
to be constant. It is a natural question to ask, why should there be
these daily fluctuations, and, since they are evidently there, what is
the sense or purport of them? The answer is, that money in France and
money in England are two different things, and the relative value of two
different things is almost certain to fluctuate. Quite apart from any
differences in the fineness of gold coined by two different countries,
or the ease or difficulty with which a credit instrument can be turned
into gold, mere distance is quite enough to make the difference that
will create fluctuation in price. New York and Chicago use exactly the
same currencies, but money in New York differs from money in Chicago by
being nearly a thousand miles away, and consequently there are frequent
variations in their relative value. The English and Australian
sovereigns are identical in weight and fineness, but there is constant
fluctuation in the buying power of the English sovereign as expressed in
its brother that is circulating in the Antipodes.

These fluctuations are based on the same influence that sways the
movements in the prices of all goods and services that are bought and
sold, that is, the influence of supply and demand. Just as the price of
boots, Consols, medical advice, football professionals, or anything else
that can be the subject of a bargain, will depend in the end upon the
number of people who want to buy them compared with that of those who
want to sell them, at or near a certain figure, so the price of English
pounds, when expressed in francs, guilders, milreis, or Australian
sovereigns, depends on the number of people abroad who have to buy money
in England as compared with the number of those who have money in
England to sell. People abroad have to buy money in England when they
owe money to Englishmen and want to pay it; and they have money in
England to sell when Englishmen owe them money.

Jacques Bonhomme in Paris has been selling shiploads of Christmas
kickshaws to John Robinson in London, and so has thousands of English
pounds due to him by the said Robinson. But English pounds, as such, are
not wanted by M. Bonhomme. He wants to sell them, to turn them into
francs, the currency of his own country, with which he makes his daily
payments at home. On the other hand, there are always plenty of
Frenchmen who have imported English goods or have had services rendered
by English bankers, or shipowners, or insurance companies, and so want
to buy English money wherewith to pay their English creditors. So it
follows that the price that M. Bonhomme will get for his English pounds
will depend on the value of goods and services that other Frenchmen have
been selling to England, so producing English pounds to be sold in
Paris, as compared with the value of the claims that have to be met in
London, for the satisfaction of which English pounds have to be bought.
If the amount of English money on offer is bigger than the amount
wanted, down will go the price of the English pound as expressed in
francs, and the seller in francs will get less in francs for his pound.
If the amount of English money wanted is the bigger, the price will go
up, and the seller will get more for his pound. When the price goes
down, the exchange is said to move against London, because there is a
depreciation in the value of the sovereign as expressed in francs. When
it goes up the exchange moves in favour of London, because the buying
power of the sovereign is enhanced.

The process is exactly the same, and is even more simple and easy to
understand when we take away the complication of the exchange of the
moneys of two different nations, and look at it at work between two
distant towns of the same country. If in the course of trade New York
has large payments to make in Chicago, money in Chicago will be wanted
in New York, and competition there will send up the price of it, so that
a dollar in Chicago will be worth more for the time being to New Yorkers
than a dollar in New York, and any New York bank or firm that has a
balance or a credit in Chicago will be able to dispose of it at a
premium. The extent of this premium, however, will obviously be limited
by the expense involved in sending lawful money, as the Americans call
it, from New York to Chicago. If we suppose, for the sake of simplicity,
that the cost of sending a dollar and insuring it is covered by a cent,
no one in New York will pay much more than one dollar and a cent for a
dollar in Chicago. Rather than do so he will send his dollar. He will
probably pay a small fraction more to save himself the trouble and time
involved by sending and insuring money, and this minute fraction that he
will sacrifice is the opportunity of the exchange dealer, who will send
money to Chicago, and put himself in funds there, and so be able to
supply money in Chicago to any one in New York who will pay for it at
the rate of one dollar and one cent plus any profit that the exchange
dealer can squeeze out of him.

Viewed in this simple example the problem of exchange has few terrors.
It is merely a question of the price of money in one place, as expressed
in the same money in another, with fluctuations governed by supply and
demand and limited by the cost of sending money from place to place.
This limitation does not mean that supply and demand cease to govern the
market, but merely that at a point supply can be increased to meet any
demand by the despatch of currency.

"FAVOURABLE" AND "UNFAVOURABLE" EXCHANGES

[104]The general feeling with regard to the function of the exchanges,
as giving evidence of the mercantile (or rather monetary) situation of
any country, is indicated by the usual phrase of a "favourable or
unfavourable state of the exchanges." A phrase which occurs so
frequently in all banking discussions that it cannot be passed over
without remark. It may originally have implied the erroneous theory that
the object of commerce is to attract gold, and that that country towards
which the tide of bullion sets with the greatest force is _ipso facto_
the most prosperous. Political economists, from their point of view, are
correct in their statement that, as regards the country at large and the
interchange of commodities, exports and imports are always balanced, and
that both the words "unfavourable balance of trade" and "unfavourable
exchanges" involve fallacy. But merchants and bankers are influenced by
the feeling, that at any given moment they may be under greater
liabilities for imports than they can temporarily meet, owing to the
system of credit which disturbs the coincidence of payments for exports
and imports, though their value may actually be equal; and further, by
the anxiety as to the possibility of meeting these liabilities in that
specific mode of payment to which they are pledged, namely, in gold or
convertible notes. When, therefore, in banking treatises, it is said
that the exchanges are favourable to any particular country, it should
be understood that the intention is simply to state the fact that bills
of that country upon foreign cities are difficult of sale, whilst bills
drawn upon it from abroad are at a premium, indicating an eventual
influx of specie. So, when it is said that the exchanges are
unfavorable, a situation is described in which foreign bills are in
great demand, and when, consequently, their value seems likely to be so
enhanced as to render the export of bullion an unavoidable alternative.

THE ORIGIN AND SUPPLY OF FOREIGN EXCHANGE

[105]Underlying the whole business of foreign exchange is the way in
which obligations between creditors in one country and debtors in
another have come to be settled--by having the creditor draw a draft
directly upon the debtor or upon some bank designated by him. John Smith
in London owes me money. I draw on him for 100 pounds, take the draft
around to my bank and sell it at, say, 4.86, getting for it a check for
$486.00. I have my money, and I am out of the transaction.

The fact that the gold in a new British sovereign (or pound sterling) is
worth $4.8665 in our money by no means proves, however, that drafts
payable in pounds in London can always be bought or sold for $4.8665 per
pound. To reduce the case to a unit basis, suppose that you owed one
pound in London, and that, finding it difficult to buy a draft to send
in payment, you elected to send actual gold. The amount of gold
necessary to settle your debt would cost $4.8665, in addition to which
you would have to pay all the expenses of remitting. It would be
cheaper, therefore, to pay considerably more than $4.8665 for a
one-pound draft, and you would probably bid up until somebody consented
to sell you the draft you wanted.

Which goes to show that the mint par is not what governs the price at
which drafts in pounds sterling can be bought, but that demand and
supply are the controlling factors. There are exporters who have been
shipping merchandise and selling foreign exchange against the shipments
all their lives who have never even heard of a mint par of exchange.
All they know is, that when exports are running large and bills in great
quantity are being offered, bankers are willing to pay them only low
rates--$4.83 or $4.84, perhaps, for the commercial bills they want to
sell for dollars. Conversely, when exports are running light and bills
drawn against shipments are scarce, bankers may be willing to pay 4.87
or 4.88 for them.

For a clear understanding of the mechanics of the exchange market there
is necessary a clear understanding of what the various forms of
obligations are which bring foreign exchange into existence. Practically
all bills originate from one of the following causes:

1. Merchandise has been shipped and the shipper draws his
draft on the buyer or on a bank abroad designated by him.

2. Securities have been sold abroad and the seller is
drawing on the buyer for the purchase price.

3. Foreign money is being loaned in this market, the
operation necessitating the drawing of drafts on the lender.

4. Finance-bills are being drawn, _i. e._, a banker abroad
is allowing a banker here to draw on him in pounds sterling
at 60 or 90 days' sight in order that the drawer of the
drafts may sell them (for dollars) and use the proceeds
until the drafts come due and have to be paid.

1. Looking at these sources of supply in the order in which they are
given, it is apparent, first, that a vast amount of foreign exchange
originates from the direct export of merchandise from this country.

Not all merchandise is drawn against; in some cases the buyer abroad
chooses rather to secure a dollar draft on some American bank and to
send that in payment. But in the vast majority of cases the regular
course is followed and the seller here draws on the buyer there.

2. The second source of supply is in the sale abroad of stocks and
bonds.

Origin of bills from this source is apt to exert an important influence
on rates, in that it is often sudden and often concentrated on a
comparatively short period of time. The announcement of a single big
bond issue, often, where it is an assured fact that a large part of it
will be placed abroad, is enough to seriously depress the exchange
market. Bankers know that when the shipping abroad of the bonds begins,
large amounts of bills drawn against them will be offered and that rates
will in all probability be driven down.

3. The third great source of supply is in the draft which bankers in one
country draw upon bankers in another in the operation of making
international loans. The mechanism of such transactions will be treated
in greater detail later on, but without any knowledge of the subject
whatever, it is plain that the transfer of banking capital, say from
England to the United States, can best be effected by having the
American house draw upon the English bank which wants to lend the money.
The arranging of these loans means the continuous creation of very large
amounts of foreign exchange.

4. Drawing of so-called "finance-bills," is the fourth source whence
foreign exchange originates. Whenever money rates become decidedly
higher in one of the great markets than in the others, bankers at that
point who have the requisite facilities and credit, arrange with bankers
in other markets to allow them (the bankers at the point where money is
high) to draw 60 or 90 days' sight bills. These bills can then be
disposed of in the exchange market, dollars being realized on them,
which can then be loaned out during the whole life of the bills.

These are the principal sources from which foreign exchange
originates--shipments of merchandise, sales abroad of securities,
transfer of foreign banking capital to this side, sale of finance-bills.
Other causes of less importance--interest and profits on American
capital invested in Europe, for instance--are responsible for the
existence of some quantity of exchange, but the great bulk of it
originates from one of the four sources above set forth.

THE SOURCES OF THE DEMAND FOR FOREIGN EXCHANGE[106]

Turning now to consideration of the various sources from which spring
the demand for foreign exchange, it appears that they can be divided
about as follows:

1. The need for exchange with which to pay for imports of
merchandise.

2. The need for exchange with which to pay for securities
(American or foreign) purchased by us in Europe.

3. The necessity of remitting abroad the interest and
dividends on the huge sums of foreign capital invested here,
and the money which foreigners domiciled in this country are
continually sending home.

4. The necessity of remitting abroad freight and insurance
money earned here by foreign companies.

5. Money to cover American tourists' disbursements and
expenses of wealthy Americans living abroad.

6. The need of exchange with which to pay off maturing
foreign short-loans and finance-bills.

1. Payment for merchandise imported constitutes probably the most
important source of demand for foreign exchange. Practically the whole
amount of our huge importations has had to be paid for with bills of
exchange. Whether the merchandise in question is cutlery manufactured in
England or coffee grown in Brazil, the chances are it will be paid for
by a bill of exchange drawn on London or some other great European
financial centre.

2. The second great source of demand originates out of the necessity of
making payment for securities purchased abroad. So far as the American
participation in foreign bond issues is concerned, the past few years
have seen very great developments.

Security operations involving a demand for foreign exchange are,
however, by no means confined to American participation in foreign bond
issues. Accumulated during the course of the past half century, there is
a perfectly immense amount of American securities held all over Europe.
The greater part of this investment is in bonds and remains untouched
for years at a stretch. But then there come times when, for one reason
or another, waves of selling pass over the European holdings of
"Americans," and we are required to take back millions of dollars' worth
of our stock and bonds. Such selling movements do not really get very
far below the surface--they do not, for instance, disturb the great
blocks of American bonds in which so large a proportion of many of the
big foreign fortunes are invested. The same thing is true with stocks,
though in that case the selling movements are more frequent and less
important.

3. So great is the foreign investment of capital in this country that
the necessity of remitting the interest and dividends alone means
another continuous demand for very large amounts of foreign exchange.
Estimates of how much European money is invested here are little better
than guesses. The only sure thing about it is that the figures run well
up into the billions and that several hundred millions of dollars' worth
of interest and dividends must be sent across the water each year. At
the interest periods at the beginning and middle of each year it becomes
apparent how large a proportion of our bonds are held in Europe and how
great is the demand for exchange with which to make the remittances of
accrued interest. At such times the incoming mails of the international
banking houses bulge with great quantities of coupons sent over here for
collection. For several weeks on either side of the two important
interest periods, the exchange market feels the stimulus of the demand
for exchange with which the proceeds of these masses of coupons are to
be sent abroad.

4. Freights and insurance are responsible for a fourth important source
of demand for foreign exchange. A walk along William Street in New York
is all that is necessary to give a good idea of the number and
importance of the foreign companies doing business in the United States.
In some form or other all the premiums paid have to be sent to the other
side. Times come, of course, like the year of the Baltimore fire, when
losses by these foreign companies greatly outbalance premiums received,
the business they do thus resulting in the actual creation of great
amounts of foreign exchange, but in the long run--year in, year out--the
remitting abroad of the premiums earned means a steady demand for
exchange.

With freights it is the same proposition, except that the proportion of
American shipping business done by foreign companies is much greater
than the proportion of insurance business done by foreign companies. An
estimate that the yearly freight bill amounts to $150,000,000 is
probably not too high. That means that in the course of every year there
is a demand for that amount of exchange with which to remit back what
has been earned from us.

5. Tourists' expenditures abroad are responsible for a further heavy
demand for exchange. The sums spent by American tourists in foreign
lands annually aggregate a very large amount--possibly as much as
$175,000,000--all of which has eventually to be covered by remittances
of exchange from this side.

Then again there must be considered the expenditures of wealthy
Americans who either live abroad entirely or else spend a large part of
their time on the other side. By these expatriates money is spent
extremely freely, their drafts on London and Paris requiring the
frequent replenishment, by remittances of exchange from this side, of
their bank balances at those points. Furthermore, there must be
considered the great amounts of American capital transferred abroad by
the marriage of wealthy American women with titled foreigners. Such
alliances mean not only the transfer of large amounts of capital _en
bloc_, but mean as well, usually, an annual remittance of a very large
sum of money. No account of the money drained out of the country in this
way is kept, of course, but it is an item which certainly runs up into
the tens of millions.

6. Lastly, there is the demand for exchange originating from the paying
off of the short-term loans which European bankers so continuously make
in the American market.

These loaning operations, it must be understood, both originate exchange
and create a demand for it. They were mentioned as one of the sources
from which exchange originates, and now as one of the sources from
which, during the course of every year, springs a demand for a very
great quantity of exchange.

In a general way, it may be pointed out, the sources of demand for
exchange conform with influences which cause exchange to go up, and the
sources of supply of exchange constitute causes which make for low
rates.

It is to be noted, however, that money rates are a great factor
influencing foreign exchange. Whenever money is cheap at any given
centre, and borrowers are bidding only low rates for its use, lenders
seek a more profitable field for the employment of their capital.

Money rates in the New York market are not often less attractive than
those in London, so that American floating capital is not generally
employed in the English market, but it does occasionally come about that
rates become abnormally low here and that bankers send away their
balances to be loaned out at other points. Such a time was the long
period of stagnant money conditions following the 1907 panic. Trust
companies and banks who were paying interest on large deposits at that
time sent very large amounts of money to the other side and kept big
balances running with their correspondents at such points as Amsterdam,
Copenhagen, St. Petersburg, etc.--anywhere, in fact, where some little
demand for money actually existed. Demand for exchange with which to
send this money abroad was a big factor in keeping exchange rates at
their high level during all that long period.

High money rates at some given foreign point as a factor in elevating
exchange rates on that point might almost be considered as a corollary
of low money here, but special considerations often govern such a
condition and make it worth while to note its effect. Suppose, for
instance, that at a time when money market conditions all over the world
are about normal, rates, for any given reason, begin to rise at some
point, say London. Instantly a flow of capital begins in that direction.
In New York, Paris, Berlin, and other centres it is realized that London
is bidding better rates for money than are obtainable locally, and
bankers forthwith make preparations to increase the sterling balances
they are employing in London. Exchange on that particular point being in
such demand, rates begin to rise, and continue to rise, according to the
urgency of the demand.

The international money markets are a most decidedly complex
proposition, and there is literally never a time when several influences
tending to put exchange rates up are not conflicting with several
influences tending to put rates down. The actual movement of the rate
represents the relative strength of the two sets of influences. To be
able to "size up" the influences present and to gauge what movement of
rates they will result in, is an operation requiring, first, knowledge,
then judgment. The former qualification can perhaps be derived, in small
degree, from study of the foregoing pages. The latter is a matter of
mental calibre and experience.

METHODS OF FINANCING IMPORTS AND EXPORTS[107]

The foreign trade of the United States has increased during the last
forty years about 370 per cent.... This increase ... reflected not alone
our own marvellous development, but as well the wonderful growth of
trade throughout the world. The United States stands third among the
countries of the world, its foreign trade being exceeded only by that of
the United Kingdom ... and Germany....

Our imports and exports[108] are being financed more and more by means
of what are known as commercial letters of credit.... An explanation of
the operation of the commercial letter of credit will ... disclose the
methods and conditions under which our imports are financed.

The commercial letter of credit is an authorization, say of an American
bank to its London correspondent, to honor drafts for its account drawn
at various tenors by foreign shippers or others against shipments of
merchandise to this country. These credits are of two kinds, documentary
and clean. Under the documentary credit the London bank is authorized to
accept drafts for the account of the American bank only when the bill of
exchange is accompanied by certain documents described in the letter of
credit. These documents may be the bills of lading for the goods,
consular invoices, insurance certificates and possibly other papers.
Probably a large proportion of such credits requires that drafts be
drawn at sixty or ninety days' sight. So many elements of danger are
involved in financing commodities under commercial letters of credit,
even where the control of the goods is given to the bank issuing the
credit or its agents, that the financial standing of those asking for
credits must be the first consideration in their issuance. Dishonesty on
the part of the shipper, resulting in a drawing under the credit against
forged documents or against shipments of inferior merchandise, is always
possible, and the financial responsibility of the buyer of the credit is
all that stands between the banker issuing the credit and a loss in such
cases.

In order to obtain a clear understanding of the working of a commercial
letter of credit, we will take a concrete example and follow its every
transaction. An importer of coffee (A) in New York purchases a certain
number of bags of coffee from an exporter (B) in Brazil. A agrees to
furnish B with a commercial letter of credit. B is not in position, we
will say, to await the arrival of the coffee in New York and the return
of a remittance before receiving his pay. A on the other hand is unable
to remit B for the coffee before its receipt and sale to his customers.
A goes to his banker in New York and requests him to authorize B to draw
upon the New York banker's London correspondent at ninety days' sight
with bills of lading for coffee to the amount of the purchase attached
to the draft, consular invoice and insurance certificate, if B is to
furnish insurance. If A's banker is willing to extend the credit he
writes a letter (or uses a printed form), requesting his London banker
to accept B's drafts upon presentation under the conditions already
mentioned and others of minor importance. This letter is issued in
duplicate, one copy going to the London banker, the other being
delivered to A. A then mails the copy received by him to B. B thereupon
arranges to ship the coffee, obtains the bill of lading, invoice, etc.,
and takes them with the copy of the credit to his banker in Brazil. A
draft is then drawn on the London bank under the terms of the credit at
ninety days' sight and is discounted by the Brazilian banker, the
proceeds being placed to the credit of B's account or given to him in
the form of a check or cash. The Brazilian banker then forwards the
draft and documents, except such documents as the instructions may
require to be forwarded direct to New York, to his London banker. He
may secure discount of the bill at once by cable or await its arrival in
London before doing so, or he may request his London banker to have the
bill accepted and hold it for maturity. If the bill is discounted the
Brazilian banker may draw against it immediately and thus put himself in
funds to purchase other coffee bills. Upon receipt of the bill by the
London correspondent it is presented to the London banker on whom it is
drawn for acceptance. The acceptor bank examines the documents and if
they are drawn according to the terms of the credit accepts the draft
and returns it to the correspondent of the Brazilian bank, retaining the
documents, which it then forwards to the New York bank which opened the
credit. In accepting the draft the London bank has in effect agreed to
pay it at the end of ninety days, or, figuring grace, ninety-three days.
Upon maturity payment is made and the amount is charged to the account
of the issuing New York bank. Upon receipt of the documents the New York
bank delivers them to its customer under a trust receipt or against
collateral, and the latter is then in position to obtain the goods. Ten
days before the bill of exchange is due in London the New York bank
collects the amount from A, together with the commission agreed upon
when the credit was opened, and remits the amount to its London banker
to meet the draft. On all such transactions the London banker, while not
himself advancing any money, is extending a credit for which he charges
the New York bank a commission. The result is that we are paying tribute
to European bankers amounting to an immense sum annually for the purpose
of financing our imports.

The fact that London exchange is more marketable generally throughout
the world than New York exchange is one of the principal reasons why it
is necessary for us to issue credits upon London instead of upon New
York.

Our imports are distributed generally throughout the United States. The
importers, however, are mostly situated at the ports of entry. A very
large proportion of them obtain their credits through New York
institutions, although some of them deal direct with foreign bankers.

Probably a smaller proportion of our exports is financed by means of
commercial letters of credit than of our imports. Different commodities
are handled in accordance with special customs which have grown up
around them, due partly to trade conditions and partly to the nature of
the products. Sellers of grain usually draw at sixty days' sight upon
the foreign buyer instead of under a bank credit. These bills, under the
customs prevailing in most foreign countries, may be rebated by the
foreign buyer whenever he desires to obtain the goods at the "bank rate"
or 1 per cent. under the bank rate, or such other rate as custom in the
country on which the drafts are drawn requires. Such drafts, with bills
of lading and such other documents as are necessary, are purchased by
American banks and are forwarded by them to their European
correspondents. The American banker is obliged to advance the money on
such paper, unless he draws his own time bills against them, until such
time as they are rebated. In the case of grain bills the average time
rebated is probably around fifty-six days, which places the American
bank in possession of demand foreign exchange, against which it can draw
in order to reimburse itself with the loss of a very few days' interest.

Flour bills, which are financed in the same manner as grain bills,
usually run nearly to maturity before they are rebated, although the
condition of the discount market sometimes influences the purchaser, and
causes him to take the bills up more promptly. Many foreign shipments
are made under three-day sight bills, which uses the money of the
American banks making the advance from four to seven days or more,
depending upon whether the laws of the country on which the bills are
drawn allow grace or not and whether the bills are purchased with
intervening days before the sailing of steamers. Other classes of bills
are drawn at sight. This includes a portion of our lumber shipments and
miscellaneous articles. Where shipments are made on sailing vessels,
drafts are frequently drawn at four or six months' sight, and many other
transactions go through against cable payments.

As nearly 40 per cent. of our exports consist of cotton, the method
under which it is financed is worthy of special consideration. Cotton
bills are ordinarily of two kinds: documentary payment bills and bills
drawn upon bankers. Documentary payment bills, which are drawn upon
cotton merchants or spinners at sixty or ninety days' sight or other
tenors, are handled in the same manner as flour bills. The cotton
merchant accepts the draft upon presentation and rebates it when the
goods arrive, or when he desires to obtain the cotton. A small
percentage of cotton is handled in this way. Most of the commodity is
financed by means of credits opened by the foreign buyer through his
banker. Various abuses have developed under this system, which have
caused losses running into millions of dollars to all of the various
parties engaged in carrying the transactions to their close. These
losses have only been possible because of the turning over of credits by
the foreign buyers to irresponsible concerns in America in their
endeavor to obtain cotton at lower prices than their competitors. A
foreign buyer makes arrangements with certain American concerns to cable
him offers of cotton. The American firms whose offers are accepted
receive cablegrams from the buyer advising them of the acceptance of
their offers and giving them the names of the foreign bankers on whom
the drafts in payment of the cotton are to be drawn. The American
sellers thereupon ship the cotton to the buyer under bills of lading
drawn to the shipper's order and endorsed in blank. The bills of lading
are then attached to drafts drawn upon the bankers designated by the
buyer at the given tenor, which is usually sixty or ninety days. This
exchange is then sold in the market to the highest bidder or it is
forwarded to New York to be sold in the same manner upon arrival. The
American exchange buyers have no means whatever of designating whose
bills shall be upon the market, as the sellers are all agents of the
European buyers. The American exchange houses in their need for exchange
to meet the demands of their importers have accepted the bills offered
in the market, each exchange man endeavoring to keep his "water line" on
weak names as low as possible. If the European buyers only dealt with
first-class houses only first-class bills would be offered, but when
they deal with second- or third-rate houses, or houses with no standing
whatever, such bills drawn upon prime European banks come upon the
market.

The American exchange buyers having the cotton as collateral while the
drafts are on the water, and then having the acceptance of a prime
European bank for the sixty or ninety days following before maturity of
the draft, have accepted these risks, although unwillingly, for want of
better bills. They endeavor to protect themselves as far as possible by
trying to buy bills only of those in whose honesty they have reason to
believe, whether they have any capital back of them or not. If the
cotton were actually shipped under a bona fide order, any fluctuation in
the value of the cotton which they accepted as collateral, although
taken entirely without margin, would probably cause them neither loss
nor friction. They have run the risk, however, of having forged
documents forced upon them which did not represent goods, or exchange
that was drawn without authority. Lines which exchange buyers are
willing to take from each cotton shipper before acceptance, and before
the name of a prime European banker is added to the paper, have to be
based upon this consideration.

The old form of the cotton bill of lading which has been signed by
freight agents or their assistants or others has been an instrument not
possible to authenticate. This was particularly dangerous, due to the
manner in which bills of lading were issued. They were formerly given
out to the shippers, who filled them in and returned them to the
railroad agent, who in turn often signed them without having any
knowledge as to whether the goods called for by the bill of lading were
in his possession or not. Under a new system bills of lading are not to
be given up until the goods are actually in possession of the railroads.
This system, which calls for validation certificates, numbered and
printed upon a specially protected water-mark paper, to be attached to
the bills of lading in such manner as to make it practically impossible
to remove them without detection, went into effect September 1, 1910,
and it is confidently hoped that it will give sufficient added safety to
the bills of lading of American railroads to satisfy the foreign
bankers.

The very act of guaranteeing such bills is recognized by foreign bankers
as being wrong in principle, and while they are requesting that American
exchange buyers guarantee bills of lading for exports yet on the other
hand they particularly call attention to the fact that no bills of
lading which pass through their hands for imports to the United States
are guaranteed by them in any way, shape, or manner.

CREDIT RISKS OF DRAFTS DRAWN ON BUYERS ABROAD

[109]Many American manufacturers do not realize the essential "credit"
element of transactions on the basis of drafts drawn on _foreign
customers_.... The exporter has received an order; he purchases the
goods covered by this order from the manufacturer, and should the
customer change his mind the exporter may suffer a loss. Or the customer
refuses to accept the goods, and the exporter may again suffer a loss.
Or the customer may accept the goods and the draft, but fail to pay, and
the exporter once more is the loser....

... The turning over of the bill of lading vests the property right to
the goods in the customer. The customer either pays the value of the
draft in cash ("documents against payment," abbreviated d/p) or accepts
the draft for payment at some future date, which is the more customary
course ("documents against acceptance," d/a). Even in the case of d/p
drafts, payment by the customer may be postponed; instead of paying cash
he accepts the draft at one to three months, but neither the documents
nor the goods are turned over to him. He may want to wait until he has
sold the goods, on the basis of samples, perhaps, and the goods are
warehoused until he can pay the amount of the draft into the bank or to
the forwarding agency. This is frequently done in the Far East. Here the
banks maintain so-called "godowns" for this purpose. The goods are
occasionally turned over to the customer for warehousing purposes
against the so-called "trust receipt." One important feature of
"acceptance" of the draft by the customer is the fact that it forms an
acknowledgment of indebtedness, which it is then unnecessary to prove
item by item in case of litigation. In most countries acceptances are
far simpler to collect judicially than open accounts. When an accepted
draft is unpaid it is "protested," and the debtors may be proceeded
against without further trouble.

Frequently open accounts may be neglected by a customer who may find
himself for some reason short of immediately available funds, but to
neglect the payment of an accepted draft is regarded in the trade and by
banks as so serious a matter that the drawee would lose caste with the
banks; oversea buyers endeavor in most cases to honor accepted
drafts....

ENGLAND DRAWS FEW BILLS, BUT ACCEPTS MANY--THE REASON AND THE RESULT

[110]It has been shown that, if two countries buy of each other to the
same amount, their transactions need not give rise to two separate sets
of bills, but that on the contrary, if the foreigner draws on us to the
full value of his exports, the bills so created will be sent as
remittances to the exporter on this side and will pay him for his sales.
Conversely, if the British exporter draws, there is no necessity for the
other side to do so.

What, then, are the facts? Does the United Kingdom, generally speaking,
draw on abroad, or does the foreigner take the initiative by drawing on
London?

As a matter of fact, both sides draw; but, as all who are acquainted
with the customs of trade are well aware, the bills drawn by Great
Britain on abroad are vastly outnumbered by those drawn from abroad on
London.

Owing chiefly to the magnitude of our trade, but also to several
contributory causes--such as the stability of our currency; the
certainty that a bill on London means gold and nothing but gold; the
facility with which those who deserve credit can obtain it here; our
freedom from invasion, etc.--London has become to a great extent the
settling-place of Europe and the world, and the seller, wherever he may
be, of a good bill on London can always be sure of finding a buyer and
of realizing a fair price. As the sale of a bill, moreover, carries the
valuable advantage of ready money and a speedy turnover of capital, it
is invariably preferred by the foreign exporter, who has consigned or
sold produce to us, to the alternative plan of awaiting remittances from
this side. The foreign importer, too, who has to pay for the goods he
has bought, would rather do so by remitting to London than by allowing
us to draw upon him. In the former case, the rate he has to pay depends
upon his own success in higgling; in the latter, it is fixed by a London
bill-broker, who has not the same interest in the matter.

If the same considerations held good on this side also, our merchants
and manufacturers might perhaps object to letting the foreigner have it
all his own way; but, on the contrary, it appears to suit both buyers
and sellers very well--the former, because in the majority of cases they
would scarcely know how or where to buy suitable bills, and the latter,
because the drawing and negotiation of a foreign bill requires a certain
amount of knowledge of the exchanges, which they do not always possess,
and entails a certain amount of trouble, which they would gladly be
spared. There is also more risk of loss in drawing. In the latter case
they have only their correspondent to look to, while on a London
remittance they have the additional security of the other parties to the
bill.

Practically speaking, therefore, the settlement of our foreign trade is
effected by means of bills of exchange which are drawn and negotiated
abroad, and are accepted and paid in London.

To the student of the exchanges this fact is of considerable importance,
for, as the rate of exchange between two countries--the price at which
bills on the one are sold in the other--must be _fixed by the one that
draws and negotiates the bill_, it follows that the exchanges between
England and most other countries are controlled from the other side, and
that we in London have scarcely part or say in the matter. The rate of
exchange, for example, between England and the United States is fixed in
New York; between England and Brazil, in Rio; between England and
Turkey, in Constantinople; and so on. There may be exceptions, of which
the Indian exchange is the most notable, but that is the general rule,
and it is one that should be carefully borne in mind.

The same fact also supplies a reason for the solicitude with which the
foreign trader watches the fluctuations of the exchange, and for the
utter indifference with which they are regarded by the British trader.
To the former, who intends maybe to draw a few hundred pounds on London
in a day or two against the shipment he is preparing, the difference
between selling his draft next week instead of this may mean, if the
rate should move in his favor, the gain of an additional half per cent.;
but to our home manufacturers, who sell their wares in sterling and
stipulate for payment in bills on London, the see-saw of rates is but of
academic interest. They pay attention to the _course of discount_,
because they may have to melt some of their paper before pay-day comes
round; but the course of the exchange--the question of the rate rising
or falling--hardly concerns them at all.

It is not sought to detract from the influence of the English-drawn
foreign bill, or, as might be imagined, to explain it away altogether.
On the contrary, paper to a considerable amount is, and will continue to
be, negotiated on the Royal Exchange (though the total, if compared with
that of the paper on London negotiated abroad, would appear quite
insignificant).[111] The object in view is merely to bring into
prominence, and to impress on the reader, the essential principle that,
while the position of every rate of exchange is the outcome of the
market conditions _in the two countries combined_, the predominant mass
of the dealings take place on the other side, so that, as a consequence,
the real significance of the fluctuations can only be grasped by viewing
them from the foreign [_e. g._, American] standpoint.

THE RECENT RISE OF THE AMERICAN ACCEPTANCE MARKET

[112]Probably the most important effect at this time [1915] of the
Federal Reserve Act is the establishment of the American acceptance
market. It may well be said that heretofore America has had no real
money market. The only semblance of a money market previously existing
in this country was the call loan market of New York City. That,
however, did not truly reflect money conditions in this country, as it
has more often reflected the secondary effect of some movement of the
stock market.

The development of a real money market in this country was greatly
hampered by the lack of a standardized credit instrument. In every other
country the bank acceptance in which the element of credit risk has been
practically eliminated is the standard instrument of credit, and the
discount rate of such paper marks the level of the money market.

Bank acceptances were not known in this country prior to the operation
of the Federal Reserve Act. For the benefit of those who may not be
familiar with bank acceptances, I will briefly describe an operation
giving rise to such acceptances. Jones, an importer of coffee in New
York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes
to his bank in New York and arranges with them to finance the deal.
Smith, the grower of the coffee in Brazil, makes the shipment to New
York and draws a ninety days' sight draft on the New York bank for the
amount of his invoice. This draft he then sells to some Brazilian
bank.... The Brazilian bank then sends the draft to New York. It is
there presented to the New York bank for acceptance. The New York bank
accepts the draft by writing the word "accepted" across the face of the
draft and affixing its official signature thereto. The draft now becomes
the primary obligation of the New York bank. Of course, Jones, for whose
account the New York bank accepted the draft, has obligated himself to
provide the New York bank with funds to meet the draft, but if he
should fail to do so the New York bank must pay the acceptance
nevertheless. It is, therefore, the direct obligation of the New York
bank, and as such it commands the best discount rates current. This
briefly is what is known as a bank acceptance, _i. e._, a draft drawn on
and accepted by a prime bank or banker.

Although this business is still in its infancy, it has reached important
proportions and there is an active market for them in New York City. A
number of brokers have taken up the business of buying and selling
acceptances. Every morning they make the rounds of the various banks
with the list of the acceptances they have for sale and the rates at
which they are willing to sell them. Incidentally, they also learn
whether the banks have any acceptances for sale and at what rates. As
the credit risk is practically eliminated, acceptances are a very
attractive form of secondary reserve; they are, as a London banker once
expressed it, a means of enabling the banker to eat his cake and have it
too--the banker by investing his money in acceptances earns the discount
and at the same time he knows that his money is instantly available in
case of need, so that they are almost as available as cash. This
explains why the discount rate on acceptances ranges so low. Ninety
days' sight acceptances sold in New York City at one time as low as 2
per cent. per annum and to-day prime acceptances command the excellent
rate of 2-3/8 per cent.

THE ECONOMIES AND ADVANTAGES OF "DOLLAR CREDITS"[113]

Many radical changes in the mechanism of international finance have
occurred during the past fifteen months, since the beginning of the
European war. Not the least important among these changes, viewed from
the standpoint of the American importer, is the evolution in the methods
of financing our importations.

Our imports in the way of commodities such as hides, coffee, rubber,
wool, etc., etc., run into hundreds of millions of dollars annually, and
these are financed generally through the medium of commercial credits
established by the purchaser in favor of the vendor of the merchandise.
Commercial credits, so called, are in effect a bank guarantee to the
seller that his drafts covering certain merchandise, when drawn in
accordance with the conditions prescribed in the credit, will meet with
due honor on presentation to the accepting bank named in the credit
instrument.

In order merely to gain an idea as to the importance and volume of such
transactions, it is only necessary to glance at the totals of a few of
our principal imports. In the year 1914 we imported, among other
commodities, the following:

Hides and skins $120,289,781.00
Coffee 110,725,392.00
Rubber 131,995,742.00
Wool (unmanufactured) 53,190,767.00

Prior to the outbreak of the war in Europe, it is safe to assume that
fully 95 per cent. of the credits issued to cover these importations
were passed through London in the form of sterling credits; that is to
say, credits available by drafts drawn in pounds sterling on London.
Requests for the issuance of credits available by drafts drawn in United
States dollars on New York were extremely rare, and they were issued
only in exceptional cases.

Conditions have changed materially in this respect. The Federal Reserve
Act grants to national banks the privilege of accepting drafts or bills
of exchange growing out of transactions involving the importation or
exportation of goods. This acceptance privilege was accorded to national
banks only a short time before the commencement of hostilities abroad,
and this fact in conjunction with the resulting dislocation in the
delicate machinery of international credit brought about by the war,
together with the coincidental establishment of American branch banks in
South America, has contributed in a large measure to bring about the use
of what is known now as "Dollar Credits."

As a factor in creating the existing demand for Dollar Credits, the
establishment of American branch banks abroad cannot be emphasized too
strongly. Through these branch banks, a new and adequate medium for the
liquidation of transactions as between the United States and certain
South American countries, especially the Argentine, Brazil, and Uruguay,
has been placed at the disposal of our merchants. A direct channel is
now open to the ebb and flow of credit transfer between the United
States and the countries mentioned, and, as a natural sequence, the
former disparity existing against the dollar, as compared with pounds
sterling and the principal continental exchanges, has disappeared. The
resulting equalization in the rates of exchange benefits the American
merchant to the extent of relieving him of the tribute formerly paid to
the indirect channels of liquidation, or, in other words, to the foreign
banker.

The Dollar Credit is of capital importance to every American merchant
who is interested either directly or indirectly in the importation of
commodities of any character. A study of the advantages accruing from
this form of credit will demonstrate the desirability of its general
employment as the vehicle for financing not only our own imports but
also those of other countries. Primarily, it is more economical than the
Sterling or Continental Credit, for the initial commission cost of
issuance is lower. Secondly, it is based on a known quantity, the
dollar, a factor of supreme importance in these days of extreme and
violent fluctuations in the exchange rates, and therefore all exchange
risk is eliminated from the operation as far as the importer is
concerned. Maturities drawn under Dollar Credits are due and payable in
dollars on a given date, and no question arises as to what the exchange
rate on London may be ninety days after acceptance of the bill.

Under existing conditions in the New York money market, and considering
the present low rates of interest actually in effect, the use of Dollar
Credits is proving to be particularly attractive to the American
importer as the medium for financing his importations. The rate of
discount in New York for prime bank acceptances is 2-1/8@2-1/4 per cent.
per annum, and a broad, well-developed discount market now exists, with
an ever-increasing demand in evidence for this class of paper. On the
other hand, the rate of discount in London for prime ninety-day bills
is 4-3/4 per cent. per annum, with operations restricted in a far from
normal market. A comparison of these two discount rates will show a
difference in favor of New York of 2-1/2@2-5/8 per cent. per annum. In
addition to this difference in interest, there is also a difference in
the initial cost in the form of commission for issuance, as between
credits available by ninety-day drafts drawn on New York in dollars and
those available by ninety-day drafts drawn on London in pounds sterling.
This difference in commission in favor of New York will average 1/2 per
cent. per annum, and when added to the saving in discount or interest
already noted, will show a net saving on the Dollar Credit of 3@3-1/8
per cent. per annum, which accrues to the importer through the use of
Dollar Credits in his operations.

Quite apart from the direct economy to the individual resulting from the
use of Dollar Credits, is the broader question of the economic value
accruing to the nation as a whole through the designation of the dollar
as the basis of value in our credit transactions with the rest of the
world. Since 1903, when the total of our imports amounted to
$1,025,719,237, the volume of our imports has increased rapidly, and in
1914, the total imports reached the enormous sum of $1,893,925,657.
These figures cover products from all parts of the world shipped direct
to our own shores, and while no nation enjoys higher international
credit than the United States, yet it is a fact that in order to finance
the movement of our imports we have been compelled to have recourse to
indirect channels and call on foreign money centers to furnish us with
the necessary credit facilities to take care of a large part of our
importations. Naturally, we have been obliged to pay for this
accommodation, and the service has cost us millions of dollars annually
in interest, commissions, etc.

These charges can be saved and an important economy effected, thus
benefiting our commerce as a whole by the general designation of dollars
in our foreign credit transactions. The purchasing power of the dollar
in foreign markets is much greater to-day than it is in normal times
because of the varying premium which the dollar commands at present
practically throughout the world. The time is unquestionably opportune
to increase the prestige of the dollar and to standardize its use in the
liquidation of our direct purchases abroad. Co-operation and concerted
action on the part of our merchants to the end of generalizing the use
of Dollar Credits is therefore a duty, which will bring about lasting
benefit to the economic fabric of our commerce.

THE NEW YORK FOREIGN EXCHANGE MARKET[114]

A market may be defined as the coming together of buyers and sellers. It
therefore involves all the mechanism necessary to facilitate their
intercourse. One may speak of a general market or of a local market, of
a market in one or in another place. Thus, there is the New York market
for the buying and selling of exchange on London. A bank in New Haven,
Connecticut, may be a part of that market if it buys from and sells to
it. That market includes, besides the commercial and industrial
organizations which buy or sell drafts, all middlemen of whatever class
who engage in the trade.

The middlemen may be divided roughly into three classes. First may be
mentioned banks which do a regular foreign exchange business, buying
bills from those who have them to sell and selling their own drafts on
foreign correspondents to persons desiring to remit. Much of this
business is done by foreign exchange banks which carry on little or no
other business. Some of it is done by ordinary commercial banks, such as
United States National Banks, in addition to their other banking
business. Second, we may call attention to those exchange dealers whose
principal business is to buy commercial and bankers' bills, and to
resell them, chiefly to banks. Third are the independent brokers who
make small commissions by bringing buyers and sellers together. These do
not invest their own capital, do not, that is, buy bills of exchange in
the market, but assist those desiring to sell bills to find buyers, and
_vice versa_....

NEW YORK CITY PRACTICALLY ABSORBS BY PURCHASE ALL AMERICAN FOREIGN
EXCHANGE

[115]There is, perhaps, no feature pertaining to banking throughout the
country so dependent upon New York financiers, as foreign exchange. The
very foundation of this branch of banking is constructed by the New York
bankers, and from their banking houses emanate the basic prices and
quotations upon which foreign bills are bought and sold throughout the
United States.

It is the custom of New York foreign exchange brokers to furnish their
Western clients, direct, or through their local representatives, daily
market quotations, and to promptly advise them of fluctuations
throughout the day. So closely is the West allied to the East, in this
respect, that any interruption caused by delayed or suspended
telegraphic service, immediately superinduces a practical standstill of
exchange transactions, and operations thereafter must necessarily be
made in the "dark" until free communication is again renewed between the
cities....

The absorptive power of the New York market, to digest not only the
surplus foreign exchange of the Chicago market, but that of the entire
United States as well, has been demonstrated for many years. The reason
for this can be attributed to the fact that international trade balances
are at the present day, and always will be, adjusted by the financiers
of New York City.

HOW MONEY IS MADE IN FOREIGN EXCHANGE--THE OPERATIONS OF THE FOREIGN
DEPARTMENT

[116]Complete description of the various forms of activity of the
foreign exchange department of an important firm would fill a large
volume, but there are certain stock operations in foreign exchange which
are the basis of most of the transactions carried out and the
understanding of which ought to go a long way toward making clear what
the nature of the foreign exchange department's business really is.

I. SELLING "DEMAND" AGAINST "DEMAND"

The first and most elementary form of activity is, of course, the buying
of demand bills at a certain price and the selling of the banker's own
demand drafts against them at a higher price. A banker finds, for
instance, that he can buy John Smith & Co.'s sight draft for £1,000, on
London, at the rate of 4.86, and that he can sell his own draft for
£1,000 on his London banking correspondent at 4.87. All he has to do,
therefore, is to buy John Smith's draft for $4,860, send it to London
for credit of his account there, and then draw his own draft for £1,000
on the newly created balance, selling it for $4,870. It cost him $4,860
to buy the commercial draft, and he has sold his own draft against it
for $4,870. His gross profit on the transaction, therefore, is $10.

As may be imagined, not very much money is made in transactions exactly
of this kind--the one cited is taken only because it illustrates the
principle. For whether the banker sends over in every mail a bewildering
assortment of every conceivable form of foreign exchange to be credited
to his account abroad, or whether he confines himself to remittances of
the simplest kind of bills, the idea remains exactly the same--he is
depositing money to the credit of his account in order that he may have
a balance on which he can draw. That is, indeed, the sum and substance
of the exchange business of the foreign department of most banking
houses--the maintaining of deposit accounts in banks at foreign centres
on which deposit account the bank here is in a position to draw
according to the wants and needs of its customers.

II. SELLING CABLES AGAINST DEMAND EXCHANGE

A "cable," so-called, differs from a sight draft only in that the banker
abroad who is to pay out the money is advised to do so by means of a
telegraphic message instead of by a bit of paper instructing him to "pay
to the order of so and so."

Under ordinary circumstances foreign exchange dealers who engage in the
business of selling cables carry adequate balances on the other side,
balances which they keep replenishing by continuous remittances of
demand exchange.

III. SELLING "DEMAND" BILLS AGAINST REMITTANCES OF LONG BILLS

If there is a stock operation in the conduct of a foreign exchange
business it is the selling by bankers of their demand bills of exchange
against remittances of commercial and bankers' long paper. Bills of the
latter class make up the bulk of foreign exchange traded in, and its
disposal naturally is the most important phase of foreign exchange
business. What the foreign exchange business really is grounded on is
the existence of commercial bills called into existence by exports of
merchandise.

Buying and remitting commercial long bills is no pastime for an
inexperienced man. Entirely aside from the question of rate, and profit
on the exchange end of the transaction, there must be taken into
consideration the matter of the credit of the drawer and the drawee, the
salability of the merchandise specified in the bill of lading, and a
number of other important points.

Where documents accompany the draft and the merchandise is formally
hypothecated to the buyer of the draft, it might not be thought that the
standing of the drawer would be of such great importance. Possession of
the merchandise, it is true, gives the banker a certain form of security
in case acceptance of the bill is refused by the parties on whom it is
drawn or in case they refuse to pay it when it comes due, but the
disposal of such collateral is a burdensome and often expensive
operation. The banker in New York who buys a sixty-day draft drawn
against a shipment of butter is presumably not an expert on the butter
market and if he should be forced to sell the butter, might not be able
to do so to the fullest possible advantage. Employment of an expert
agent is an expensive operation, and, moreover, there is always the
danger of legal complication arising out of the banker's having sold the
collateral. It is desirable in every way that if there is to be any
trouble about the acceptance or payment of a draft, the banker should
keep himself out of it.

The successive steps in an actual transaction are as follows:

The banker in New York having ascertained by cable the rate at which
bills "to arrive" in London by a certain steamer will be discounted,
buys the bills here and sends them over, with instructions that they be
immediately discounted and the proceeds placed to his credit. On this
resulting balance he will at once draw his demand draft and sell it in
the open market. If, from selling this demand draft, he can realize more
dollars than it cost him in dollars to put the balance over there, he
has made a gross profit of the difference.

To illustrate more specifically: A banker has bought, say, a £1,000
ninety days' sight prime draft, on London, documents deliverable on
acceptance. This he has remitted to his foreign correspondent, and his
foreign correspondent has had it stamped with the required "bill-stamp,"
has had it discounted, and after having taken his commission out of the
proceeds, has had them placed to the credit of the American bank. In all
this process the bill has lost weight. It arrived in London as £1,000,
but after commissions, bill-stamps, and ninety-three days' discount have
been taken out of it, the amount is reduced well below £1,000. The net
proceeds going to make up the balance on which the American banker can
draw his draft are, perhaps, not over £990. He paid so-and-so many
dollars for the £1,000 ninety-day bill, originally. If he can realize
that many dollars by selling a demand draft for £990 he is even on the
transaction.

IV. THE OPERATION OF MAKING FOREIGN LOANS

In its influence upon the other markets, there is perhaps no more
important phase of foreign exchange than the making of foreign loans in
the American market. The mechanics of these foreign loaning operations,
the way in which the money is transferred to this side, etc., will now
be taken up.

To begin at the very beginning, consider how favorable a field is the
American market for the employment of Europe's spare banking capital.
Almost invariably loaning rates in New York are higher than they are in
London or Paris. This is due, perhaps, to the fact that industry here
runs on at a much faster pace than in England or France, or it may be
due to the fact that we are a newer country, that there is no such
accumulated fund of capital here as there is abroad. Such a hypothesis
for our own higher interest rates would seem to be supported by the fact
that in Germany, too, interest is consistently on a higher level than in
London or Paris, Germany, like ourselves, being a vigorous industrial
nation without any very great accumulated fund of capital saved by the
people. But whatever the reason, the fact remains that in New York money
rates are generally on so much more attractive a basis than they are
abroad that there is practically never a time when there are not
hundreds of millions of dollars of English and French money loaned out
in this market. All through the past ten years London has at various
times opened her reservoirs of capital and literally poured money into
the American market.

To take up the actual operation of loaning foreign money in the American
market, suppose conditions to be such that an English bank's managers
have made up their minds to loan out £100,000 in New York--not on joint
account with the American correspondent, as is often done, but entirely
independently. Included in the arrangements for the transaction will be
a stipulation as to whether the foreign bank loaning the money wants to
loan it on the basis of receiving a commission and letting the borrower
take the risk of how demand exchange may fluctuate during the life of
the loan, or whether the lender prefers to lend at a fixed rate of
interest, say 6 per cent., and himself accept the risk of exchange.

What the foregoing means will perhaps become more clear if it is
realized that in the first case the American agent of the foreign lender
draws a ninety days' sight sterling bill for, say, £100,000 on the
lender, and hands the actual bill over to the parties here who want the
money. Upon the latter falls the task of selling the bill, and, ninety
days later, when the time of repayment comes, the duty of returning a
_demand_ bill for £100,000, plus the stipulated commission. In the
second kind of a loan the borrower has nothing to do with the exchange
part of the transaction, the American banking agent of the foreign
lender turning over to the borrower not a sterling draft but the dollar
proceeds of a sterling draft. How the exchange market fluctuates in the
meantime--what rate may have to be paid at the end of ninety days for
the necessary demand draft--concerns the borrower not at all. He
received dollars in the first place, and when the loan comes due he pays
back dollars, plus 4, 5, or 6 per cent., as the case may be. What rate
has to be paid for the demand exchange affects the banker only, not the
borrower.

Loans made under the first conditions are known as sterling, mark, or
franc loans; the other kind are usually called "currency loans." At the
risk of repetition, it is to be said that in the case of sterling loans
the borrower pays a flat commission and takes the risk of what rate he
may have to pay for demand exchange when the loan comes due. In the case
of a currency loan the borrower knows nothing about the foreign exchange
transaction. He receives dollars, and pays them back with a fixed rate
of interest, leaving the whole question and risk of exchange to the
lending banker.

To illustrate the mechanism of one of these sterling loans. Suppose the
London Bank, Ltd., to have arranged with the New York Bank to have the
latter loan out £100,000 in the New York market. The New York Bank draws
£100,000 of ninety days' sight bills, and, satisfactory collateral
having been deposited, turns them over to the brokerage house of Smith &
Jones, the borrowers. Smith & Jones at once sell the £100,000, receiving
therefor, say, $484,000.

The bills sold by Smith & Jones find their way to London by the first
steamer, are accepted and discounted. Ninety days later they will come
due and have to be paid, and ten days prior to their maturity the New
York Bank will be expecting Smith & Jones to send in a _demand_ draft
for £100,000, plus 3/8 per cent. commission, making £375 additional.
This £100,375 less its commission for having handled the loan, the New
York Bank will send to London, where it will arrive a couple of days
before the £100,000 of ninety days' sight bills originally drawn on the
London Bank, Ltd., mature.

What each of the bankers concerned makes out of the transaction is plain
enough. As to what Smith & Jones' ninety-day loan cost them, in addition
to the flat 3/8 per cent. they had to pay, that depends upon what they
realize from the sale of the ninety days' sight bills in the first place
and secondly on what rate they had to pay for the demand bill for
£100,000. Exchange may have gone up during the life of the loan, making
the loan expensive, or it may have gone down, making the cost very
little. Plainly stated, unless they secured themselves by buying a
"future" for the delivery of a £100,000 demand bill in ninety days at a
fixed rate, Messrs. Smith & Jones have been making a mild speculation in
foreign exchange.

If the same loan had been made on the other basis, the New York Bank
would have turned over to Smith & Jones not a _sterling bill_ for
£100,000, but the _dollar proceeds_ of such a bill, say a check for
$484,000. At the end of ninety days Smith & Jones would have had to pay
back $484,000, plus ninety days' interest at 6 per cent., $7,260, all of
which cash, less commission, the New York Bank would have invested in a
demand bill of exchange and sent over to the London Bank, Ltd. Whatever
more than the £100,000 needed to pay off the maturing nineties such a
demand draft amounted to, would be the London Bank, Ltd.'s profit.

From all of which it is plainly to be seen that when the London bankers
are willing to lend money here and figure that the exchange market is on
the down track, they will insist upon doing their lending on the
"currency loan" basis--taking the risk of exchange themselves.
Conversely, when loaning operations seem profitable but rates seem to be
on the upturn, lenders will do their best to put their money out in the
form of "sterling loans." Bankers are not always right in their views,
by any means, but as a general principle it can be said that when big
amounts of foreign money offered in this market are all offered on the
"sterling loan" basis, a rising exchange market is to be expected.

From what has been said about the mechanism of making these foreign
loans, it is evident that no transfer of cash actually takes place, and
that what really happens is that the foreign banking institution lends
out its credit instead of its cash. For in no case is the lender
required to put up any money. The foreign lender is at no stage out of
any actual capital, although it is true, of course, that he has
obligated himself to pay the drafts on maturity, by "accepting" them.

Where, then, is the limit of what the foreign bankers can lend in the
New York market? On one consideration only does that depend--the amount
of accepted long bills which the London discount market will stand. For
all the ninety days' sight bills drawn in the course of these transfers
of credit must eventually be discounted in the London discount market,
and when the London discount market refuses to absorb bills of this kind
a material check is naturally administered to their creation.

V. THE DRAWING OF FINANCE-BILLS

Approaching the subject of finance-bills, the author is well aware that
concerning this phase of the foreign exchange business there is a wide
difference of opinion. Finance-bills make money, but they make trouble,
too. Their existence is one of the chief points of contact between the
foreign exchange and the other markets, and one of the principal reasons
why a knowledge of foreign exchange is necessary to any well-rounded
understanding of banking conditions.

Strictly speaking, a finance-bill is a long draft drawn by a banker of
one country on a banker in another, sometimes secured by collateral, but
more often not, and issued by the drawing banker for the purpose of
raising money. Such bills are not always distinguishable from the bills
a banker in New York may draw on a banker in London in the operation of
lending money for him, but in nature they are essentially different.
Whether or not any collateral is put up, the whole purpose of the
drawing of finance-bills is to provide an easy way of raising money
without the banker here having to go to some other bank to do it.

The origin of the ordinary finance-bill is about as follows: A bank here
in New York carries a good balance in London and works a substantial
foreign exchange business in connection with the London bank where this
balance is carried. A time comes when the New York banking house could
advantageously use more money. Arrangements are therefore made with the
London bank whereby the London bank agrees to "accept" a certain amount
of the American banker's long bills, for a commission. In the course of
his regular business, then, the American banker simply draws that many
more pounds sterling in long bills, sells them, and for the time being
has the use of the money. In the great majority of cases no extra
collateral is put up, nor is the London bank especially secured in any
way. The American banker's credit is good enough to make the English
banker willing, for a commission, to "accept" his drafts and obligate
himself that the drafts will be paid at maturity. Naturally, a house has
to be in good standing and enjoy high credit not only here but on the
other side before any reputable London bank can be induced to "accept"
its finance paper.

The ability to draw finance-bills of this kind often puts a house
disposed to take chances with the movement of the exchange market into
line for very considerable profit possibilities. Suppose, for instance,
that the manager of a house here figures that there is going to be a
sharp break in foreign exchange. He, therefore, sells a line of
ninety-day bills, putting himself technically short of the exchange
market and banking on the chance of being able to buy in his "cover"
cheaply when it comes time for him to cover. In the meantime he has the
use of the money he derived from the sale of the "nineties" to do with
as he pleases, and if he has figured the market aright, it may not cost
him any more per pound to buy his "cover" than he realized from the sale
of the long bills. In which case he would have had the use of the money
for the whole three months practically free of interest.

It is plain speculating in exchange--there is no getting away from it,
and yet this practice of selling finance-bills gives such an opportunity
to the exchange manager shrewd enough to read the situation aright to
make money, that many of the big houses go in for it to a large extent.
During the summer, for instance, if the outlook is for big crops, the
situation is apt to commend itself to this kind of operation. Money in
the summer months is apt to be low and exchange high, affording a good
basis on which to sell exchange. Then, if the expected crops
materialize, large amounts of exchange drawn against exports will come
into the market, forcing down rates and giving the operator who has
previously sold his long bills an excellent chance to cover them
profitably as they come due.

VI. ARBITRAGING IN EXCHANGE.

Arbitraging in exchange--the buying by a New York banker, for instance,
through the medium of the London market, of exchange drawn on Paris--is
another broad and profitable field for the operations of the expert
foreign exchange manager. Take, for example, a time when exchange on
Paris is more plentiful in London than in New York--a shrewd New York
exchange manager needing a draft on Paris might well secure it in London
rather than in his home city.

Between such cities rates are not apt to be wide enough apart to afford
a wide margin of profit, but the chance for arbitraging does exist and
is being continuously taken advantage of. So keenly, indeed, are the
various rates in their possible relation to one another watched by the
exchange men that it is next to impossible for them to "open up" to any
appreciable extent. The chance to make even a slight profit by shifting
balances is so quickly availed of that in the constant demand for
exchange wherever any relative weakness is shown, there exists a force
which keeps the whole structure at parity. The ability to buy drafts on
Paris relatively much cheaper at London than at New York, for instance,
would be so quickly taken advantage of by half a dozen watchful exchange
men that the London rate on Paris would quickly enough be driven up to
its right relative position. If a chance exists to sell a draft on
London and then to put the requisite balance there through an
arbitration involving Paris, Brussels, and Amsterdam, the chances are
that there will be some shrewd manager who will find it out and put
through the transaction. Some of the larger banking houses employ men
who do little but look for just such opportunities.

The foregoing are the main forms of activity of the average foreign
department, though there are, of course, many other ways of making money
out of foreign exchange.

GOLD MOVEMENTS

[117]When there is a heavy demand for exchange and little supply, the
price of exchange gradually advances. The banker, called on by his
customers to draw exchange for them, finding few bills in the market
that he can remit to cover his drafts, sends gold and directs its
equivalent in foreign coin to be placed to his credit, and against this
credit he draws. There may be no market abroad for our crops or
manufactures; but gold need not be sold in order to produce money; it
need only be coined. As this process can be carried on indefinitely, the
cost of sending gold is obviously the limit beyond which the price of
demand bills cannot advance. Let us follow this transaction in detail.
The pure gold contained in one English sovereign is exactly equal to the
pure gold contained in $4.8665 of our gold coins; so that, apart from
charges and expenses, $4.8665 of our gold will, when sent abroad,
produce a credit of £1; to this cost must be added freight, insurance,
and other expenses, amounting to about one-fourth of 1 per cent. This
brings the cost of £1 through shipment of gold to about $4.88, which is,
roughly, the gold export point for full weight coin. The exporting
banker obtains his gold either by drawing gold coin from his bank or
else by drawing suitable currency from his bank, and obtaining gold coin
for it at the subtreasury. In either case, he obtains coin that has
suffered more or less abrasion by handling, and this loss of weight by
abrasion, amounting to perhaps one-tenth of 1 per cent., increases the
cost of his remittance. Generally, however, the banker can obtain gold
bars from the United States Assay Office at the nominal charge of one
twenty-fifth of 1 per cent., although at times a larger charge is made.
The banker prefers bars, because on these there is no loss by abrasion;
the Government can afford to give bars, because their export prevents
the export of coin, and so saves the cost of coining new money to
replace that shipped.

Now for gold import. When there is a large volume of bills offered to
bankers, perhaps by grain and cotton exporters, and but little demand
from buyers of exchange, the market gradually declines in price, while
New York bankers, sending abroad the bills they buy, with little
occasion to draw against them, accumulate large sums to their credit in
London, with no way of getting the money back to New York through
operations in the exchange market. They are not, however, helpless; they
can order gold sovereigns sent here, and, once here, can have them
melted down at the United States Assay Office and coined into eagles and
double eagles, which they can deposit with their banks. Obviously, the
amount received in dollars for each melted sovereign will mark the price
the banker can afford to pay for sterling bills, and competition among
bankers will prevent the rate of exchange from declining below this
point by more than a fair margin of profit. The British sovereign, if
full weight, will, when sent here and melted down, yield gold for which
the United States Assay Office will pay $4.8665; the expense of sending
the sovereign, freight, insurance, cartage, and kegs, will amount to
about one quarter of 1 per cent., so that the net yield of the full
weight sovereign in dollars will be $4.85-3/8. But between the day on
which the banker buys the bill of exchange in New York and the day on
which he receives in New York the gold which the bill entitled him to
collect in London, there must elapse the time needed to send the bill to
London, plus the time needed to send the gold back (roughly fifteen
days), during which period the banker loses the use of the money. This
loss of interest must be deducted from the net yield of the imported
sovereign, and thus, if money is worth 6 per cent. per annum, the net
yield of full weight sovereigns is brought down to about $4.84-1/4,
which is the gold import point for demand exchange, when money is worth
6 per cent. per annum. Losses by abrasion will bring down this point by
perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is
higher, the import point will be lower, and _vice versa_. There is
therefore a margin of profit in buying demand bills and importing gold
sovereigns against the purchase, whenever the rate for demand bills
falls below the gold import point. Active exchange bankers take
advantage of this profit whenever exchange prices decline to the proper
point, and their competition in buying bills to cover their gold
importations stops further decline in exchange rates. It is interesting
to note that during the recent crisis, when gold and currency were at a
premium, bankers could sell the imported gold at a premium, and this
constituted an additional and very large profit; gold importers could
therefore pay higher prices than ordinarily for exchange bought to cover
the importations, and the stress of competition so drove up the rate of
exchange that gold was being imported at a profit, though exchange rates
stood at what, under ordinary circumstances, would have been the gold
export point.

Gold is, however, not always imported from England in the form of
sovereigns. The Bank of England has in its vaults large quantities of
American eagles and double eagles exported to England in the past and
held without melting. The bank also holds foreign coin and bar gold. Any
holder of Bank of England notes can get sovereigns on demand--other gold
he can get only as the result of a special bargain. When gold is wanted
for export, the bank is often glad to sell bar gold or double eagles at
rates somewhat more advantageous to the exporter than would be the
export of sovereigns; this the bank can afford to do, for the expense
of coining sovereigns to replace those exported is thus saved, while
the exporter, if he can get bar gold on the same basis as sovereigns,
avoids the losses of abrasion. Eagles are even more advantageous to
the exporter, for they are bought in England by weight and used in
America by count; the banker therefore gets an advantage if they are
light, so long as that lightness is not so great as to make them
uncurrent--practically he buys them as light and uses them as full
weight....

The mechanism of gold import to, and export from, Germany is practically
the same as with England, the Reichsbank being required to give gold
coin in exchange for its circulating notes. At times, however, German
exchange has fallen below the theoretical gold import point, owing, not
to the refusal of the Reichsbank to give gold, but to the practical
obstacles that at times are somehow placed in the way of free export of
gold. The Reichsbank does not refuse gold for its bank-notes, but
German bankers say to their correspondents: "Don't ask us to get gold
for you, or we shall lose caste," and on such occasions German exchange
rates drop to a point that is theoretically impossible. I do not mean to
criticise them: German banks, when they refuse to demand gold of the
Reichsbank, do no more than our own banks and bankers did recently, when
asked by foreign correspondents to collect in gold the maturing
obligations of railroads and other corporations. As will be remembered,
clearing-house funds rather than cash were at that time current here,
and New York banks and bankers sent to their foreign correspondents the
same answer as the Germans have at times sent us. I cite the German
instance in partial mitigation of censure of our own course rather than
as a reproach to them.

The Bank of France is not compelled to give gold in exchange for its
circulating notes; it may at its option give silver. Thus, when it is
inconvenient to give gold, the bank can refuse, or, if it prefers, it
can exact a premium. This power has been very moderately and very wisely
used by the bank to modify foreign demands on the one hand, and, on the
other, to keep interest rates low for the requirements of internal
trade. Of course, when a premium is exacted, the French gold import
point drops accordingly.

Between the gold export point and the gold import point, exchange
fluctuates under the sway of conflicting currents and tendencies--I had
almost said emotions, for these currents and tendencies have their rise
in emotions, needs, and passions as varied as life itself, whether they
be hunger as expressed in the grain bill, or love of elegance in the
importation of silk, or forethought in the profitable investment of
capital.

This brief review will have made clear what is meant by a free gold
market--a market in which current money can at all times be exchanged
for gold without delay and without premium. Such a market has great
commercial advantages; its stability draws business to it. London is
such a market, and its commercial and financial pre-eminence is in great
measure due to that fact. Paris is not such a market and does not
pretend to be; Berlin pretends to be, but cannot always be counted on;
New York was believed to be before our recent panic.

I have spoken of the exchange market as an economical mechanism,
automatically making delicate international adjustments. In
justification of that observation, let me direct attention to the manner
in which gold, in moving from financial centre to financial centre,
always travels by the most direct route, and that, too, not because some
public official is charged with the duty of preventing waste, but
because a private trader is trying to make a profit, and is incidentally
serving the community; serving it perhaps better than if he had
consciously determined to serve it.

Useful acts springing from self-interest have one very comforting
aspect--we need have no misgivings as to their continuance. Charity may
grow weary or disgusted, but self-interest, once enlisted, may be
counted on to continue in operation, whether it be the business man's
self-interest in a profit or the professional man's self-interest in
advancement and fame. Of course, both the business man and the
professional man, in addition to seeking the direct rewards of their
labor, take an interest in their work as work and make it yield them
pleasure.

It is therefore satisfactory to know that, so long as the banker looks
after his profits, gold will move by the most direct route. Let us
suppose the United States to be exporting a large quantity of cotton to
England at a time when little merchandise is being imported here from
England, but when much is being imported from France. If the volume of
exports to England and of imports from France were large enough, we
might conceivably be importing gold from England in payment of our
produce, and exporting it to France in payment for her luxuries; but, in
practice, gold does not move that way. Every morning, the New York
exchange banker learns by cable the Paris market rate for demand bills
on London. When, therefore, he finds a large volume of bills on London
offered for sale, and little demand for such bills, while there is large
demand for bills on Paris and little supply, he determines, instead of
drawing from New York against his purchases of London bills, to let his
Paris agent draw against these purchases, placing the proceeds to his
credit in Paris; against this credit in Paris, the New York banker draws
his bill in francs, having thus supplied via London the New York demand
for bills on Paris. He knows how many dollars each pound sterling costs
him in New York, and the Paris rate for bills on London tells him how
many francs each pound sterling will net him in Paris, and so he can
calculate how many cents each franc will cost him. Moreover, he is not
the only banker in New York that receives cable quotations; and so with
a large volume of London bills offered and little direct demand for such
bills, and large demand for Paris bills with little direct supply, we
get a situation where New York bankers, competing with each other to buy
the London bills for use via Paris, prevent the price of sterling from
falling to the gold import point; and then, as a result, these same
bankers, competing with each other to supply the demand for Paris bills,
by their competition prevent the Paris rate from rising to gold export
point. Lastly, they compete with each other in Paris, where all are
sellers of bills on London against their New York purchases of London
bills, and by that competition they reduce the rate for London bills in
Paris to the point, at which, other things being equal, gold will go
from London to Paris. What has happened, therefore, is that instead of
our importing gold from London, and then exporting it to Paris, it has
gone direct from London to Paris.

COMPLICATIONS IN THE DETERMINATION OF GOLD POINTS

[118]It is safe to assert that when the exchanges go down to the point
at which it pays better to ship gold from London than to buy a bill,
gold will go. But in the first place, experts always differ as to where
that point begins; and in the second, gold often leaves London long
before there is any question of its being the more profitable form of
remittance. In fact, it may be asserted that the foreign exchanges very
seldom go down to the export gold point, because gold begins to go
before they can get there.

It has often happened to me, when I was a financial journalist and had
to try to find out the how and why of gold movements, to ask several of
the most experienced and well-informed cambists in the city whether a
gold shipment which had taken place had been made as a genuine exchange
transaction or was done for some other reason, and to hear from one that
there was a reasonable exchange profit on it, from another that there
might be just a shade of a turn to be got out of it if you scraped it
very hard with a knife, and from another that you could not find a
particle of profit in it if you put it under a microscope for a week. So
many complications have to be considered that the most eminent doctors
may be pardoned for disagreeing.

It may be objected that dealers in exchange, and the comparatively few
firms that make a special study of gold shipping, are not in the
business for their health, and that shipments would not happen if there
were not some profit in them. This is perfectly true, but the profit
need not be got from the exchange. As an exchange transaction it only
pays to ship gold to America when bills on London can only be sold in
New York at a lower price than gold would fetch if brought from London
and exchanged into dollars in New York. If bills on London are selling
at 4.83-3/4, and gold can be bought and shipped and turned into dollars
at the rate of 4.83-7/8, after allowing for all charges and commissions
and the loss of interest during transit, then the operation pays as an
exchange transaction. If the dollars realized by the gold were at the
rate of only 4.83-3/4 the importer would be no better off than if he had
sold a bill; if they were at the rate of 4.83-5/8 he would be out of
pocket on the business, viewed strictly as an exchange transaction. But
this is by no means the only consideration. Gold has such a magical
fascination for moneyed mankind, and its movements are so eagerly
discussed in their markets and newspapers, that it is often handled and
shipped at a loss, especially in America, for the sake of the
advertisement that the importing firm thereby gains for itself.

Moreover, imports of gold have a very stimulating effect on speculative
stock markets, because an increase in the amount of gold available means
a roughly corresponding increase in the amount of credit that bankers
can give, so that when gold is known to be coming speculators know that
credit will be cheaper for carrying their commitments, and will come in
and buy, with a light heart, stock that they could not possibly pay for,
but hope to pawn with their bankers until they can sell it at a higher
price. And so unless the loss on the exchange side of the business is
too great, it often pays the leaders of a bull campaign to import gold,
having first laid in a line of stock, and make their profit by unloading
during the fit of exhilaration produced by the news that the gold is on
the way.

Or, again, quite apart from any speculative and spectacular motives
behind gold shipments, it may pay bankers, in a country where rates for
money are ruling high, to import gold at an apparent loss, because of
the high rates that they get for the credit that they are thereby
enabled to give. They thus, in effect, borrow gold, and recoup
themselves by being able to lend, on profitable terms, larger amounts
than they borrow, since they can always create credit to larger amounts
than that of the gold in their vaults. Sometimes, in fact, in times of
pressure banks find themselves obliged to import gold so as to
strengthen their position, whatever the loss on exchange may be.

For instance, last September, when the Berlin exchange was at the point
at which, if theory ruled in these matters, Berlin ought to have been
thinking of packing up some gold to send to London, Berlin was buying
gold in London and shipping it to the Fatherland, because there is
always great pressure for currency in Germany at the end of September
when the interest on mortgages falls due and has to be paid in cash,
with the result that the Reichsbank's note circulation expands very
rapidly and the backing of gold behind it has to be increased.
Sometimes, again, in order to attract gold, a central bank will give
importers credit for gold that is on the way, so that they may be saved
from loss of interest while the metal is afloat. Thus the actual
importer may make a profit on the shipment, not as a genuine exchange
transaction, but at the expense of the central bank.

In these cases two of the many functions performed by gold have to be
considered. As a means of international remittance, it may not be as
cheap as a bill, but it may have to be sent, not as a means of
remittance, but because it is urgently wanted in the importing country
as a make-weight for the balloon of credit.

So we see that the grumbling bill broker who ... [said] that these
confounded exchanges only work one way, was actually understating his
case. Not only do we [Englishmen] always lose gold when the exchanges go
against us, and often get none when they go in our favour, but we also
often lose gold long before the exchanges are sufficiently against us to
justify its going, and sometimes even when they are strongly in our
favour.

The effect on the exchange of an import or export of gold is, of course,
just the same as that of the import or export of any other commodity--an
import turns the exchange against us and an export turns it in our
favour. If we send gold, for example, to Germany we thereby meet a
German claim on us or create a claim for ourselves on Germany; in the
former case the bills drawn on us will be less by the amount of the gold
shipped, and the supply in Berlin of bills on London will be less in
relation to the demand, so that the tendency will be for the price of
sovereigns, as expressed in marks, to rise. In the latter case some one
in Berlin will have a claim to meet in London and will have to bid there
for a bill on London, and his bidding will have the same beneficent
effect on the exchange. When we import gold, whether brought out of
bankers' vaults, or dug out of the bowels of the earth, the country that
sends it to us meets claims of ours on it or establishes claims on us.
In either case the tendency is for the exchange to move against us.

THE HANDLING OF GOLD SHIPMENTS

[119]Whether in coined pieces or bars (bullion), the gold is packed in
strong kegs or boxes, securely strapped with hoop iron, and carefully
sealed with private seals; the latter to discover if tampered with en
route. Space is chartered from the steamship company, as in the case of
merchandise, although nearly all large fast steamers have rooms
especially constructed for such valuable cargo.... As an extra safeguard
in case of large shipments, the steamship company details special armed
men to guard the room day and night, and sometimes the shipper employs
special detectives in citizens' clothes to watch the passengers on the
trip, since it is generally known several days in advance when large
shipments of gold are to be made.

THE SILVER EXCHANGES

[120]... It is acknowledged that commerce between gold standard
countries is satisfactory to all classes of traders, for both importers
and exporters know exactly the return they may expect, but in trade
between a silver-using country and one on a gold basis, a large measure
of uncertainty invariably exists. Whenever there is a fall in the gold
value of silver, either the exporter in the gold standard country or the
importer in the silver country must suffer.

Let us take the case of the exporter. We will suppose that A. Blank &
Company, of Manchester, calico printers, send goods to Shanghai, which
they hope to sell there for a total sum of, say, £1,000. The price of
silver when the shipment was despatched was, we will say, 25_d._ per
standard ounce, and on this basis A. Blank & Company have calculated the
selling price which is to yield them £1,000. By the time the calico
arrives in Shanghai, the gold price of silver has dropped, we will
suppose, to 20_d._ per standard ounce, and this obviously indicates that
the manufacturers will receive one-fifth less for their wares, since
they are paid in the currency of the province (taels in this instance),
and when Blank & Company's money comes to be converted back into British
gold pieces, they are face to face with the fact that the outturn is
£200 less than they had calculated: they have lost one-fifth, and
receive £800 only. This is, of course, an extreme case, as in the
ordinary course silver would be unlikely to drop 5_d._ in the period
between shipment and arrival of the goods in Shanghai; but whatever the
fall, the principle is the same, and the illustration serves to show
exactly what happens.

It is not only the British exporters who stand to lose in the lottery of
trade with countries which have an unstable silver exchange; the
capitalist also, and every class of investor, is liable to be adversely
affected in operations with silver standard countries. The rate of
exchange between such countries and gold standard countries is plainly
the exchange between gold and silver; therefore, if a person has
invested in undertakings in the silver country, when he receives his
dividends in the currency of that country, he will obtain less for his
dividend warrant on the London market in proportion to the fall in the
price of silver--assuming that it does fall. Conversely, he may reap a
higher return on his investment if silver has gone up before the
encashment of his dividend.

Finally, the principal is affected in the same way, whenever it is
desired to convert it back into gold. A further example will show how
this works out in practice.

We may assume that an investor, encouraged by the chance of earning 6
per cent. on his money, remits to China £1,000. The price of silver on
the 1st January, 1914, was 26-7/16_d._ per ounce standard; on the 31st
December, 1914, 22-11/16_d._ For the sake of argument, we will imagine
our investor sent the money out to the Eastern country on the 1st
January, 1914, but circumstances made it advisable for him to recall his
money at the end of December in the same year, when the metal had
depreciated to 22-11/16_d._; in converting his principal back to British
currency he will find himself faced with a sharp loss. Silver, in which
the investment stood, has dropped 3-3/4_d._ of its gold equivalent,
roughly, one-seventh; consequently on conversion the gold value of his
original £1,000 has fallen to about £857....

... The exchanges of these silver standard countries ... [are] quoted in
shillings and pence to the dollar, tael, or rupee, as the case may be,
that is, the gold value of the respective silver coins. Hong-Kong, for
instance, is quoted 1_s._ 10-3/8_d._ to the dollar, and Shanghai, 2_s._
5-5/8_d._ to the tael. The rates from these centres ... indicate the
price for telegraphic transfers on London: the unit of exchange in the
centres named being by general consent the rate for telegraphic
transfers on London.

Let us take the Shanghai rate as an example: 2_s._ 5-5/8_d._ per tael,
means that for every silver tael the remitter hands over to the exchange
bank in Shanghai, 2_s._ 5-5/8_d._, or, to give it its real significance,
a little less than one-eighth of a sovereign in gold, will be paid to
the person in whose favour the remittance is made, as soon as a telegram
can reach the bank's London branch....

... Besides the T. T. rate, as it is called for the sake of brevity, we
have the four months' sight and six months' sight rates, which are the
quotations for first-class bank bills. Both quotations are higher than
for the telegraphic transfers, that is to say, for every silver tael
paid in Shanghai the bank will allow more shillings and pence where it
is a question of paying the gold value in London four or six months
hence, than it would if the payment is to be made on demand or by wire.
The reason is, that if a bill drawn on London, payable four months after
sight, is sent, the remitter is bound to place the receiver in such a
position that if the latter chooses to turn the bill into cash after it
has been "sighted" and accepted, he will not be worse off than if the
money had been sent by cable....

As may be gathered, therefore, the discount rates ruling on the London
market are of great importance to the Eastern bankers and exchange
dealers: so important are they in fact, that it is necessary for each
side to keep in direct telegraphic communication regarding the existing
discount quotations and the probable trend of the markets....

... The rate at which they are able to cover their drawing operations
... governs the price at which they will sell bills. If a banker has
funds deposited with his correspondent upon which he can draw, well and
good: if he has no balance with the agent, he must either provide the
wherewithal to meet the bills which he has drawn, or, alternatively, he
can instruct the agent to draw on him in reimbursement. Finally, there
comes a time,... when, as all other means of placing his correspondent
in funds have been exhausted, the banker will be obliged to ship ...
silver to be sold for what it will fetch....

It is fairly clear that the real trouble in Eastern exchange lies in the
fact that we have three main factors to deal with instead of two. In the
gold exchanges we have simply the demand for and supply of bills and
telegraphic transfers; in the silver exchanges the matter is complicated
by the way in which we also have to depend upon the fluctuations in the
price of silver on the London market....

Shanghai draws on London for the cost of her exports and remits to
London for the value of her imports, and the principal reason for this
procedure is that the manufacturer in Great Britain does not wish to be
bothered with the variations in exchange, although as the reader has
seen, he may be pretty severely affected if silver has depreciated
before his goods are sold. Leaving that out of the question, however, we
may take it that as all his expenses are payable in gold, he naturally
prefers to deal in terms of that metal. Consequently, goods shipped to
China are nearly always paid for by remittances, or drawn for in
sterling, which comes to the same thing. The Chinese producer is on
rather a different footing. His expenses are in silver, and in silver he
wishes to be paid. His produce, however, he has sold to Great Britain
for a gold price, and either he cannot afford to, or does not want to
wait until a remittance can be sent by mail from London. The one way
open to him is to draw in sterling and settle the rate of exchange on
the spot, which he does and so makes an end of the matter....

FOOTNOTES:

[103] Hartley Withers, _Money Changing_, pp. 30-35. E. P. Dutton and
Company. New York. 1914.

[104] Adapted from the Rt. Hon. Viscount Goschen, _The Theory of the
Foreign Exchanges_, pp. 85-88. Effingham Wilson. London. 1913.

[105] Adapted from Franklin Escher, _The Elements of Foreign Exchange_,
pp. 3-14. Bankers Publishing Company. New York. 1913.

[106] _Ibid._, pp. 15-24, 26, 31-33, 44.

[107] Adapted from Frederick I. Kent, _Financing Our Foreign Trade_, The
Annals of the American Academy of Political and Social Science, Vol.
XXXVI, No. 3, November, 1910, pp. 492-500.

[108] [The method explained would apply without qualification to our
imports generally prior to 1914, whether coffee from Brazil, hides from
the Levant or textiles from France. The recent and growing practice of
drawing on New York rather than on London is discussed later in this
chapter.]

[109] Adapted from Archibald J. Wolfe, _Foreign Credits_, pp. 22, 23,
Special Agents Series--No. 62. Department of Commerce and Labor.
Washington. 1913.

[110] George Clare, _The A B C of the Foreign Exchanges_, pp. 11-15.
Macmillan and Company. London. 1911.

[111] [English bills drawn on our banks have increased in volume since
1914, through the operation of the Federal Reserve Act and the amended
New York State Bank Law which make provision for the acceptance of time
drafts by National and New York State banks, respectively.]

[112] John E. Rovensky, _How the War Affects Practical Operations in
International Exchange_, Journal of the American Bankers Association,
Vol. 7, No. 12, June, 1915, pp. 1008, 1009.

[113] Joseph T. Cosby, _The Economies and Advantages of "Dollar
Credits."_ The National City Bank. New York. 1915.

[114] Harry G. Brown, _International Trade and Exchange_, pp. 65-66. The
Macmillan Company. New York. 1914.

[115] Anthony W. Margraff, _International Exchange_, pp. 104-105. Fergus
Printing Company. Chicago. 1903.

[116] Adapted from Franklin Escher, _Elements of Foreign Exchange_, pp.
68-101. Bankers Publishing Company. 1910.

[117] Albert Strauss, _Gold Movements and the Foreign Exchanges_, The
Currency Problem and the Present Financial Situation. A Series of
Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The
Columbia University Press. 1908.

[118] Hartley Withers, _Money Changing_, pp. 159-164. E. P. Dutton and
Company. New York. 1914.

[119] Address by H. K. Brooks. _Lectures on Commerce_, Edited by Henry
Rand Hatfield, University of Chicago Publications of the College of
Commerce and Administration, Vol. I., pp. 283-4. The University of
Chicago Press. Chicago. 1904.

[120] William F. Spalding, _Foreign Exchange and Foreign Bills in Theory
and in Practice_, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New
York and Melbourne. 1915.

CHAPTER XIX

CLEARING HOUSES

The following discussion of clearing houses is confined
mainly to the United States and England. References to the
clearing houses of France and Germany, where the
introduction of the use of checks and the consequent
development of clearing facilities have been tardy, are
contained in the chapters devoted to the banking systems of
those countries.

I. IN THE UNITED STATES

A CLEARING HOUSE DEFINED

[121]What is a clearing house? The Supreme Court of the State of
Pennsylvania has defined it thus:

It is an ingenious device to simplify and facilitate the
work of the banks in reaching an adjustment and payment of
the daily balances due to and from each other at one time
and in one place on each day. In practical operation it is a
place where all the representatives of the banks in a given
city meet, and, under the supervision of a competent
committee or officer selected by the associated banks,
settle their accounts with each other and make or receive
payment of balances and so "clear" the transactions of the
day for which the settlement is made.

But we must go farther than this, for though originally designed as a
labor-saving device, the clearing house has expanded far beyond those
limits, until it has become a medium for united action among the banks
in ways that did not exist even in the imagination of those who were
instrumental in its inception. A clearing house, therefore, may be
defined as a device to simplify and facilitate the daily exchanges of
items and settlements of balances among the banks and a medium for
united action upon all questions affecting their mutual welfare.

METHODS OF EXCHANGE IN NEW YORK PRIOR TO 1853

[122]During a comparatively short period immediately following 1849 the
number of banks in New York increased from 24 to 60. In the daily course
of business each bank received checks and other items on each of the
other banks, which had to be presented for collection. All such items on
hand were assorted and listed on separate slips at the close of the day,
and items coming in through the mail on the following morning were added
at that time. To make the daily exchanges each bank sent out a porter
with a book of entry, or pass book, together with the items to be
exchanged.

The receiving teller of the first bank visited entered the exchanges
brought by the porter on the credit side of his book and the return
exchanges on the debit side, who then hurried away to deliver and
receive in like manner at the other banks. It often happened that five
or six porters would meet at the same bank, thereby retarding one
another's progress and causing much delay. Considerable time was
consumed in making the circuit. Hence, the entry of the return items in
the books of the several banks was delayed until the afternoon, at an
hour when the other work of the bank was becoming urgent.

A daily settlement of the balances was not attempted by the banks, owing
to the time it would have required, but they informally agreed upon a
weekly adjustment, the same to take place after the exchanges on Friday
morning. At that time the cashier of each bank drew a check for each of
the several balances due it, and sent a porter out to collect them. At
the same time the porter carried coin with which to pay balances due by
his bank. After the settlement had been made, there was a meeting to
adjust differences and bring order out of chaos.

An old bank officer (J. S. Gibbons), in describing the inconveniences
and defects of this system, says that some of the more speculative banks
took advantage of the weekly method of settlements by carrying a line of
discounts to an amount greater than their legitimate resources would
allow. Thus, a bank would manage to carry a small debit balance of
$2,000 or $3,000 with thirty or more institutions, making a total debit
balance of, say, $100,000 on which it discounted paper. It was the
practice to borrow enough on Thursday to make the settlements on Friday,
and the return of the loan on Saturday threw it again into the debtor
column. Virtually, therefore, the weekly settlements were nominal only,
and to show that there was no attempt at economy of time and labor in
making them, it is only necessary to say that the cashier drew a check
for every balance due him, whereas a draft on one bank in favor of
another might have settled two accounts at once.

The banks were at liberty to draw on each other for their credit
balances without waiting for the settlements on Friday, and hence, when
specie was needed, this was not infrequently done. But so far did many
of the banks extend their loans and discounts that a single small draft
by one bank on another would induce a general drawing and involve them
all in confusion and virtual war on each other. Three o'clock would
arrive, with the line of drafts incomplete, thus enabling debtor banks
ofttimes to add $50,000 to their specie, whereas creditor banks would
find themselves at the close of the day depleted in perhaps twice that
sum.

THE ORIGIN OF THE NEW YORK CLEARING HOUSE

[123]The desirability of a substitute for such a system had long been
realized, but as yet no plausible scheme had been proposed. As early as
1831 a plan had been suggested by Albert Gallatin, which, to a very
remarkable degree, coincided with the one ultimately adopted.

But the times were not ripe for the scheme thus proposed. Mr. Gallatin
was thinking in advance of the age. In time, however, the question began
to be more generally discussed. For nearly a year it was under
consideration, and finally it was deemed advisable to call a meeting to
take decisive action upon it.

On August 23, 1853, 16 presidents, 1 vice-president, and 21 cashiers,
representing 38 banks, assembled in the directors' room of the
Merchants' Bank, and at this meeting a resolution was passed providing
that "a committee be appointed to procure or hire a suitable room in or
near Wall Street, for the purpose of holding meetings of the officers of
the city banks; that the said committee be requested to submit a plan,
at an adjourned meeting of this body, to simplify the system of making
exchanges and settling the daily balances; and that when a room is
procured or hired for the above purpose, the presidents or cashiers be
requested to meet weekly until a plan is agreed upon." In compliance
with this request, the committee presented a plan for the daily
settlement of balances, at a meeting held on August 31, 1853, which plan
was amended so as to provide "that a room be procured for that purpose,
sufficiently large to afford suitable accommodations."

On September 13, 1853, the scheme was adopted and the committee was
"clothed with full power to hire a room, appoint a manager and clerks,
and make all the necessary arrangements to carry the plan for a clearing
house into effect." The date for beginning operations was fixed for
October 11. Accordingly, on the appointed day, the representatives of
the banks, members of the association, met in a room which had been
procured in the basement at No. 14 Wall Street, and made the first
exchanges. The total clearings on that day were $22,648,109.87, and the
balances were $1,290,572.38. These clearings have since been eclipsed by
over $30,000,000 in the totals of a single bank.

The clearing system in America was thus fairly launched, and from that
time forth its success exceeded the expectations of even its most ardent
projectors. The association consisted at that time of 52 banks, banded
together for their common good, which, as they then conceived, consisted
solely in the exchange of items and settlement of balances at a uniform
time and place. For nearly a year the operations were conducted without
a constitution. The adoption of such an instrument was opposed, on the
ground that it was not needed and might lead to a dangerous
concentration of power in the hands of a few managers, who might use it
for personal aggrandizement, or for the exercise of an arbitrary
supervision.

MEMBERSHIP AND ADMITTANCE FEES AT NEW YORK

[124]The association at present (1909) consists of 50 members[125] (32
National Banks and 18 State Banks) and the United States subtreasury
located at New York. The latter makes its exchanges only at the clearing
house, its balances being settled at its own counter. It has no voice in
the government of the association, and pays a nominal sum for actual
expenses. The privilege which the subtreasury enjoys of making its
exchanges through the clearing house is a matter of great accommodation
both to the subtreasury and to the banks. The New York post-office
clears through one of the members, but renders no compensation to the
association for the privilege.

The membership of the association since its organization has been
constantly changing, owing to the admission and expulsion of members and
voluntary withdrawals, as provided by the constitution.

The association began with 51 members, but by 1858 the list had declined
to 46, the lowest number in the history of the clearing house. A
membership of 67 was attained in 1895.

On February 28, 1854, the Bank of the Union was expelled and the
clearing-house association was authorized to return to it whatever
amount was necessary to offset its advances toward the expenses of the
clearing house. In the following December the Empire City Bank was
expelled and a similar resolution was passed but in no case thereafter
were any such refunds made....

The constitution is very explicit in its terms governing the admission
and conduct of members. Applicants are first considered by the
clearing-house committee and referred hence to the committee on
admissions. The latter committee, if, in its opinion, after a careful
examination, the applicants are qualified for membership, refers them to
the association for final action, a three-fourths vote of those present
being necessary for admission. Banks may be elected to membership at any
meeting of the association, but before being considered by the
clearing-house committee each applicant must be shown to have an
unimpaired capital or an unimpaired capital and surplus of at least
$500,000. Each new member is required to signify its assent to the
constitution, in the same manner as the original members, and pay an
admission fee, according to capital, as follows: A bank the capital of
which does not exceed $5,000,000 must pay $5,000; a bank the capital of
which exceeds $5,000,000 must pay $7,500. Any member increasing its
capital is required to pay in accordance with those rates.

[126]METHODS OF SETTLING BALANCES

There are no less than five different methods of settling balances, in
whole or in part, without the use of money at the clearing house. They
are (1) by manager's check on debtor banks given to creditor banks; (2)
by borrowing and loaning balances without interest; (3) by borrowing and
loaning balances with interest; (4) by the use of one or more of four
forms of certificates, viz., gold and currency depository certificates,
United States assistant treasurer certificates, and clearing-house loan
certificates; and (5) by draft on another city.

When money is not used in the adjustment of balances at the clearing
house, one of the most common methods of settlement is by manager's
check on debtor banks in favor of creditor banks. In such cases the
creditor banks send clerks to the clearing house to receive the
manager's checks, which may be cashed by the debtor banks, exchanged for
cashier's checks or exchange on another city, or sent through the
clearings on another day.

There is one important advantage of the manager's check over settlements
in cash at the clearing house: By its use only one transfer of cash is
necessary in making settlements, and thus the risk is greatly
diminished.

The second mode of settlement, other than on a cash basis, is by
borrowing and loaning balances without interest. At Chicago and
Pittsburg this method is practised as a matter of convenience to the
several members. After the exchanges have been made and the balances
determined, a certain length of time is devoted to this transfer.

The third method is that of borrowing and loaning balances upon
interest, as practised in Boston.

The fourth method is that of employing some form of certificate. Many of
the large clearing houses provide for a depository to receive in special
trust such United States gold coin as any of the banks belonging to the
association may voluntarily deposit with it for safekeeping, upon which
certificates may be issued, to be used in the settlement of
clearing-house balances. Such certificates are usually issued in
denominations of $5,000 and $10,000, and are negotiable only among the
associated banks. Many of the clearing houses impose a fine for their
transfer to any other party than a member of the association.

Coin certificates were devised by F. W. Edmunds of New York, and came
into use about 1857. The Bank of America first acted as a depository,
but after the beginning of the greenback epoch the associated banks
chose the United States subtreasury as such depository for both gold and
currency. When the new clearing house in Cedar Street was occupied, the
gold deposits were transferred to the magnificent vaults with which it
is provided, and these at the present time hold a very heavy deposit of
gold, as well as a very large amount of currency, against which have
been issued clearing-house certificates as before mentioned. The
associations in practically all of the large cities of the United States
now use these gold depository certificates in the settlement of
clearing-house balances.

Clearing-house loan certificates are issued only in emergencies. The
period during which balances are settled by such instruments lasts
usually only three or four months, or until the financial disturbance
which called them forth has subsided.

The fifth method is by draft on some other city. In some places the
option is given of settling in cash or by draft, as at Austin, Tex.;
Charleston, S. C.; Frederick, Md.; Jacksonville, Fla.; Kansas City, Mo.;
New Orleans, La.; Rochester, N. Y.; and Saginaw, Mich. In others
settlements are made exclusively by drafts on another city. Among these
are Syracuse, N. Y.; Worcester, Mass.; Fall River, Mass.; Fremont,
Ohio; Hartford, Conn.; Holyoke and Lowell, Mass.; and Binghamton, N. Y.
Sometimes foreign drafts are used in payments of equal thousands only,
as at Wilmington, Del., and Chester, Pa.

Generally speaking, about 40 per cent. of the clearing houses of the
United States use drafts on other cities in paying their balances. About
30 per cent. settle by manager's check, and about 25 per cent. settle by
cash alone, the remaining 5 per cent. settling by a combination of two
or more of the foregoing methods.

Clearing houses located in New England settle, as a rule, with drafts on
Boston or New York, or both. Clearing houses in the vicinity of
Philadelphia usually settle with drafts on that city or on New York, and
those located in that part of the country lying east of the Mississippi
River settle more or less by draft on New York or Chicago. Settlement is
also sometimes made by draft on some of the larger cities, such as
Baltimore, Washington, Savannah, Kansas City, Detroit, Omaha, and San
Francisco.

[127]RATIO OF BALANCES TO CLEARINGS

The ratio of balances to clearings depends partly upon the number of
banks, but much more upon the amount and character of their business and
upon their relations one to another. This is illustrated by figures
which have just been collected, covering the transactions for the year
1908. At Pittsburg, with 20 members and 128 non-members clearing through
members, the balances were 16.5 per cent. of the clearings; at Buffalo,
with 11 members and 7 non-members, 12 per cent.; at Chicago, with 20
members and 40 non-members clearing through members, 7.5 per cent.; at
Philadelphia, with 31 members and 1 non-member, 11.5 per cent.; at St.
Louis, with 17 members and 35 non-members, 9.3 per cent.; while in New
York, during the fifty-four years of its existence, the percentage of
balances to clearings has been only 4.64 per cent., notwithstanding the
operation of the United States assistant treasurer, who almost always
has a heavy debit balance.

The more nearly the banks stand on an equality with one another, the
more nearly will their transactions approach a complete offset, which,
of course, would leave no balance to settle.

[128]THE NATURE OF CLEARING-HOUSE LOAN CERTIFICATES

Clearing-house certificates are of two kinds--those issued upon the
deposit of gold coin (and in New York City and Boston on gold and silver
certificates and legal-tender notes) and those issued upon the deposit
of collateral securities. The former are employed in ordinary times
solely as a method of economizing time and labor and reducing risk in
handling large sums of money. The latter are employed in times of
financial disturbance or panic, and although both are intended for use
solely in the settlement of balances at the clearing house, the
circumstances that call them forth, the results effected by their use,
and the part they play in banking economy have little or nothing in
common. The certificates issued upon the deposit of gold, etc., are
termed "Clearing-house certificates," and those issued upon the deposit
of collateral security are very properly termed "Clearing-house loan
certificates," with which latter only are we here concerned.

Clearing-house loan certificates may be defined as temporary loans made
by the banks associated together as a clearing-house association, to the
members thereof, for the purpose of settling clearing-house balances.
Such certificates are negotiable, as a rule, only among the members of
the association, and are not in any sense to be regarded as currency.
They are not even seen by the business community, and do not pass from
bank to bank except in payment of clearing-house balances.

To obtain an intelligent understanding of the real character and purpose
of such certificates it will be well to treat somewhat of the
circumstances under which they are issued. In the course of the present
century the United States has undergone periodical derangements of
business affairs, when confidence was displaced by mistrust, when the
payment of debts became difficult, when property values declined, and
business houses failed; when industry and trade were paralyzed, and
general stagnation ensued in all lines of enterprise. In such times
depositors in banks, stricken with fear and sometimes pressed by need,
draw out their deposits, in many cases to such an extent as to render it
difficult or even impossible for the banks to contract their loans
sufficiently to meet the demands thus made upon them. Under our currency
system no adequate method is [was] provided for expanding the money
volume as occasion demands, whereby the banks can continue their usual
loans and discounts, and thus prevent a panic with all its evil
consequences. Hence it is left in a large measure to the financiers of
each community to work out their own remedy, supplemented by such mutual
assistance as a courteous regard for each other may dictate or as
business relations may demand.

Quick to see the defects in our currency system, and the desirability of
in some way supplying it, the bankers of New York, nearly fifty years
ago, devised the scheme of issuing clearing-house loan certificates as a
method of relief from temporary stringencies. Subsequently, nearly all
the clearing houses in the great centres adopted the same device, and by
their heroic resort to the measure they have at different times relieved
the business community of untold disaster, for which invaluable service
they have justly received the grateful recognition of the entire
country.

The great value of clearing-house loan certificates lies in the fact
that they take the place of money in settlements at the clearing house,
and hence save the use of so much actual cash, leaving the amount to be
used by the banks in making loans and discounts, and in meeting other
obligations. The volume of currency, to all intents and purposes, is
expanded by this means to the full amount of the certificates issued.

The loan certificates are taken out by the clearing-house members
through loan committees, specially appointed, and are used, as a rule,
only in the payment of balances among the associated banks. Thus, when
the stringency in the money market seems sufficient to demand it, the
clearing-house association meets and appoints a committee called the
"loan committee," consisting usually of five bank officers, to act in
concurrence with the president of the clearing-house association, who
serves ex officio as a member. It is the duty of such committee to meet
each morning at the clearing house and examine the collateral offered as
security by the banks and issue loan certificates thereon, in such
denominations and proportions to collaterals deposited as may be agreed
upon. In the past the denominations have varied from 25 cents to
$100,000 in the different associations and in proportions varying from
$50 to $100 of certificates to $100 of collateral deposited.

These loan certificates bear interest at rates varying from 5 to 10 per
cent. per annum, payable by the banks to which they are issued to the
banks receiving such certificates in settlement of daily balances. Hence
the interest charged against certain banks must exactly equal and offset
that credited to certain other banks. The aim is to fix the rates
sufficiently high to insure the retirement of the certificates as soon
as the emergency which called them forth has passed by. As a rule they
are retired by the banks, which take them out as soon as they have
obtained sufficient cash to meet their daily obligations. Notice is
given by the debtor banks to the committee, calling for such
certificates as they wish to retire, and the committee gives notice to
the banks holding the same, stating that the interest will cease after a
specified date. In due course the holders send the certificates to the
clearing house for redemption. Upon the retirement of the certificates
the collateral deposited as security is surrendered by the committee in
the same proportion to certificates turned in as was required for
deposit at the time of issue.

It is by no means the general practice for all the members to take out
loan certificates when issues are arranged by the association. Some
banks are in such condition as to be able to weather the storm without
them, while others are weak and in great need of relief. Some banks
regard their use of clearing-house loan certificates as a reflection
upon their standing, and hence refuse to apply for them unless driven to
it by sheer necessity. Others regard it as in no way prejudicial to
their interests, but rather as a patriotic movement in which all the
banks should engage, both for the purpose of assisting their
fellow-members and for the welfare of the community as a whole.

CLEARING-HOUSE LOAN CERTIFICATES AND THE EQUALIZATION OF RESERVES[129]

Comparison of the course of events during the crisis of 1873 with that
in subsequent crises shows a progressively increasing unwillingness or
inability among the New York banks to make use of their cash reserves.
In 1873 the New York banks at the outset of the crisis held an available
reserve of $34,300,000. In the course of four weeks this was reduced to
$5,800,000, and the ratio to deposit liabilities was then less than 4.5
per cent.[130] Suspension was not escaped in 1873 but it was of shorter
duration than in later crises. The banks at that time were unable to
increase their cash resources by any of the means which have been
available in later crises. The Government had no surplus of greenbacks,
aside from about $12,000,000 which was almost entirely secured and
retained by the savings banks. Banknotes could not be issued because the
total circulation was at that time limited by law. Finally, additional
supplies of gold, secured through imports, were useless for ordinary
banking purposes because the business of the country was then carried on
by means of an inconvertible and depreciated paper currency.
Notwithstanding all these special difficulties, the New York banks, by
continuing to use their reserves freely even after payments had been
restricted, were able to restore confidence in a comparatively short
time, and money began to flow back to them within three weeks after the
outbreak of the crisis.

In 1893 the New York banks were in what was for them an unusually strong
condition at the beginning of the disturbance, having early in June a
cash reserve exceeding 30 per cent. of their net deposits. A succession
of banking failures in the West and South led to heavy withdrawals from
New York during the latter part of June and the beginning of July. Then
followed a lull and money began to be returned to New York. During the
third week of July banking failures were renewed in the West and South
and the drain was resumed. The positively unfavorable aspects of the
situation were altogether similar to those of the previous month with
the one further circumstance of a reduced cash reserve in New York. On
the other hand, additional means with which to meet the situation were
becoming available. At the end of July gold imports in large amount had
been arranged. Foreign purchases of our securities were heavy,
reflecting increasing confidence in the repeal of the silver purchase
law. Arrangements had also been made which would certainly lead to a
considerable increase in the issues of bank-notes during August and
September. Notwithstanding all these favorable circumstances the New
York banks suspended, during the first week of August, when they still
held a cash reserve of $79,000,000, more than 20 per cent. of their
deposit liabilities.

In 1907 the New York banks restricted payments when they still held a
cash reserve of more than $220,000,000 and when the reserve ratio was
also above 20 per cent. Both in 1893 and in 1907 suspension was not a
measure of last resort taken after the banks had entirely exhausted
their reserves and when there was no means of securing additional cash
resources. Moreover, after cash payments were restricted the policy of
the banks was unlike that adopted in 1873, in that the banks did not
make further use of their reserves; they hoarded them and added to their
amount, thus unduly prolonging the period of suspension.

Explanation of the failure of the banks in 1893 and 1907 to use their
cash resources as completely as in 1873 is simple; but it is of the very
greatest significance because it will bring to light the most serious
element of weakness in our credit structure. [Written before our banking
reform of 1913.]

In 1893 and in 1907 the clearing-house loan certificate was the only
device resorted to in order to secure the adoption of a common policy by
the banks. In 1873, as on earlier occasions when its use was
authorized, provision was also made for the equalization of the reserves
of the banks. Thus in 1873 the Clearing House Association in addition to
the customary arrangements for the issue of loan certificates adopted
the following resolution:

That in order to accomplish the purposes set forth in this
agreement the legal tenders belonging to the associated
banks shall be considered and treated as a common fund, held
for mutual aid and protection, and the committee appointed
shall have power to equalize the same by assessment or
otherwise at their discretion. For this purpose a statement
shall be made to the committee of the condition of such bank
on the morning of every day, before the opening of business,
which shall be sent with the exchanges to the manager of the
Clearing House, specifying the following items:

(1) Loans and discounts. (2) Amount of loan certificates.
(3) Amount of United States certificates of deposit and
legal tender notes. (4) Amount of deposits deducting
therefrom the amount of special gold deposits.

Two fairly distinct powers were given the clearing-house committee: the
right to issue clearing-house certificates, and control over the
currency portion of the reserves of the banks. This machinery was
devised (according to tradition) after the crisis of 1857 by George S.
Coe, who for more than thirty years was president of the American
Exchange National Bank. The purpose of the certificate was to remove
certain serious difficulties which had become generally recognized
during that crisis. The banks had pursued a policy of loan contraction
which ultimately led to general suspension, because it had proved
impossible to secure any agreement among them.[131] The banks which were
prepared to assist the business community with loans could not do so
because they would be certain to be found with unfavorable
clearing-house balances in favor of the banks which followed a more
selfish course. The loan certificate provided a means of payment other
than cash. What was more important, it took away the temptation from any
single bank to seek to strengthen itself at the expense of its fellows,
and rendered each bank more willing to assist the community with loans
to the extent of its power.

But in addition to the arrangement for the use of loan certificates
provision was also made for what was called the equalization of
reserves. The individual banks were not, of course, equally strong in
reserves at the times when loan certificates were authorized. From that
moment they would be unable to strengthen themselves, aside from the
receipt of money from depositors, except in so far as the other banks
should choose to meet unfavorable balances in cash. Moreover,
withdrawals of cash by depositors would not fall evenly upon the banks.
Some would find their reserves falling away rapidly with no adequate
means of replenishing them. The enforced suspension of individual banks
would pretty certainly involve the other banks in its train. Finally, it
would not be impossible for a bank to induce friendly depositors to
present checks on other banks directly for cash payment, instead of
depositing them for collection and probable payment in loan
certificates, through the clearing house. The arrangement for equalizing
reserves therefore diminished the likelihood of the banks working at
cross purposes--a danger which the use of clearing-house certificates
alone cannot entirely remove.

These arrangements had enabled the banks to pass through periods of
severe strain in 1860 and in 1861 without suspension. In both instances
the use of the loan certificate was followed immediately by an increase
in the loans of the banks, and in no short time by an increase in their
reserves. The situation in 1873 was more serious, and as events proved,
the reserve strength of the banks, while sufficient to carry them
through the worst of the storm, was not enough to enable them to avoid
the resort to suspension.

In 1884, the next occasion when clearing-house loan certificates were
issued, the opposition to the provision for the equalization of reserves
was so widespread that it does not appear that it was even formally
considered. The ground for this opposition can be readily understood. In
1873 the practice of paying interest upon bankers' deposits was
generally regarded with disfavor. Only twelve of the clearing-house
banks offered this inducement to attract deposits; but by this means
they had secured the bulk of the balances of outside banks. It was in
meeting the requirements of these banks that the reserves of all the
banks were exhausted at that time. The noninterest paying banks entered
into the arrangement for the equalization of reserves in expectation of
securing a clearing-house rule against the practice of paying interest
on deposits. But their efforts had resulted in failure. Some of them had
employed their reserves for the common good most reluctantly in 1873,
and the feeling against a similar arrangement in 1884 was naturally far
stronger and more general. Moreover, the working of the pooling
agreement in 1873 had occasioned heart-burnings which had not entirely
disappeared with the lapse of time. It was believed, and doubtless with
reason, that some of the banks had evaded the obligations of the pooling
agreement. It was said that some of the banks had encouraged special
currency deposits so as not to be obliged to turn money into the common
fund. Further, as the arrangement had not included bank-notes, banks
exchanged greenbacks for notes in order either to increase their
holdings of cash or to secure money for payment over the counter. Here
we come upon an objection to the pooling arrangement which doubtless had
much weight with the specially strong banks, although it is more
apparent than real. In order to supply the pressing requirements of some
banks, others who believed that they would have been able to meet all
demands of their depositors were obliged to restrict payments. That such
an expectation would have proved illusory later experience affords ample
proof. When a large number of the banks in any locality suspend, the
others cannot escape adopting the same course. But in 1884 the
erroneousness of the belief had not been made clear by recent
experience.

The New York banks weathered the moderate storms of 1884 and 1890
without suspension, by means of the clearing-house loan certificate
alone, and in the course of time all recollection of the arrangement for
the equalization of reserves seems to have faded from the memory of the
banking community. There was, however, in those years another potent
influence which tended to lessen the likelihood of suspension following
the issue of loan certificates. Many banks were unwilling to take them
out, fearing that such action would be regarded as a confession of
weakness. The prejudice against them was indeed so strong that needed
loan expansion did not follow the authorization of their issue. In 1890
the directors of the Bank of Commerce, then, as now, one of the most
important banks of the city, passed a resolution urging other banks to
relieve the situation by increasing loans and by taking out loan
certificates.

In 1893 only a small part of the balances between the banks was settled
in certificates at first; but by the end of July practically all
balances were settled in that way and suspension followed at once. In
1907 all the banks having unfavorable balances, with but one important
exception, took out certificates on the first day that their issue was
authorized, and suspension was then for the first time simultaneous with
their issue.

The connection between suspension and the use of clearing-house loan
certificates as the sole medium of payment between the banks is simple
and direct. The bank which receives a relatively large amount of drafts
and checks on other banks from its customers cannot pay out cash
indefinitely if it is unable to secure any money from the banks on which
they are drawn. So long as only a few banks are taking out certificates
and the bulk of payments are made in money, no difficulty is
experienced; but as soon as all the banks make use of that medium, the
suspension of the banks which have large numbers of correspondents soon
becomes inevitable. The contention of bankers both in 1893 and in 1907
that they had not suspended since they had only refused to honor drafts
on other banks was untenable. The clearing-house loan certificate was a
device which the banks themselves had adopted and they had failed to
provide any means for preventing partial suspension as the result of its
use. The further contention of some bankers that they had suspended
because they had no money to pay out was doubtless true of a few banks,
but for that very reason other banks must have been all the stronger,
probably well above their required reserve.

That the arrangement for equalizing the reserves, adopted in 1873, would
have availed to prevent suspension on subsequent occasions, is highly
probable, indeed a practical certainty. In 1893 events proved that the
banks had maintained payments up to the very last of the succession of
disasters with the results of which they had been contending. During
August the number of bank failures was not large and none of them was of
great importance. We cannot, of course, know how soon money would have
begun to flow back to New York, but certainly the suspension of payments
could hardly have hastened the movement. From the beginning of September
the reported movements of currency showed a gain for the New York banks,
and for the week ending September 16 the gain was no less than
$8,000,000. One month more of drain, therefore, was the most that the
banks would have been obliged to endure, and for the needs of that month
the banks would not, as in 1873, have been confined to the single
resource of the $79,000,000 of the cash in their vaults.[132]

Similarly, the enormous increase in the money supply of the country in
November and December, 1907, would have offset much of the loss of
reserve which the banks would have incurred, if they had continued to
meet all the demands of their customers for cash. And, finally, it may
be observed that in the unlikely event that alarm had not been allayed
and suspension in the end had become unavoidable, it would not have made
any practical difference to depositors whether the reserves of the banks
had been but 10 per cent. rather than 20 per cent. of their demand
liabilities.

CLEARING-HOUSE BANK EXAMINATIONS[133]

Most bank failures are due to the gradual acquirement of undesirable
assets over a period of years, and if some authority exists with power
to make recommendations of a remedial character, with the further power
to enforce such recommendations, if necessary, there is little doubt
that many bank failures would be averted.

The panic of 1907 presented many striking examples of just what is
intended to be here emphasized, viz., that under the careful
supervision of a competent and reliable examiner many of the assets of
the failed banks, upon which it was impossible for them to realize at a
time when they needed their funds, would probably have been liquidated
upon his recommendation and advice long before the necessity for such
liquidation had arisen.

Mr. J. B. Forgan of Chicago, has recently said on this subject:

A competent examiner--and there are many such now in the
government employ--while he can not pass judgment on all the
loans in a bank, can, after a careful examination, or a
series of examinations, form a wonderfully correct judgment
as to the general character of its assets and as to whether
its management is good or bad, conservative or reckless,
honest or dishonest. Examinations, as they are now
conducted, have a most beneficial influence on bank
management, especially by way of restraint. The
correspondence carried on by the Comptroller, based on the
examiners' reports, does an inestimable lot of good in the
way of forcing bank officers to comply with the law and in
compelling them to face and provide for known losses as they
occur. Supervision by examination does not, however, carry
with it control of management and can not, therefore, be
held responsible for either errors of judgment or lapses of
integrity. Examination is always an event after the act,
having no control over a bank's initiative, which rests
exclusively with the executive officers and directors, and
depends entirely on their business ability, judgment, and
honesty of purpose.

The clearing-house association of Chicago was the pioneer in the
establishment of an independent system of clearing-house bank
examinations in this country, its system having been inaugurated on June
1, 1906, with results that have, to the present time, more than
fulfilled the expectations of the bankers of that community[134]....

In substantially his own words the Chicago examiner operates under the
following conditions: The examinations extend to all the associated
banks of Chicago and to all non-member institutions. The work is
conducted with the aid of five regular assistants, each fitted by
experience to thoroughly do that part of the work assigned to him. The
examinations include, besides a verification of the assets and
liabilities of each bank, so far as is possible, an investigation into
the workings of every department and are made as thorough as is
practicable. After each examination the examiner prepares a detailed
report in duplicate, describing the bank's loans, bonds, investments,
and other assets, mentioning specially all loans, either direct or
indirect, to officers, directors, or employees, or to corporations in
which they may be interested. The report also contains a description of
conditions found in every department. One of these reports is filed in
the vaults of the clearing house, in the custody of the examiner, and
the other is handed to the examined bank's president for the use of its
directors. The individual directors are then notified that the
examination has been made and that a copy of the examiner's report has
been handed to the president for their use. In this way every director
is given an opportunity to see the report, and the examiner, in every
instance, insists upon receiving acknowledgment of the receipt of these
notices.

The detailed report retained by the examiner is not submitted to the
clearing-house committee, under whose direct supervision he operates,
unless the discovery of unusual conditions makes it necessary. A special
report in brief form is prepared in every case and read to the
clearing-house committee at meetings called for that purpose. The report
is made in letter form, and describes in general terms the character of
the examined bank's assets, points out all loans, direct or indirect, to
officers, directors, or employees, or to corporations in which they may
have an interest. It further describes all excessive and important
loans, calls attention to any unwarranted conditions, gross
irregularities, or dangerous tendencies, should any such exist, and
expresses, in a general way, the examiner's opinion of each bank as he
finds it.

Less than a year after the Chicago Clearing House Association appointed
its special examiner the associated banks of Minneapolis took similar
action. The conditions under which the Minneapolis examiner operates are
substantially the same as those governing the examiner at Chicago, the
principal difference being that instead of the examiner sending a copy
of his report to the president of the examined bank and notifying each
of the directors of such bank that he has made such examination and
that the report is in the hands of the president of the institution, as
is the rule of procedure at Chicago, and which, in a measure, leaves it
to the discretion of the directors whether they examine the report
carefully and in detail, the original report is delivered by the
examiner at Minneapolis in person to the board of directors of each bank
which he examines, at a meeting convened for that purpose. The report is
read and the criticisms, if any, are fully discussed, and the
recommendations considered. In this way no director can complain that he
had not sufficient opportunity to become fully conversant with all the
details of his bank.

II. CLEARING HOUSES IN ENGLAND

THE LONDON BANKERS' CLEARING HOUSE AS THE FOREMOST EXAMPLE

[135]The exact origin of the London Bankers' Clearing House will
probably never be determined, for, like other institutions whose purpose
has been to save time and trouble, its system appears to have been
gradually evolved.[136]

With the growth of the check system, each banker would daily find
himself in possession of a number of drafts for the credit of his
customers that needed collection at the offices of other bankers. This
would necessitate each bank sending out one or more clerks on what
became known as "walks" to obtain cash or notes for these drafts from
the houses on which they were drawn.

As in London alone there were some fifty or more private firms carrying
on a banking business this necessitated a considerable amount of work
and was attended with grave risk of robbery.

It is probable, therefore, that arrangements were made by some of the
bankers, as it is still done in some country towns, to meet at one bank
one week and at another the next for the purpose of exchanging checks.

But in consequence of the number of the London bankers this method would
prove awkward, and about the year 1770 we find that the walk clerks from
the city and West End banks had made a practice of meeting at lunch time
at a public house called the Five Bells in Dove Court, Lombard Street,
close to St. Mary Woolnoth Church, and not so very far from the site of
the Bankers' Clearing House of to-day. Here in the public room, or
according to tradition on the posts in the court outside, each day after
lunch a rough system of exchange of checks was carried on between the
clerks from each bank, the balances being settled in notes and cash.
From this rough system has developed the efficient organization of
to-day.

In May, 1854, the clearing house was closed for alterations and
enlargement, and the business was temporarily carried on at the Hall of
Commerce. Here, on June 6, 1854, applications for admission to the
clearing house were received from the following joint-stock banks: The
London and Westminster, the London Joint Stock, the Union Bank of
London, the Commercial Bank of London, and the London and County Bank;
and it was resolved "that the secretary be authorized to comply with
such applications, subject to the payment of an annual sum to be fixed
by the committee to reimburse them for the outlay that has been found
necessary to afford accommodation for their admission." There were at
this time 25 private banks in the clearing house.

Following on the admission of the five premier joint-stock banks in 1854
there were frequent applications from other joint-stock banks--many from
the moment of their foundation. But the wise reply of the committee was
invariably that they did not "deem it expedient to take into
consideration such applications from any banking establishment that has
not been in operation at least for a period of twelve months."

Though the joint-stock banks had been admitted to the clearing house yet
they were only allowed to rent seats there and had no share in the
management, so for the support of their mutual interests they had a
committee of their own which settled the rate to be given by the
joint-stock banks in the London district for deposit money at seven
days' notice.

In 1858 the country bankers submitted a plan for establishing a country
bankers' clearing house in London and proposed that the clearing house
committee should appoint two or three of their number to unite with them
as a working committee.

The establishment of a separate country bankers' clearing house would
have led to many inconveniences, and Mr. John Lubbock, now Lord Avebury,
submitted a plan for carrying out a separate country clearing at the
clearing house. The committee approved the plan and submitted it to the
country bankers' committee, who also gave their approval.

Thus was instituted at the Bankers' Clearing House the country clearing,
which more than all else has brought about the almost universal use of
checks in England, to the exclusion of notes and coin.

Mr. Lubbock's scheme was so well thought out that from its initiation to
the present time the rules have had to be only very slightly modified.

In 1864 the Bank of England entered the clearing house to clear on one
side only, the outside, for though the bank presents to the clearing
bankers at the clearing house all checks payable by them, all checks and
bills drawn on the bank are presented by the clearing bankers at the
bank itself, and the proceeds placed to the credit of each bank's
account. At the same time the governor of the Bank of England was made
ex officio a member of the committee of clearing bankers. After 1864 few
changes were made in the working of the clearing house, the volume of
the country and town clearings increased greatly, but the house proved
capable of meeting any increase.

Friction between the old private bankers and the joint-stock banks grew
less as amalgamations and absorptions increased, and before many years
the committee of London clearing bankers and joint-stock banks committee
amalgamated, it being agreed, as a condition of the joint-stock banks
committee ceasing to exist, that all the banks would abide by the ruling
of the committee as to the rate of deposit at seven days' notice.
Henceforth, every bank in the clearing house was entitled to have one
representative on the committee. Such representatives have hitherto
been chosen solely from the board or the partners and are nominated by
their banks and formally elected by the committee. The committee elects
its own chairman, vice-chairman, and honorary secretary. This committee
meets regularly on the first Thursday in each month, Thursday being the
day on which the Bank of England in normal times makes any alteration in
the bank rate of discount, but it may be summoned by requisition at any
time and meets automatically should the bank rate be altered, since this
governs the rate of deposit allowed by the bankers.

The committee has full power over all clearing house matters, and from
the importance of the banks who compose the clearing house its opinion
carries very great weight on all matters in the banking world. It is,
however, controlled only by the mutual agreement of its members: and the
decision of the majority of its members, though followed loyally, is
never used with any ultimate power of compulsion in matters affecting
banking in general.

In 1907 a third clearing, the Metropolitan, was established. Hitherto,
with the exception of one or two city offices which were included in the
town clearing, the collection of drafts on London branches of the
clearing banks had been effected by the post and by the sending out of
walk clerks by each bank; but in 1907 it was determined to do away with
such means of collection as far as possible and to collect the branch
checks through the clearing house. This proved so successful that the
West End banks were approached the following year, and with one
exception readily consented to come into the new plan by which their
clearing agents had delivered to them at the Metropolitan clearing all
checks drawn upon them. This clearing is the first clearing made each
morning and is handled so expeditiously that even the most distant
London branches get their checks almost earlier than under the old
system. They have, therefore, plenty of time to go through them and to
make returns of any checks that cannot be paid in time for such return
checks to reach the clearing house early in the afternoon. There are now
over 330 banks and branches using this clearing.

For the better defining of the three clearing areas--town,
metropolitan, and country--the letters T M C have been placed in the
corner of all bank checks. From February 19, 1907, the date of the
initiation of the Metropolitan Clearing, up to December 31 of that year,
£482,227,000 was paid in this clearing, while for the year 1908 the
total was £647,842,000, as compared with the town clearing total for
that year of £10,408,254,000 and the country total of £1,064,266,000,
making in all a grand total of £12,120,362,000, which figures, vast as
they are, were a decrease of £610,031,000 on the total £12,730,393,000
for the previous year, 1907.[137] The work entailed by such vast figures
as these could scarcely have been dealt with by hand alone, but by the
installation of adding machines the work is easily and quickly done.

It must not be thought that all checks on London are presented through
the clearing house, for checks on the London branches of the Scotch
banks and of the colonial and foreign banks are still presented over the
counter.

Moreover, though it is mutually understood between the clearing banks
that checks on each other will only be presented through the clearing
house, this agreement has no legal binding.

Two exceptions are continually made; documents or goods have to be taken
up against cash, and the owner before parting wishes to be certain of
his money. In this case the presenting banker either presents his check
for marking--that is to say, the paying banker having ascertained from
his customer's account that there is sufficient money thereon, marks the
check for payment, which has the same effect as if the banker had
accepted it; or, as is becoming more usual, the paying banker gives one
of his own drafts on the Bank of England in exchange for the check.

PROVINCIAL CLEARINGS

Besides the London clearing house, which is an irregular building of no
architectural features whatever, there are eight provincial clearing
houses in England--Birmingham, Bristol, Leeds, Leicester, Liverpool,
Manchester, Newcastle and Sheffield.[138]

Two only of these clear over £100,000,000 in the year. Manchester
cleared £320,296,332 in 1907, with an average weekly total of £6,159,545
and an average daily total of £1,039,923, and Liverpool £196,325,829.
The others cleared in the same year from £12,000,000 to £61,000,000.
Small figures, indeed, compared with London, where the highest total
paid on any one day was, in 1907, £106,703,000. In 1908 the highest
total paid in one day in the London clearing was £85,833,000 and the
lowest £24,903,000.

In London, as in the provincial places, the object of the clearing house
is primarily the convenience of exchange of checks, not the regulation
of banking, and little is regulated save, perhaps, the rate of interest
to be paid on deposits at seven days' notice.

In these days, too, when the tendency is strong for amalgamation, the
local banks are dwarfed by their gigantic competitors, with their
branches in many counties and head offices in London, with the result
that London each year controls more of the banking in England and the
provincial clearings cease more and more to be under local control, but
are controlled by their London head offices.

This may, if the present tendency of amalgamation continues,[139] result
in the committee of London clearing bankers becoming an important
controlling body, but that time is not yet at hand, and though, as we
have said, an expression of opinion on the part of the committee carries
very great weight, yet anything like dictation would very properly be
resented by the important and old-established banks in both London and
the provinces that are outside the clearing house.

FOOTNOTES:

[121] James G. Cannon, _Clearing Houses_, Publications of the National
Monetary Commission, Senate Document, No. 491, 61st Congress, _2nd
Session_, p. 1.

[122] _Ibid._, pp. 148-150.

[123] _Ibid._, pp. 150-154.

[124] _Ibid._, pp. 163-165.

[125] 62 members in 1914.

[126] _Ibid._, pp. 41, 43, 44-46.

[127] _Ibid._, p. 37.

[128] _Ibid._, pp. 75-79.

[129] O. M. W. Sprague, _Banking Reform in the United States_, pp.
104-113. Harvard University. 1911.

[130] The figures in the text refer to the legal tender holdings of the
banks. The banks also held a considerable amount of specie but it was
not a free asset as most of it had been received on special accounts
payable in gold. Including the specie holdings the reserve ratio was
12.8 per cent.

[131] C. F. Dunbar, Economic Essays, chap. XVI.

[132] The increase in the amount of money in circulation for August,
1893, was estimated at $70,000,000.

[133] James G. Cannon, _Clearing Houses_. Publications of the National
Monetary Commission, Senate Document No. 491, 61st Congress, _2d
Session_, pp. 137-141.

[134] [A number of the more important cities such as St. Paul, St.
Louis, and Philadelphia, following the example of Chicago and
Minneapolis, have instituted clearing house bank examinations since
1907.]

[135] Adapted from Robert Martin Holland, _The London Bankers Clearing
House_. Publications of the National Monetary Commission, Senate
Document No. 492, 61st Congress. _2nd Session_.

[136] The date of the establishment of the Clearing House is not known.
The Clearing has, however, been in existence about 150 years.--EDITOR.

[137] [For the five years 1910-14, the total clearings of the London
Clearing House were in the neighborhood of £15,000,000,000 per annum of
which the Town, Metropolitan, and Country Clearings were about 86, 5.5,
and 8.5 per cent., respectively.]

[138] [The approximate number of clearing houses outside of London, in
England, in 1915 is twelve, but these are used only for local clearings.
In addition, most of the towns in England and Wales have a local
exchange which is a clearing on a small scale.]

[139] This tendency has continued as to both the joint-stock and private
banks.--EDITOR.

CHAPTER XX

STATE BANKS AND TRUST COMPANIES SINCE THE PASSAGE OF THE NATIONAL BANK
ACT

[140]The banking institutions of the United States other than national
banks are ordinarily classified into (a) state banks, (b) trust
companies, (c) stock savings banks, (d) mutual savings banks, and (e)
private banks. The following pages deal with two of these classes, viz.,
state banks and trust companies. It will be desirable at the outset to
distinguish them from the other classes, and to outline the history of
legislation concerning them since 1865.

The term "state bank" has been used in the United States in several
different senses; but whatever the variance in meaning, such banks have
always had one common characteristic--incorporation under state
authority. In the bank reports of some of the States, private banks are
not distinguished from state banks. This is due to the fact that in
these States incorporated and unincorporated banks are subject to the
same regulation. A private bank, however, is an unincorporated bank.

Not all banking institutions incorporated by the States are state banks.
Mutual savings banks, stock savings banks, and trust companies are also
corporations organized under state laws or charters granted by state
legislatures. The distinction between mutual savings banks and state
banks is clear. Mutual savings banks do not have a capital stock and do
not carry on a discount and deposit business--_i. e._, they do not
discount commercial paper, and do not receive demand deposits payable on
check. State banks, on the other hand, have a capital stock and carry on
a discount and deposit business. Many state banks, however, receive
also savings deposits. The line of demarcation between state banks and
stock savings banks is much less definitely marked. Both state banks and
stock savings banks have a capital stock. Stock savings banks are
primarily savings banks, and many of them do not do a discount and
deposit business, but confine themselves to the savings bank business.
But in several States the distinction between state banks and stock
savings banks is of the most unsubstantial character, since the stock
savings banks carry on the business of a commercial bank, receiving
demand deposits payable on check, and discounting commercial paper.
Finally, the distinction between state banks and trust companies is not
exactly the same in any two of the States.

"State banks" then, as the term is used in the following pages, are
banks of discount and deposit (as distinguished from savings banks,
mutual and stock) incorporated by one of the States or Territories (in
contrast with private banks, which are unincorporated, and with national
banks, which are organized under the national-bank act).[141]

In 1860 there were in the United States 1,562 state banks. Owing to the
repressive influence of the national-bank act, hastened in its effect by
the 10 per cent. tax on state-bank notes, the number of state banks had
by 1868 fallen to 247. One result of this decline in the number and
importance of state banks was the cessation of state banking
legislation. The old laws regulating state banks of issue were swept
away by code revisions, or remained obsolete and unchanged on the
statute books.

The number of state banks began to increase about 1870. In a few States
old banking laws intended for the regulation of banks of issue hampered
their development, but in the remaining States they were left for a
considerable period almost entirely without regulation. As late as 1892,
in his digest of the state statute law, Mr. Stimson said:

It seems unnecessary to incorporate the state banking laws
in this edition. Nearly all the States, except the newer
States and Territories, have special chapters in their
corporation acts concerning banks and moneyed institutions,
but these chapters are usually of old date, and have
practically been superseded for so long a time by the
national banking laws that they have become obsolete in use
and form.

The increasing attention paid in recent years by the state legislatures
to the regulation of the state banks has been partly due to the rapid
growth of the banks in numbers and in financial importance; but it is to
be accounted for primarily by a change of view as to the purpose of
banking regulation. The antebellum state-bank regulations were intended
to secure the safety of the bank note. Although the depositor was
protected by many of the regulations, this protection was purely
incidental. The view that note-issuing banks alone required governmental
regulation persisted for a considerable time after the passage of the
national-bank act. Since the national banks had a monopoly of the issue
of bank notes, the regulation of state banks was considered needless. As
the importance of note issue as a banking function decreased, banking
regulation, as seen in the national-bank act, began to be considered
desirable as a protection to depositors.

THE EVOLUTION OF THE TRUST COMPANY

With the exception of the power to issue notes, which would be
unavailable because of the tax on note issue, the powers of the state
banks of to-day are essentially the same as the powers of the state
banks which were in operation before the Civil War. On the other hand,
the trust company is a new type of banking institution, the functions of
which are even yet not clearly defined. A great part of the legislation
with reference to trust companies, therefore, has had to do with
defining the powers of these corporations.

The early laws for the incorporation of trust companies show the widest
differences of opinion with regard to their field of operation. The one
point of agreement appears to have been the idea that a corporation
could administer trusts more advantageously and safely than an
individual. But the companies in all the States were given additional
powers more or less closely connected with their trust powers. Some of
the companies, chiefly the very early ones, were empowered to insure
lives and to grant annuities. In a considerable number of States the
companies were authorized to insure the fidelity of persons in positions
of trust and in some States to insure titles to land. Almost all the
companies were empowered to do a safe-deposit business. Among these
powers there was a certain apparent connection. The power to insure the
fidelity of trustees, administrators, and executors seemed a natural
addition to the powers of a company which might act in such capacities.
Similarly, it appeared that the business of insuring titles to land was
one which could be most economically conducted by a corporation which,
in its capacity of trustee, would be a large owner of real estate.

One other power was given to practically all the companies--the power to
receive deposits of money in trust. The following quotation from the
Report of the Massachusetts Commissioners of Savings Banks for 1871
shows the use which it was expected would be made of this power:

The trust company in Worcester and the New England Trust
Company in Boston, both in successful operation, are the
first of such corporations established in this State. They
were incorporated after a very careful investigation by the
legislature, with power to hold money in trust, and so
restricted in making loans and investments as to afford the
safety which the character of their business requires. A
similar institution will soon be organized in Northampton,
and others are contemplated. They are well calculated to
promote public interests by affording to the owners of
capital not engaged in business many of the advantages
secured by our savings-bank system for the savings of labor.

The development of the trust company as reflected in the legislation
with reference to its powers shows two main tendencies: (1) The
companies have to a very large extent given up the insuring of the
fidelity of persons in positions of trust and the guaranteeing of land
titles. (2) They have largely increased their banking activities.

1. In some States which formerly authorised trust companies to insure
the fidelity of persons in positions of trust, or to guarantee titles to
real estate, the more recent laws do not permit the combination of such
business with the business of a trust company.

The fidelity insurance business during the past twenty years has been
largely concentrated in the hands of a comparatively small number of
companies which have agencies in all parts of the country and which do
not undertake a trust or banking business. The elimination of fidelity
insurance from the functions of the trust company has not been chiefly
or even largely due to adverse legislation, but to the nature of the
fidelity insurance business. The most successful conduct of that
business appears to require, like other kinds of insurance, that the
risks shall be numerous and widely distributed. These conditions are
best met by companies which carry on business in many different places.

For the most economical conduct of the title insurance business an
expensive plant is necessary. The business in each city tends therefore
to fall into the hands of a single company, which ordinarily finds it
profitable to devote itself entirely to the one kind of business. At the
present time, only a very small part of the trust companies in the
United States insure titles to land.

2. The second great tendency in the development of the powers of the
trust company--the enlargement of its banking powers--has also been
primarily an economic development and not one due to legislative design.
As has already been noted, the early trust companies ordinarily had
power to receive trust deposits and to loan money. Some such powers were
necessary for the exercise of their trust functions. The opportunity to
enlarge the banking powers of the companies lay in the difficulty of
distinguishing clearly between the powers which it was intended to
confer upon the trust companies and the banking powers possessed by
state and national banks.

In the greater number of the States the wording of the sections
conferring powers to do a trust business was such that the trust
companies were either held by the courts to be empowered to do a banking
business, or, if the power to do such business seemed not to be granted,
were able by some change in the method of doing the kind of banking
business in question to bring it within the powers actually conferred.
In Missouri, for instance, since 1885 trust companies have been
empowered to "receive money in trust and to accumulate the same at such
rate as may be obtained or agreed upon or to allow such interest thereon
as may be agreed." The supreme court of Missouri in construing the power
thereby conferred has held that a trust company can take only
interest-bearing deposits, but that such deposits may be demand deposits
payable on check. The rate of interest may, however, be nominal.

In other States the trust companies have attained legal recognition of
their banking powers by slow steps. The history of the Pennsylvania
trust companies affords an illustration. In the Pennsylvania general
corporation act of 1874 no provision was made for the formation of trust
companies, but provision was made for the incorporation of
title-insurance companies. By an amendment to the corporation act in
1881 title-insurance companies with a capital of at least $250,000 were
given trust and fidelity-insurance powers; but it was expressly provided
that such companies were not authorized thereby to do a banking
business. In 1885 the trust companies were given the power to receive
upon deposit for safekeeping valuable property of every description, and
in 1895 trust companies were given power to "receive deposits of money
and other personal property and to issue their obligations therefor ...
and to loan money on real and personal securities." In 1900 the United
States circuit court of Pennsylvania decided that Pennsylvania trust
companies might legally receive demand as well as time deposits.
Pennsylvania trust companies apparently even now cannot discount
commercial paper, but they may loan on it as collateral and may purchase
it from the holder.

The States in which the banking powers of the trust companies have been
most narrowly restricted are Iowa, Michigan, Nebraska, and Wisconsin. In
Nebraska a trust company cannot do a banking business. In Iowa trust
companies cannot do a banking business except that they may receive time
deposits and issue drafts on their depositories. In Michigan trust
companies are expressly forbidden to do "a general banking business."
The Michigan commissioner of banking in his report for 1906 complained,
however, that the law was not clear as to the banking powers of the
companies. In Minnesota the trust companies may receive trust deposits,
but may not "engage in any banking business except such as is expressly
authorized for such a corporation." In Wisconsin the extent of the power
of trust companies to receive deposits was much debated until 1909, when
the legislature provided for the incorporation of "trust-company banks,"
which have power to receive time and savings deposits, but do not have
power to receive deposits subject to check.

The result of the two tendencies described above--the elimination of the
insurance powers of the trust company and the addition of banking
powers--has gradually standardized the powers of the trust company,
until at the present time the trust company, as it appears in the
corporation laws of most of the States, may be fairly well defined as a
bank which has power to act in the capacity of trustee, administrator,
guardian, or executor.

In a number of States the legislation concerning trust companies deals
with them explicitly from this standpoint. The Illinois bank act of 1887
provided that any bank might have power to execute trusts by complying
with the trust-company law. In Alabama and Tennessee any state bank may
be appointed and may act as an executor, administrator, receiver, or
guardian. In Mississippi any bank with a paid-up capital of $100,000 may
do a trust-company business. In Georgia any trust company may acquire
banking powers by complying with the laws regulating banks. In Texas
banks may acquire trust-company powers. The same tendency is shown in
the important banking laws enacted in Ohio in 1905 and California in
1909.

The gradual change from the view that the trust company is an
institution of markedly different character from the ordinary bank of
discount and deposit to the view that the trust company is merely a bank
exercising functions additional to those exercised by the majority of
banks has been the chief influence in determining the form of the legal
regulations imposed upon trust companies. As long as the older view
obtained, the regulations concerning trust companies were widely
different from those imposed upon banks; but as the trust company has
increased both the scope and amount of its banking business, the
regulation of the banking business of the trust company has tended to
become assimilated to the regulations imposed upon state banks.

INCORPORATION

Since 1865 state banks and trust companies have been incorporated by the
use of one of three methods: (1) By special charter; (2) under the
"business incorporation law"; (3) under the general banking law. Not
very many of the States have used consecutively all three methods, for
the special charter and the "business incorporation law" were used
contemporaneously in different sections of the country. Both have given
place, in the great mass of States, to the general banking law. From
1865 to 1875 probably the greater number of the banks formed were
incorporated under special acts; from 1875 to 1887 incorporation under
the "business incorporation law" was the prevailing method, and since
then the general banking law has become the almost universal method of
incorporating banks and trust companies.

CAPITAL AND SURPLUS REQUIREMENTS

When the States began to give attention to the regulation of the banking
business the question of capital received immediate attention. The
national-bank act and the banking laws in New York and the Middle West
which had survived from the antebellum period contained provisions
concerning the amount and payment of capital. A requirement with regard
to capital was recognized as the central point in any system of bank
regulation. The capital stock is a buffer interposed between the bank's
creditors and losses which the bank may suffer. If there is no capital,
losses may fall directly on the creditor, and the larger the capital
stock, other things being equal, the less the likelihood of loss to the
depositor.

The States and Territories may be divided roughly into two groups
according to the amount of the smallest permissible capital for state
banks:

1. In the Eastern States and the more easterly of the Middle Western
States, the banking laws, with one exception, require that banks shall
have a capital of at least $25,000.

2. In the other sections of the United States banks in most of the
States are incorporated with a capital as small as $10,000, although in
a few of these States the smallest permissible capital is $15,000,
$20,000, $25,000, and $30,000, and in one, North Carolina, it is $5,000.

The amount of capital required, except in a few States, is not a uniform
amount, but is graded, usually according to the size of the city in
which the bank is located. In 29 of the 37 States and Territories which
require under a general law a specified amount of capital for the
incorporation of state banks the amount of capital is thus graded. The
grading of the amount of capital required according to the population of
the place in which a bank is located has been chiefly due to the desire
to bring about some adjustment between the capital of each bank and the
volume of its business. It is assumed that the larger the business of
the bank the greater the chance of its suffering large losses and the
larger the capital necessary to protect its depositors against loss. It
is also assumed that the size of the city in which it is located is a
rough index of the volume of business done by a bank. Under many of the
state banking laws the grades are very numerous. The minute gradation of
the capital requirements found in many of the state banking laws is due
to the desire to encourage the formation of banks in the smaller cities
and towns, for it is to be noted that in the greater part of the state
laws the grades are not numerous for the larger places.

Obviously, if any law requiring a minimum capital for banks is to be
effective, it must provide specifically for the payment either of all
the capital or of a specified sum; otherwise the directors of the bank
may require the payment of only a small part of the capital. The
provision in the national-bank act concerning the payment of capital has
been the model for similar provisions in the banking laws of a large
number of the States. Many of the state banking laws likewise contain
the same provision as the national-bank act with reference to surplus.

In several States the laws make no provision with reference to the
amount of capital required for a trust company. In Connecticut,
Delaware, New Hampshire, and Vermont, trust companies are incorporated
only under special acts and the amount of their capital is determined in
each particular case by the legislature. In Rhode Island trust companies
are incorporated by a board which has power to fix the terms of
incorporation, including the amount of capital.

The first general laws for the incorporation of trust companies in the
United States required such companies to have a much larger capital than
that required for banks, but the later legislation shows a distinct
tendency in the direction of lowering the requirements in regard to
capital. In nearly all of the States, however, the requirement for trust
companies is still substantially different from that for state banks.
The smallest permissible capital for a trust company ranges from $5,000
in North Carolina to $1,000,000 in the District of Columbia. The
majority of the States, which provide that trust companies must have a
specified minimum capital, do not permit the organization of trust
companies with a smaller capital than $100,000.

In only one State, Iowa, is the smallest permissible capital less for
trust companies than for state banks; in six States it is the same; in
all the others it is larger. The accumulation of a surplus is not
required in so many States for trust companies as for banks.

LIABILITY OF STOCKHOLDERS

With the practical prohibition of the issue of state bank notes in 1866
and the consequent decrease in the number of state banks, the liability
of stockholders in state banks became in nearly all of the States,
except where an additional liability was imposed by the constitution,
the same as that of stockholders in ordinary business corporations.
Since 1880, however, provisions imposing an additional liability on the
stockholders of banking corporations have been placed in the banking and
trust-company laws of nearly all the States in which state banks or
trust companies have assumed any great importance. In the larger number
of the States and Territories the liability is a proportionate one, and
the stockholders are responsible "equally and ratably and not one for
another."

The imposition of the statutory liability on the stockholders of state
banks and trust companies has not proved of great service as a
protection to bank creditors against loss. As yet little has been
accomplished in the way of making the enforcement of the liability
effective.

RESTRICTIONS ON LOANS AND DISCOUNTS

The desirability of some legal limitation on the extent of the liability
to a banking institution which any one person, firm, or corporation may
incur is largely due to the fact, that, since the American banking
system is a system of independent banks, the resources of many of the
banks are necessarily small in comparison with the needs of some of
their customers for loans. A large manufacturing concern located in a
small town may very well be able to use all the assets of the local
bank. If the local bank were the branch of a larger bank, the mere fact
that a large loan was wanted by a manufacturer in a small town would be
of no significance, since the amount of the loan would be small compared
with the total assets of the bank.

Moreover, in many banks a controlling interest is held by a person,
firm, or corporation that is actively engaged in other business
enterprises. Such control is far more likely to be found in small banks
than in large, and in a system of independent banks than in one of
branch banks. One consequence of the close identification of interest
thus brought about between banking and other business enterprises is the
probability that loans will be made directly or indirectly to some one
borrower to an amount larger than a proper distribution of risks would
justify.

The national-bank act in its original form provided that the total
liabilities to any national bank of any person, company, corporation, or
firm for money borrowed should not exceed one-tenth of the amount of the
paid-in capital stock of the bank. The liabilities of the members of the
firm or company were to be included in the liabilities of the firm or
company. It was provided, however, that "the discount of bills of
exchange in good faith against actually existing values and the discount
of commercial or business paper actually owned by the person negotiating
the same" should not be considered as money borrowed. This section of
the national-bank act remained unchanged until 1906, when it was amended
so as to permit a single liability to be contracted equal to one-tenth
of the capital and surplus, instead of one-tenth of capital only, but it
was also provided that the liability should not, in any case, exceed 30
per cent. of the capital stock.

In the banking laws of seven States the limit on the amount of single
liability is the same as under the national-bank act. The banking laws
of almost all the other States permit a larger amount to be loaned on a
single liability than is permitted by the national-bank act.

In nearly all of those States in which trust companies have acquired
full banking powers the provision limiting the amount of any single
liability applies to both banks and trust companies. In only one State
or Territory--New Mexico--is there such a provision for trust companies
and none for state banks. In a few States--Kansas, Michigan, Minnesota,
Missouri, Montana, Oklahoma, New Jersey, Nebraska, and Wisconsin--there
are limitations on the amount of a single liability for banks, but none
for trust companies.

LOANS TO DIRECTORS AND OFFICERS

In almost all the banking institutions of the United States the
directors or a part of them are actively engaged also in other business
enterprises; and in many cases they borrow from the banks or trust
companies in which they are directors. Moreover, in some banks one or
two of the directors own a controlling interest, and are at the same
time large borrowers. The possibility, in such cases, that larger loans
may be made than the credit of those directors warrant is very
considerable. The national-bank act contains no provisions regarding
loans to directors, but in the laws of about one-half of the States
attempts have been made to devise rules which would prevent the making
of loans to directors in excess of the amount to which their credit
entitles them. The requirement that loans to directors shall be formally
approved by the board of directors is the one most frequently found. It
has been thought that directors would be reluctant to vote for excessive
loans to other directors if their vote is to be recorded.

REAL ESTATE LOANS

There is no more characteristic difference between state banking laws
and the national-bank act than the fact that, in almost all the States,
state banks and trust companies may make loans on the security of real
estate, whereas national banks are [were] prohibited from doing so
[before the passage of the Federal Reserve Act]. In some States, where
the influence of the example of the national-bank act was strong enough
at the beginning of state-bank regulation to secure the insertion in the
state banking laws of the prohibition of real estate loans, it has later
been found desirable to amend the laws in this respect. The Pennsylvania
general banking law of 1878, for instance, did not permit banks to loan
on real estate, but was amended in 1901, so as to permit such loans to
be made. In North Dakota and South Dakota, also, similar changes have
been made in the banking laws. In 1910 trust companies in all the States
and Territories where incorporated under general laws were allowed to
loan on the security of real estate. State banks so incorporated may
also loan on real estate in all the States and Territories except New
Mexico and Rhode Island. In Rhode Island, however, banks may loan on
real estate part of their savings deposits.

A few of the state banking and trust-company laws contain provisions
limiting the amount which may be invested in real estate loans.

Not withstanding the disadvantages of real estate as a convertible
asset, the power to loan on the security of real estate is a valuable
one to many of the state banks.[142] Many banks, particularly those in
the smaller towns and cities, if restricted to loans on personal
security, find it difficult to fully employ their funds. There are not
sufficient local loans of this kind to employ all the funds of the bank;
and the amount not so employed, if it is to yield a revenue, must either
be invested in outside commercial paper or deposited with banks in the
great commercial cities.

RESERVES

In most of the antebellum state banking laws reserves were required only
against note issue. In Ohio, for example, the general banking law
required a reserve of 30 per cent., against circulation, but none
whatever against deposits. Several of the state banking laws which
survived the destruction of the state bank-note issue contained,
however, provisions requiring banks to hold a reserve against deposits;
but in none of these States was the increase in the number of state
banks important. In those States in which the state banks were organized
under the "business incorporation laws" there were, of course, no
reserve requirements. Until 1887 a reserve was required for state banks
in only three States, Ohio, Minnesota, Connecticut, and in these the
required reserves were small. Even since the revival of state bank
regulation, which began in 1887, the requirement of a reserve has not
been regarded in many of the States as an important part of the state
banking law.

The most striking and important difference between the reserve required
by the national-bank act and the reserves required by the state banking
laws is that under the national-bank act the reserve is a percentage of
"deposits"--_i. e._, of all deposits--while under the banking laws of a
majority of the States either no reserve is required against time or
savings deposits, or a smaller amount of reserve is required than
against demand deposits.

None of the state banking laws require that the reserve of any class of
banks shall consist wholly of cash in bank. All the laws permit balances
in other banks to be counted at least as a part of the reserve. There
are great differences among the laws, however, with respect to the
amount which may be so counted.

The laws in all the States leave the banks almost entirely free to
deposit their funds in banks in the great commercial centres. The strong
economic pressure toward concentration is thus left free to act toward
drawing reserves into banks located in the reserve and central reserve
cities.

In the greater number of States which incorporate both state banks and
trust companies the reserve requirement is the same for both classes of
credit institutions. Slight differences between the requirements for
trust-company reserves and those for state-bank reserves are chiefly of
two kinds. In the first place, the provisions for trust-company reserves
more frequently permit the counting of bonds as a part of reserve;
secondly, the provisions for differing amounts of reserve against time
and demand deposits.

In recent years there has been much complaint in some States that the
reserves required for trust companies are inadequate.

BRANCH BANKS

The most characteristic feature of American banking is the extent to
which the banks and trust companies are independent institutions. The
national-bank act makes no provision for the establishment of branch
banks except in cases of the conversion of state banks which already
have branches. Such banks are allowed to retain their branches on
condition that the capital is assigned to the mother bank and the
branches in definite proportions, but only a few national banks have
branches. Under none of the state banking laws has there been built up
an important system of branch banks. This has been partly due to the
very general desire of each American community, no matter how small, to
have its bank managed by its own citizens, and partly to the fact that
in most of the States the establishment of branch banks is either
explicitly forbidden or in no way provided for by law. In eight
States--Colorado, Connecticut, Mississippi, Missouri, Nevada,
Pennsylvania, Texas, and Wisconsin--the opening of branch offices is
forbidden by specific enactment. In a large number of other States the
banking laws make no provision for the establishment of branches, and it
has been held in most of these States that the opening of branch offices
is unlawful.

The States in which state banks and trust companies are definitely
permitted to have branches are California, Delaware, Florida, Georgia,
New York, Oregon, Rhode Island, Virginia, and Washington. In Louisiana,
Maine, and Massachusetts trust companies may have branches. In Maryland
and North Carolina branches are operated by some banks and trust
companies which were chartered by special act. There are in several of
these States, however, restrictions on the opening of branch offices. In
New York and Massachusetts branches may be established only in the city
in which the principal office of the bank or trust company is located.
In New York, moreover, only banks located in a city of 1,000,000
inhabitants or over may have branches; but any trust company may have
branches. In Maine a trust company may establish branches only in the
county in which it is located or in an adjoining county.

In nearly all the States which permit banks or trust companies to
establish branches one or both of two conditions are imposed. In the
first place, additional capital is required for each branch bank over
and above the amount of the parent bank. Secondly, the establishment of
a branch bank must be specifically authorized by some state official or
officials.

The number of branches of banks and trust companies cannot exceed a few
hundred in the entire United States. Compared with the total number of
banks and trust companies this is a small development. Moreover, the
most important affiliations among banking institutions are among those
located in the same city. The "chains" of country banks possess, for the
most part, little vitality, and in the total banking business of the
country they play an insignificant rôle. The great mass of state banks
and trust companies are independent institutions. The most enduring
affiliations at present existing among the banking institutions are
those between a national bank and a trust company or a state bank and a
trust company. The comparatively limited powers of the national banks
and in some States of the state banks have made it desirable for many of
these institutions to affiliate trust companies with themselves in order
that desirable business may not be lost.

FURTHER REASON FOR THE LACK OF BRANCH BANKS IN THE UNITED STATES

[143]It would seem that there must be a reason for this peculiarity [the
small number of branches] in the banking system of the United States. In
searching for this reason, the first fact of importance seems to be
that, although the organization of branches has been permitted to the
non-note-issuing banks in some of the States, they have not been
organized, while in other countries they have been established in nearly
every case. by note-issuing banks. This seems at once to indicate that
in places where notes are the most important medium of exchange a
connection of some sort exists between the issue of notes and the
establishment of branches.

The inducement to the establishment of branches by banks is, of course,
the possibility of profit. But as has already been frequently pointed
out, profit can be obtained only by making loans. These when greater
than the amount of the capital, as it is necessary that they should be,
can be made by the loan of funds left with banks by others or by the
issue of circulating notes. It is also clear that, were the
possibilities of loaning beyond the amount of the capital wholly or
chiefly confined to one of these forms of liability--the other being
unavailable, as in the case of the state bank notes whose issue is
prohibited by the 10 per cent. tax--and were this other form distasteful
or impossible of introduction among the community where the branch was
to be established, the motive for the creation of the branch would be
absent. This motive has been wanting in many parts of the United States.
By the laws of the United States, the issue of notes has been made
impossible to all save national banks, and the capital of these banks
has been limited to $50,000 as a minimum. Banks other than national
must, therefore, be established under state laws, some of which have
permitted the organization of such institutions with capitals as low as
$5,000 or $10,000. They can, however, make use only of deposits as a
means of loaning beyond the amount of their capital. But deposits do not
provide a desirable form of currency for use in country districts. It
follows, therefore, that the state-bank systems supply the deficiencies
of the national system only in so far as they furnish independent banks
of smaller capital than $50,000 ($25,000 since 1900).

Nor would it have been of material assistance had the organization of
national banks of capitals smaller than $50,000 been allowed. As the
system has worked out, the issue function has been a useless one. The
compulsory deposit of bonds to secure circulation has hampered the banks
in exercising this function, since the requirement to deposit bonds now
cuts off all profit arising from the issue of notes. Moreover, the rural
communities are those where interest is highest, and hence where notes
can least advantageously be issued under the present system of
bond-deposit, owing to the high price of the bonds. These difficulties
probably cannot be overcome by the establishment of banks of lower
capitals than now exist.

[144]At the 1910 convention of the Alabama Bankers' Association, held in
Birmingham in May, one of the speakers, whose topic was "State Banks and
Their Branches," closed a condemnatory address with the words: "We
believe the days of the branch bank are numbered." Two months later, at
Cooperstown, Hon. E. B. Vreeland told the bankers of New York State, at
their convention: "No one will ever live to see the day when the branch
banking system which prevails in Canada and in Germany and in England
and in France will be tolerated by the people of the United States."...
"The economies of the branch banking system are such that no other
system can live beside it. It is just as sure as the sun will rise
to-morrow that the branch banking system, if taken up in the United
States, would in the end drive out of existence all the banks in every
city and town in the country outside of the great financial centres.
That is the experience of the world."

If this statement means anything it is a confession that the system of
local single-office banks is wasteful in operation, and it seems to me
that it sets forth one reason why branch banks are inevitable. When a
banking system is wasteful it is the stockholders, borrowers, and
depositors who suffer from the circumstance, and as soon as they realize
the fact its doom is sealed.

It should be said here that it is not their economical operation alone
that has enabled the branch banks to displace the small local banks in
England, Germany, and France. The branch institutions are cleaner, more
efficient, and they provide better opportunities for the clerks and
officers; they give a better and more complete service to the localities
in which they work.... Another reason is found in their stability during
crises....

THE NEW YORK STATE BANK ACT OF 1914[145]

In June, 1913, George C. Van Tuyl, Jr., superintendent of banks of the
State of New York, appointed a commission to look into the banking
conditions of the State and to make a thorough revision of the law
relating to banks. This commission conducted many public hearings;
sought information from banking experts in this State and in other
States; made a careful study of private banking conditions, rural
credits, and other special banking problems of the State; and, finally,
on February 25, 1914, they presented their report in the form of a bill
of some 500 pages. After a good many amendments had been made to appease
conflicting interests, the bill was passed and became law April 16,
1914.

In general, the new law marks a decided improvement and shows a
commendable spirit of progressiveness. Its framers believe that it is a
law which may well become the model for other States, and there are some
who say that it is without question the best balanced and most
comprehensive state banking legislation which has ever been enacted.

The new law was the outgrowth of the general agitation for banking
reform which had swept over this country following the panic of 1907.
The inciting cause, however, was the passage of the Federal Reserve Act
which made it necessary to revise the state law so that the state banks
either might join the federal system or be in a position to compete
successfully against the national banks of the State, whose powers had
been considerably enlarged by this act. In part, the law is modelled
after the federal act, and, in part, European experience has been drawn
upon.

Under the new law the state banks will have even more importance in the
competition for banking business than in the past. From the point of
view of banking power, the 278 banks of deposit and discount and trust
companies have aggregate deposits in excess of those of the 479 national
banks in the sum of $281,786,000.[146] Furthermore, it has been
estimated that the total resources of the New York state banks are
equivalent to 17 per cent. of the aggregate resources of all banks in
the United States, both state and national. Superiority in banking power
is one element in the strong competitive position of the state banks,
and another element is the privileges granted to these banks under the
new law which, in some respects, are superior to those granted the
national banks under the federal law. In view of the fact that the state
banks can enjoy either directly or indirectly most of the advantages of
the federal system and also that in some particulars the state law gives
them more liberal powers, it seems probable that these banks will
continue to see an advantage in their state charters; and thus the
amount of defection from the state system will be negligible.

More real power has been given to the banking department in the
provisions of the law. Through investigation, authorization
certificates, and regular uniform reports, the superintendent of banks
has more direct control over the banks than ever before. Besides the
extension of the supervisory powers, the penal provisions of the act
have been strengthened and made more exacting.

1. _Features of the act relating to banks of deposit and discount and
trust companies._ The reserves required against deposits were reduced
substantially, and made nearly uniform with those required for national
banks. The following table gives the percentage of reserve required and
the percentage of reserve on hand which the new law specifies for these
banks.

------------------------+---------------------+--------------------------
|Banks of deposit and |
| discount | Trust companies
|Per cent. of deposits| Per cent. of deposits
------------------------+----------+----------+----------+---------------
Population | Required | Reserve | Required | Reserve
| reserve | on hand | reserve | on hand
------------------------+----------+----------+----------+---------------
2,000,000 or over | 18 | 12 | 15 | 10
1,000,000-2,000,000 | 15 | 10 | 13 | 8
Elsewhere in the state | 12 | 4 | 10 | 4 or 3
------------------------+----------+----------+----------+---------------

The reserve requirements are made still more definite by the fact that
the law compels the banks to keep one-half at least of the reserve on
hand in "gold, gold bullion, gold coin, United States gold certificates,
or United States notes: and the remainder in any form of currency
authorized by the law of the United States other than federal reserve
notes."

Among the powers granted to these banks is the power "to accept for
payment at a future date, drafts drawn upon its customers and to issue
letters of credit authorizing the holders thereof to draw drafts upon it
or its correspondents at sight or on time not exceeding one year." This
clause gives a much wider power to the state banks in the important
matter of acceptances than its counterpart in the Federal Reserve Act.
In the one case both domestic and foreign acceptances may be made and
handled without stipulation as to aggregate amount and bearing
maturities of one year or less, while in the other case the acceptances
are limited to those arising out of the importation or exportation of
goods with maturities not exceeding six months. Seemingly, the state
banks have the advantage, and to this extent the state law is superior
to the federal act.

One other important forward step was taken in relation to this group of
banks. They are given the privilege of establishing branches outside
the State of New York, either in the United States or in foreign
countries. This privilege is qualified, however, by the provision that
no bank can establish such branches unless it has a combined capital and
surplus of $1,000,000 or over and the written approval of the
superintendent of banks. Although the old law permitted trust companies
to establish branches in the place where they were incorporated, the
practical effect was to limit branch banking to the city of New York. In
this particular also the state banks have the advantage over the banks
in the federal reserve system which are allowed to establish branches
only in foreign countries.

2. _Features relating to private banks and bankers._ The regulation of
private banks and bankers is an entirely new departure in the law of
this State. In the past the banking department had no authority to
supervise that relatively large number of private bankers who receive
deposits in small amounts from the wage-earning classes while conducting
in connection therewith a mercantile or some other kind of business.

Mercantile firms like the Siegel Company, by paying a higher rate of
interest upon deposits than savings banks, were able to obtain the
savings of many small depositors. This money was invested in the
business and secured only by the capital stock of the mercantile
establishments. In case the firm failed there was no security back of
these deposits but these same shares of stock, and so depositors were
fortunate if they received in settlement even 40 per cent. of their
claims. Such firms were not doing a legitimate banking business inasmuch
as they did not keep their assets in liquid form and carried no reserve
against deposits.

The new act corrects this situation by giving the banking department
authority to conduct independent investigations into any violation of
the banking law by a corporation or individual. In the future a
corporation which is in any way engaged in the business of banking
cannot hide under the wing of the general corporation law when the
banking department sees fit to make an investigation of its affairs.

Some of the specifications of this part of the law are all securities,
property, and the evidences of title thereto in which the permanent
capital and the deposits are invested are to be segregated and kept
separate from all other property and assets of the private banker;
depositors have a prior lien on the assets of the private banker, in
case of insolvency or suspension of business; and, in addition, every
private banker must maintain a reserve of 15 per cent. against deposits
in cities of the first class and a reserve of 10 per cent. in any other
city, one-tenth of which shall consist of reserve on hand and the
remainder may be kept on deposit subject to call with banks approved by
the superintendent of banks. These requirements will go far toward
preventing the recurrence of such disasters as the Siegel failure.

3. _Features relating to co-operative credit._ Within the last thirty
years the agricultural methods of the State, in harmony with the
agricultural methods throughout the United States, have undergone great
changes. Scientific farming, improved machinery, and changed market
conditions have brought new problems in the field of agricultural
credit. To-day agriculture has come to be in a real sense capitalistic
and has in consequence laid new requirements on the credit structure of
the nation. Moreover, the period of large returns or satisfactory
returns from an extensive and rather careless cultivation of the soil,
which made possible an ignoring of unit cost, or, at least, brought the
farmer to minimize the importance of such cost, has given way, so far as
the successful farmer is concerned, to the careful estimates of cost and
close calculations of profits on a narrow margin between unit cost and
unit selling price.

In the field of cost, the rate at which capital or money may be borrowed
is no small factor; and with the high rates prevailing in the United
States in comparison with those current in Europe, the borrower in this
country who pledges his land or agricultural products as security for a
loan finds himself at a disadvantage. To meet this condition cheaper
agricultural credit has been strongly urged. Europe furnishes the
example in her well-organized land banks and co-operative credit unions.
Already Massachusetts has a law authorizing co-operative organizations
for furnishing cheaper credit facilities to the agriculturalist, and in
Illinois there is a "crédit foncier" which has been in successful
operation a number of years. New York State has put itself in line with
this growing movement to furnish ample and cheaper credit to the farmer
and the purchasers of real estate by putting into the new law provisions
for the establishment of a land bank and co-operative credit unions.

Sections 421-438 authorize ten or more savings and loan associations,
the aggregate resources of which shall not be less than $5,000,000, to
form a Land Bank of the State of New York. This bank can "issue, sell
and redeem debenture bonds secured by bonds and first mortgages made to
or held by member associations" and "invest its capital and other funds
in bonds secured by first mortgages on real estate situated within the
territory in which its members are authorized to make loans." The bank
is not permitted to do a general deposit business or incur any
indebtedness upon notes and bonds in excess of twenty times the amount
of its capital. The debenture bonds authorized by the act are to be
issued in series of not less than $50,000, and may be called on any
interest day at 102-1/2 provided a sixty-day notice is given.
Amortization payments upon mortgages which are given as collateral
security for the debentures of the land bank shall be sufficient to
liquidate the debt in a period not exceeding forty years.

In Article XI the law provides for the establishment of credit unions. A
credit union may be organized by any seven or more persons with a share
capital the par value of which shall not exceed $25. The objects of the
credit union are: (1) to loan money in small amounts on personal
security or in larger amounts on endorsed notes at rates not exceeding 1
per cent. per month, inclusive of all charges incident to the making of
such loans; (2) to receive the savings of its members in payment of
shares on deposit; (3) to borrow money to an amount not to exceed 40 per
cent. of its capital; (4) to pay dividends on its share capital. As to
the method of making loans, the law prescribes that a credit committee
shall pass upon all applications for loans which must be made in writing
and must state the purpose for which the loan is desired and the
security offered. No loan will be made unless it receives the unanimous
approval of the members of the committee present at the meeting,
provided always a majority of the committee is present.

With the land bank acting as a central clearing agency for the local
savings and loan associations and the organization of many rural credit
unions the problem of agricultural credit will be largely solved for New
York State. This, however, all hinges on the proper functioning of the
land bank and the co-operation of the farmers in the establishment of
local credit unions. Agriculturists as a class are slow to adopt new
methods and it may be only after prolonged education that all the
possibilities of this new legislation will be realized.

FOOTNOTES:

[140] Adapted from George E. Barnett, _State Banks and Trust Companies
since the Passage of the National Bank-Act_, Publications of the
National Monetary Commission. Senate Document No. 659, 61st Congress,
_Second Session_.

[141] [At least one savings bank has gained admittance to the Federal
Reserve System as a "state" bank.]

[142] According to reports to the National Monetary Commission on April
28, 1909, the loans of all the state banks in the United States on the
security of real estate were 20.6 per cent. of their total loans and
discounts.

[143] _The Report of the Monetary Commission of the Indianapolis
Convention_, pp. 377-8. The University of Chicago Press. 1898.

[144] Adapted from H. M. P. Eckardt, _Branch Banking Among the State
Banks_, The Annals of the American Academy of Political and Social
Science, Vol. 36, No. 3, November, 1910 pp. 626-630.

[145] Adapted from Everett W. Goodhue, _The Revision of the New York
State Banking Law_, The American Economic Review, Vol. V, No. 2, pp.
413-421.

[146] Annual Report of the Superintendent of Banks of the State of New
York, Jan. 6, 1915, p. 33.

CHAPTER XXI

THE CANADIAN BANKING SYSTEM

[147]Financially, Canada is part of the United States. Fully half the
gold reserve upon which its credit system is based is lodged in the
vaults of the New York Clearing House. In any emergency requiring
additional capital Montreal, Toronto, and Winnipeg call on New York for
funds just as do St. Paul, Kansas City, and New Orleans. New York
exchange is a current and universal medium in Canada and is in constant
demand among the banks. A Canadian wishing to invest in securities that
may be quickly marketed commonly turns to the New York market for stocks
and bonds. Yet the American banker visiting in Canada, if he is
unacquainted with the history of banking in his own country, finds
himself in a land of financial novelties, for Canada has a banking
system unlike any in operation in the United States at the present time.
Twenty-nine banks, known as the "chartered banks," transact all the
banking business of the Dominion. They have 2,200 branches, and each may
establish new branches without increase of its capital stock. [At the
close of the year 1915 there were twenty-two banks with approximately
3,200 branches.] They issue notes without depositing security with the
Government and in such abundance that no other form of currency in
denominations of $5 and above is in circulation. Notwithstanding the
fact that the notes are "unsecured," their "goodness" is unquestioned
among the Canadian people.

THE SYSTEM NOT NEW

But to the student of the history of banking in the United States there
is little that is radically new in the Canadian system. He finds in it
many of the practices and expedients that were found excellent in the
United States in the first half of the nineteenth century, and is almost
persuaded that but for the Civil War what is now known as the Canadian
banking system would everywhere be called the American system.

The fiscal exigencies of war, which have caused changes in the banking
systems of most countries, have had no influence upon the development of
banking in Canada. During the first half of the nineteenth century the
commercial and financial interests of Canada and the United States were
comparatively intimate and the financial institutions of both countries
developed on similar lines. The safety-fund system, first introduced in
the State of New York in 1829, found favor also in Canada and is still
an integral part of the Canadian banking system. Branch banking, which
was most successfully illustrated in this country by the State Bank of
Indiana, and which now exists in some form or other in almost all
countries except the United States, has always prevailed in Canada. The
importance of a prompt redemption of bank notes as exemplified in the
old Suffolk banking system in New England before the war, was fully
realized in Canada and is probably better illustrated in the present
Canadian system than in any other country. There bank notes and bank
checks are treated as identical in nature, both being cleared with the
same regularity and promptness. The so-called free banking system, which
was first adopted in the State of New York in 1839 and thereafter
adopted by eighteen other States of the Union, was tried in Canada in
the fifties, but not on a large scale. This system, requiring that
issues of bank notes should be secured by a segregated deposit of
certain classes of stocks and bonds, has never met with approval among
the leading bankers of Canada.

The Canadian system is a product of evolution. It has taken its present
form because of the commercial and financial needs of the Canadian
people. It was not created by lawyers or statesmen to meet a fiscal need
of the Government, but has grown up gradually under the fostering care
of experienced bankers, no changes having been made until experience
proved them necessary or advisable.

The chartered banks transact the business which in the United States is
divided among national banks, trust companies, private banks, and
savings banks. They buy and sell commercial paper, discount the notes of
their customers, lend money on stocks and bonds, make advances to
farmers, and sometimes aid in the financing of railroads and industrial
enterprises. To a Canadian the word "bank" means one of the twenty-odd
"chartered banks," for the law prohibits the use of the word "bank" by
any other institution.

OTHER FINANCIAL INSTITUTIONS

The only other financial institutions in Canada which possess much
importance are the mortgage and loan companies. These usually operate
under charters granted by the provincial legislatures and do a business
similar to that of the farm and mortgage companies which once flourished
in the United States, making loans to farmers for a term of years and
taking farm mortgage for security. They also make loans upon urban and
suburban real estate and thus aid in the upbuilding of the cities and
their suburbs. The business of these institutions is made possible by
the fact that the bank act does not permit the chartered banks to accept
loans secured by real estate.

The Dominion Government maintains a double system of savings banks. One
set is managed by the post-office department, every post-office
receiving deposits. The other set is managed by the finance department.
The post-office department also sells annuities and old-age pensions.
The money received through the savings banks is regarded as a loan from
the people and is used, like money obtained by taxation, in the payment
of the Government's general expenses. The Government is required to
carry a gold reserve of 10 per cent. against the savings deposits, but
no assets are set aside for their security. The chartered banks pay the
same rate of interest and get most of the business, for they offer
facilities with which the Government does not attempt to compete. Most
of the Government's deposits come from the poorest and most ignorant
classes, people who in all countries are suspicious of banks. Some of
the Canadian cities maintain municipal savings banks, but they are of
relatively small importance.

Trust companies in Canada are not financial institutions. They are
trust companies in fact as well as in name, their business being to act
as trustee and administrator. A few of them accept deposits, although it
is not certain that they have a right to do so. The bulk of the money
they handle comes to them through the administration of estates and
trust funds.

Private banking firms are almost unknown in Canada, there being only two
or three in the entire Dominion, and these do a mortgage and loan
business rather than a strictly commercial banking business.

Hence, if any one seeks to understand the financial or banking situation
in Canada, he must devote his attention in the main to the chartered
banks. These through their branches furnish the loanable capital
necessary for the support of the Dominion's trade and industry and for
much of its agricultural enterprise. To them the Government turns when
funds are needed for internal improvements or when the exchequer faces a
deficit. The promoters of street railways, steam railways, steam
railroads, and other permanent improvements take counsel with the
managers of these chartered banks before they issue their securities.
The banks as a rule do not invest their funds in the stocks or bonds of
new enterprises, yet their managers are the men most familiar with the
world's money markets and their approval, therefore, of any financial
undertaking is highly esteemed.

THE ESSENTIALS OF THE SYSTEM

A chartered bank in Canada is a bank of branches, not a bank with
branches. The parent bank, technically known as the "head office,"
neither takes deposits nor lends money. All the banking business is done
by the branches, each enjoying considerable independence, but all
subject to the supervision and control of the head office. The law
places no restrictions upon the number or location of branches. Canadian
banks, therefore, have branches in foreign countries as well as in
Canada.

PROCESS OF INCORPORATION

The provisions of the bank act with respect to the organization of new
banks are intended to guard against the entry of unfit or inexperienced
persons into the banking business. The minimum required capital of a
bank is $500,000, of which all must be subscribed and one-half paid in
before a new bank can open. At least five men of integrity and good
financial standing must agree to act as provisional directors and secure
a favorable report on their project from the parliamentary committee on
banking and commerce. These men must agree to subscribe for fairly large
blocks of stock, otherwise the committee will be inclined to reject
their application. They must convince the committee that their project
is a well considered one, that there is need for the new bank. If they
satisfy the parliamentary committee it will be granted. The bank,
however, cannot yet begin business. Provisional directors now have
merely the right to advertise and cause stock books to be opened. If
inside of one year capital stock to the amount of $500,000 has been
subscribed and $250,000 thereof paid in, the provisional directors may
call a meeting of the shareholders, at which a board of regular
directors shall be chosen. Before this meeting is held at least $250,000
in cash must be paid over to the Minister of Finance. The regular
directors must then apply to a body known as the treasury board for a
certificate permitting the bank to issue notes and begin business and
the treasury board may refuse this certificate unless it is entirely
satisfied that all the requirements of the law have been met. Delay on
the part of the treasury board might prove fatal to the new enterprise,
for if a new bank does not obtain a certificate within one year from the
date of its incorporation, all the rights, powers, and privileges
conferred by the act of incorporation cease. These requirements make it
impossible to organize a new bank in Canada with any degree of secrecy.

NOTE ISSUES

Having obtained its charter, a new bank must open its head office in the
place designated, and may then proceed to establish branches or
agencies, upon the number and location of which the law places no
restriction. Under its charter it has authority to issue circulating
notes up to the amount of its unimpaired paid-up capital in
denominations of $5 and multiples thereof. An amendment of the bank act
passed July 20, 1908, gives the bank the right to issue what may be
called an emergency circulation during the crop-moving season (October 1
to January 31). During this period the legal maximum of the circulation
of a bank is its paid-up capital plus 15 per cent. of its combined
paid-up capital and surplus or rest fund. This emergency circulation,
which consists of notes in form and in other respects exactly like the
regular issues, is subject to a tax at a rate not to exceed 5 per cent.
per annum, the rate being fixed by the governor in council. If a bank's
circulation does not exceed its paid-up capital, it pays no tax.

SECURITY OF NOTES

The law is silent on several subjects that seem of great importance to
most bankers in the United States. For instance, it does not require
that the banks shall deposit with a government official, or in any way
set aside any kind of security for the protection of the note holder. It
does not even require that the banks shall carry a cash reserve against
either notes or deposits, nor does the law make the notes a legal tender
for any payment. A bank need not accept the notes of other banks. The
Government does not guarantee the redemption of the notes. Neither does
it bind itself to receive them in payment of dues to itself.

Nevertheless the notes of the Canadian banks are everywhere acceptable
at par, the people apparently not being at all concerned about their
"goodness." And their confidence in the note has been well justified,
for nobody since 1890 has lost a dollar through the failure of a bank to
redeem its notes. Following are the legal requirements, which for twenty
years have proved adequate protection for the note holder:

1. Every bank must redeem its notes at its head office and in such
commercial centres as are designated by the treasury board. The
redemption cities are the same for all the banks. They are Toronto,
Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown.

2. Each bank must keep on deposit with the Minister of Finance a sum of
lawful money (gold or Dominion notes) equal to 5 per cent. of its
average circulation; the total so deposited is called the "circulation
redemption fund." It is a guaranty or insurance fund for use, if need
be, in the redemption of the notes of failed banks.

3. Bank notes possess first lien upon the assets of a bank.

4. Bank stockholders are liable to an assessment equal to the par value
of their stock.

5. A bank must make to the Minister of Finance on or before the
fifteenth of each month a detailed statement of its assets and
liabilities on the last business day of the preceding month. This
monthly return, the form for which is set forth in the act, must be
signed by three general officers.

6. The Canadian Bankers' Association, an incorporated body of which each
bank is a member, is given supervision by the bank act of the issue and
cancellation of notes and of the affairs of a failed bank.

7. The notes of a failed bank draw interest at 5 per cent. from the date
fixed for their redemption by the Minister of Finance, who may redeem
them out of the assets of the bank or out of the "circulation redemption
fund."

IMPORTANCE OF REDEMPTION

Each of these provisions of the law has its value and significance, but
only the first is absolutely essential to the successful operation of
the system. All the other provisions might be changed or abolished
without impairment of the efficiency of the banking system. But the
abolishment of this redemption system would at once give Canada a new
banking system. The bank note is _almost the sole circulating medium_ in
Canada, and the people have confidence in it because it is tested every
day at the clearing houses and proves itself as good as gold. This daily
test would probably not take place with the same regularity as now if
the banks did not have branches or if they were obliged to deposit
security against their issues. Canadian banks are national, not local
institutions. All but a few of them have branches in every part of the
Dominion, and these branches, as fast as they receive the notes of other
banks, either send them in to the nearest redemption centre or convert
them into lawful money--or its equivalent, a bill of exchange--through
branches of the issuing banks located in the same towns. Each bank is
seeking, through its branches, to satisfy all the legitimate needs of
the people for a circulating medium. When the note of a bank is in
circulation it is earning money for the bank, but when it is in the
vault or on the counter of the bank it is an idle and useless piece of
paper. Hence every bank always pays out its own notes through its
branches and sends the notes of other banks in for redemption, thus
increasing its own circulation and _strengthening its own reserve_.

Furthermore, if the banks were not allowed complete freedom of issue
within the prescribed limit, but were required to deposit some form of
security, as is required of the national banks in the United States, an
investment or speculative risk would arise that would inevitably cause
friction. If bonds were designated as security, bankers might often be
tempted by high prices to sell their bonds and forego the profit on
circulation for the sake of making a larger profit by the sale of the
security. Thus the volume of bank notes might contract even at a time
when the people needed more currency. In such case, of course, Canada
would be obliged to import gold in order to fill the gap in the
circulating medium.

THE CIRCULATION REDEMPTION FUND

The 5 per cent. insurance fund for the redemption of the notes of failed
banks is theoretically an important and prominent part of the system,
yet practically it would seem to be of little consequence, for not once
since 1890 has it been necessary to use a dollar of the fund. Banks have
failed, to be sure, but the notes of these banks have always been
redeemed either out of the assets or by recourse to the double liability
of the shareholders. It is a mistake to suppose that the people of
Canada have confidence in bank notes because of the existence of this
redemption fund. The average business man knows nothing about the fund
and if his attention were called to it as being a source of security for
the bank notes, he would probably think a 5 per cent. reserve altogether
too small. The real reason why the people have faith in bank notes is
because the notes are always honored by the banks and never fail to
stand the test of the clearing house. In other words, they believe that
bank notes are good for about the same reason that they believe the sun
will rise in the east every twenty-four hours, and do not bother
themselves about reasons.

Nevertheless this redemption fund does contribute to the strength of the
banking system. It makes each bank to a certain extent liable for the
mistakes of other banks, and as a result gives rise to a spirit of
mutual watchfulness and helpfulness. Other features of the system
contribute to the same result, especially the fact that a Canadian bank
accepts from a depositor without indorsement the notes of other banks.
Since the banks have branches in agricultural and mining communities,
often distant from the railroad by several days' journey, and these
branches are accepting the notes of other banks and giving credit for
them as if they were gold itself, it is evidently important that each
banker should have all possible information with regard to the status
and business of his competitors. As a result one finds among the bankers
of Canada a surprisingly intimate knowledge of each other's affairs.

TWO NEGATIVE QUALITIES

The two negative qualities of the Canadian bank note--its lack of a
legal-tender quality and of a government guaranty--at first sight may
seem to readers in the United States a source of weakness. Yet Canadian
bankers would doubtless all agree that nothing would be gained by making
bank notes legal tender for any kind of payment or by making the
Government in any measure liable for their ultimate redemption. Such
measures would probably be rejected as likely to prove harmful. It would
be like hampering a flying machine with unnecessary bars of steel. Bank
notes, like bank checks, are mere promises to pay money and are more
convenient than money because they can be created as need for a medium
of exchange arises. When either has done the work that called it into
existence, it should disappear from circulation and be redeemed. If it
is made a legal tender like money itself, or if its redemption is
guaranteed by a strong government, there is always the danger that
ignorant classes of people will regard it as money itself and withdraw
it from circulation.

The Canadian Government has nothing to do with the daily redemption of
bank notes and does not guarantee that they shall be redeemed. It is
custodian of the 5 per cent. redemption fund and is under obligation to
redeem the notes of failed banks out of this fund, but if a series of
bank failures should exhaust it the note holder has no guaranty that
government funds will be used for his relief.

The possession by the note holder of a first lien upon the assets of a
bank, including the funds that may be collected from shareholders on
account of their double liability, gives rise to such general confidence
in the ultimate convertibility of a bank note that the notes of a failed
bank, on account of the interest they bear, sometimes command a premium.
As a rule, the notes of such a bank are collected by the other banks and
held until the date of redemption has been named by the Minister of
Finance.

CANADIAN BANKERS' ASSOCIATION

The Canadian Bankers' Association is an incorporated body with powers
and duties prescribed in an amendment to the Bank Act passed in 1900.
Each chartered bank is represented in the membership and has one vote.
The association is required by law to supervise the issue of bank notes
and to report to the Government all over-issues, to look after the
destruction of worn and mutilated notes, and to take charge of suspended
banks. Its headquarters are in Ottawa. The expenses of the association
are apportioned among the banks and do not apparently constitute a very
heavy burden, for the secretary has an exceedingly small staff. All
expenses incurred by the association on account of a suspended bank are,
of course, a charge against the assets of the bank.

When the notes of a bank are so worn or mutilated that it wishes to
replace them with new notes, notice is sent to the secretary of the
association, a date is fixed, and in the presence of the secretary the
old notes are duly counted and taken to a furnace, where they are
consumed in the presence of the secretary and other witnesses. After
this solemn operation has been performed and the signatures of all
parties observing it have been duly attested, new notes are issued by
the association to replace those that have been destroyed.

The clearing houses in the Dominion are subject to regulation by the
association. It also has the power to establish sub-sections and to do
educational work by providing for lectures, competitive papers,
examinations, etc. The _Journal of the Canadian Bankers' Association_, a
quarterly publication of excellent quality, is edited by the secretary
and is at present the only educational force at work among bank
employees.

ELASTICITY OF THE CIRCULATION

While the amount of notes that the chartered banks may issue is limited
by the Bank Act to the amount of their paid-up capital, experience has
proved that this legal limitation is only nominal and that the real and
effective limit is imposed unconsciously and automatically by their
customers and themselves. Each constantly seeks to increase its issue of
notes to the legal limit, yet the combined efforts of all are never able
to force into circulation more notes than the people need.

The reason why an excessive issue of bank notes in Canada is impossible
is found in the two following facts:

1. Every bank must redeem its notes on demand in seven commercial
centres in different parts of the Dominion.

2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and
"change" consists entirely of bank notes.

The redemption system is an automatic and effectual check against
inflation. It is easier to get notes redeemed in Canada than it is to
secure payment of checks in the United States, for the notes are
redeemable at different points throughout the Dominion and no exchange
is ever charged. If a country merchant accumulates more currency than he
desires to keep on hand, he deposits it, together with his checks and
drafts, in the local branch of his bank. This branch immediately sorts
out the notes of other banks and treats them as it does checks and
drafts upon other banks, either sending them to the nearest redemption
agency or using them as an offset in the local clearing house if the
issuing banks have branches in the locality. The branches of a bank are
not obliged to redeem the notes of the parent bank, but must accept them
at par in the payment of all dues. Thus each bank is doing its utmost to
bring about the redemption of the notes of other banks. At the same
time it is paying out its own notes to all customers who ask for cash,
seeking to bring its circulation up to the limit. As a result of these
operations, two powerful forces are constantly at work, one putting
notes into circulation, the other retiring them, and the people of
Canada always have on hand just the amount of currency they need and no
more. It is the people, not the banks, who determine how much the
circulation of the banks shall be.

BANK NOTES HAVE NO COMPETITION

The fact that the bank note has exclusive possession of the monetary
field in Canada is most important. His ignorance of this fact is one
reason why the average banker or business man in the United States has
been unable to get a practical understanding of the Canadian system. Its
significance is easily seen. If Canada, like the United States, had in
circulation a lot of government notes in denominations of $5, $10, $20,
the Canadian banks would be able to increase their issues of bank notes
almost without limit, for their new notes would simply take the place of
the government notes, the latter going into bank reserves. The people of
Canada in making deposits would not discriminate against bank notes, but
would deposit the government paper quite as freely as the bank paper. As
a result, the amount of the government paper in circulation would
gradually decrease and the amount of bank notes would increase. The
volume of Dominion notes in the vaults of the banks would expand, and as
these notes are redeemable in gold the banks would feel justified in
larger extension of their credit, so that an increase in deposits and
current loans would ensue. Under such circumstances such freedom of
issue as is enjoyed by the Canadian banks would doubtless result in
inflation.

But such conditions do not exist in Canada. All the paper currency in
the hands of the people, excepting $1 and $2 bills, is in the form of
bank notes. There is no chance to substitute bank notes for government
notes. Hence, if at any time business relaxes and the need for money
among the people grows less, an increasing tide of bank notes flows into
the banks. The people who bring these notes do not ask for money in
exchange, for to them the notes are money. They take bank notes to the
banks just as people in the United States take greenbacks and silver
certificates--to be exchanged for a deposit credit or account.

NO LIMIT OF ISSUE REALLY NECESSARY

Theoretically there is no reason why any limit should be fixed upon the
amount of notes which a bank may issue. Even though a bank has a
monopoly of issue in a country--like the Bank of France--it nevertheless
is unable to expand its circulation beyond the people's needs. Such a
bank, unless it should adopt a reckless policy of lending which would
bring ruin quickly upon itself, can exercise very little influence upon
the amount of currency in circulation. In a country like Canada, where
several banks are issuing currency, no single institution can enlarge
its issue of notes beyond the needs of its own customers. If it should
endeavor to do this by lending freely to customers who promised to use
its notes in different parts of the country, the effort would be futile.
The notes would quickly find their way into the branches of other banks
and be sent in for redemption.

Like most other countries, however, Canada has placed a limit on the
note-issuing privilege, fixing it at the amount of a bank's paid-up
capital. While there is no scientific necessity that such a limit be
fixed in order to prevent the over-issue of notes, nevertheless there
are other considerations which justify it. It is an indirect method of
compelling banks to increase their capitalization _pari passu_ with the
growth of their business. Inasmuch as the capital of a bank is the
stockholder's contribution toward its assets, it is exceedingly
desirable that this contribution be made as large as possible, for,
other things being equal, the strength of a bank varies with the amount
of its capital. It is not unreasonable, therefore, to require that banks
in return for the useful note-issuing privilege should be required to
keep their capital resources large.

When a Canadian bank has reached the limit of its note issue--which has
rarely happened--it begins at once to treat the notes of other banks
very much as if they were its own. Instead of going to the expense of
sending them in for redemption, it uses them as counter money, paying
them out to depositors in response to their calls for cash. If all the
banks in Canada should issue notes up to the limit, as some of them did
during the exciting months of 1907, and if the current rate of interest
did not warrant the issue of the taxed notes provided for by the
amendment of 1908, the note circulation would immediately lose its
elasticity. As further expansion would be impossible, the banks would
have to meet any increasing demand for currency by paying out gold and
Dominion notes, thus depleting their reserves. Such a situation would
doubtless lead to a sharp advance in the discount rate and to the
importation of gold.

THE PRACTICAL LIMIT UNDER THE LEGAL

It should be noted that the practical limit of note issue is about 10
per cent. below the legal limit. The manager of a bank having a paid-up
capital of $1,000,000 begins to get nervous when his circulation equals
$900,000. His office may be in Montreal and his bank may have branches
in the far East and in the far West and in the mining wilderness of the
North. Some of these branches he can not reach by telegraph and some are
distant a week by mail. He immediately sends warning to all the branches
and cautions them against any large out-giving of notes and against
entering into transactions which will be likely to lead to unusual
demands for currency. On account of this situation, even in times of
greatest pressure, the total issue of the banks is usually 10 per cent.
below the authorized limit.

DEPOSITS

The liabilities of Canadian banks, like those of commercial banks in
Great Britain and the United States, furnish a fairly correct index to
the expansion of the country's credit. Since the Canadians, like other
Anglo-Saxons, make free use of the check book in the settlement of both
business and private accounts, any increase of bank loans and discounts
is usually attended by a corresponding increase in deposits. When a
Canadian business man discounts his note at his bank he almost
invariably leaves the proceeds on deposit with the bank. As he makes
his payments by check his own deposit account declines, but the bank
accounts of his creditors increase, so that the net result of borrowing
in Canada is an increase in the total of bank deposits. Consequently, in
good times, when the banks are freely extending credit, the deposits
grow, and in periods of dullness and liquidation they decline. A growth
of deposits, therefore, is commonly accepted as an indication of
business and industrial activity.

If a business man in Canada has temporarily a large balance in his bank
and realizes that he will not need the money for several months, he will
either arrange for its entry as a time or savings bank account, or for
the payment of interest on his balance as a current account. Of course,
the bankers do not encourage this practice, nor can it be indulged in by
a depositor who is also a borrower. Depositors of the class who are paid
a small rate of interest--usually 2 per cent.--by national and state
banks in the United States, usually have savings department accounts in
Canada and get 3 per cent.

SAVINGS DEPOSITS ALWAYS PAID ON DEMAND

On account of the fact that the time or savings bank deposits contain
such a large proportion of money likely to be needed in business at any
time, the banks regard both classes of deposit as being essentially the
same form of liability. Practically all the deposit liabilities of a
Canadian bank are payable on demand, although payment on two-thirds of
them at the present time can not legally be demanded until after notice.
Custom has made it imperative that a Canadian bank shall pay any and all
of its depositors on demand. For any bank to refuse to let a depositor
have his money when he calls for it would be regarded by the public as
an acknowledgment of weakness. Certainly no Canadian bank would take the
risk of making the experiment.

Canadian bankers feel that 3 per cent. is too high a rate of interest to
pay depositors. This rate is a matter of tacit agreement among the banks
and no single bank can afford to lower it, for such action would cause
it a loss of business. On the other hand, if any bank, hoping to
increase its deposits, should offer to pay 3-1/2 per cent. or 4 per
cent., its conduct would be looked upon with grave disapproval by its
competitors. Some of the new banks in recent years have obtained
business in this manner and have been severely criticised by the
managers of the older institutions.

SAVINGS DEPOSITORS NOT PROPERLY REWARDED

To an outsider it would seem that the savings bank depositor in Canada
is not generously treated. In the United States he gets 4 per cent. on
his savings even in the large cities. In Canada, a country where real
estate mortgages yield from 7 to 9 per cent. and the bonds of new
corporations are selling at prices giving the investor a higher return
than he can get in the United States, it is certain that a real savings
bank could well afford to pay depositors 4 per cent. It is doubtless
true that 4 per cent. is a higher rate of interest than most of the
savings depositors in the chartered banks have a right to expect. A
large part of these deposits are not savings deposits at all.
Nevertheless it is doubtful if the banks would be justified in a
reduction of the rate.

The right solution of the problem seems to lie in another direction,
namely, in the making of a sharper distinction between demand and
savings deposits. The funds received from both classes of depositors
should not be treated alike. The money of savings bank depositors should
be invested in bonds and mortgages and then could be made to yield a net
return of over 5 per cent. If the depositors were not allowed to check
upon their accounts they would be a source of such little expense to a
bank that it could easily afford to pay them interest at the rate of 4
per cent. At the present time the banks are paying 3 per cent. interest
on money which they are lending to commercial borrowers and for the care
of which they are maintaining an expensive force of clerks. Depositors
who have checking accounts might be allowed 2 per cent. on large
balances, but out-and-out savings depositors, people who make no use of
the check book, are certainly entitled to a 4-per-cent. rate in a
country where investment capital is as fruitful as it is in Canada.

Strictly speaking, the savings departments of the chartered banks are
not savings banks, for they do not pretend to devote their time funds
to long-time investments. The amount of securities held by the banks is
never equal to the amount of time deposits.

A thorough reorganization of the savings departments of the chartered
banks, to equip them for the real business of a savings bank, would not
be possible without an amendment to the Bank Act, which now prohibits
them from loaning money upon real estate or upon the security of
real-estate mortgages. It is generally believed that this prohibition is
commonly evaded by the banks through the acceptance of such mortgages as
"additional security" after loans have been made. A savings bank, of
course, must have the legal right to accept such security.

NO BANKERS' BANK

The indebtedness of banks to banks is not large in Canada. The branch
system makes it unnecessary for banks to carry balances in other
institutions located in the financial centres. Nearly every bank has a
branch in either Montreal or Toronto and in these branches carries the
major proportion of its cash reserve, so that branches in the far West
or in the maritime Provinces are always able to sell exchange on
Montreal or Toronto. Canada has no bankers' bank. The Bank of Montreal,
which is the largest bank in the Dominion, its assets being equal to
about 25 per cent. of the total, is often spoken of as the government
bank because it is the largest government depositary, yet it holds a
very small amount of funds belonging to other banks.

AMOUNT OF THE RESERVE FIXED BY EACH BANK

It must not be supposed that the Canadian banks do not carry adequate
reserves. On the contrary, every bank manager gives to this subject
daily and most conscientious thought. To the Canadian banker the word
"reserve" means a fund immediately available for the liquidation of
liabilities. How much this fund ought to be depends altogether upon the
amount and character of the liabilities to be protected.

A Canadian bank manager, having before him the amount of time deposits
and demand deposits, respectively, knowing the probable future needs of
the various depositors, being in constant touch with branch managers
both by wire and by letter, and having back of him information born of
many years' experience, easily determines how much his bank's reserve
ought to be in order to assure its safety. The law neither helps nor
hinders him; it simply requires that the bank shall satisfy the demands
of depositors in accordance with the terms of the contract and that it
shall redeem its notes on demand. The public by force of custom expects
a bank to do a little more than the law requires, for its credit is
bound to suffer if it take advantage of its legal privilege to delay
payment upon time deposits. The manager is a hired man, sworn to do his
utmost to protect the credit of the bank, trained for many years in its
service, familiar with its history and its policy, anxious to guard his
own reputation and character against criticism. Under these
circumstances it would be remarkable if he did not fix the amount of his
bank's reserve nearer the ideal figure--if an ideal banking reserve is
possible--than could possibly be done by a body of lawmakers or of any
other men outside the bank.

COMPETITION IS NOT LACKING

In many respects banking competition is quite as active in Canada as it
is in the United States. Apparently there are only two things which the
banks do not like to do in order to attract business--lower the discount
rate, or advance the rate paid on depositors' balances. There is no
express agreement among the bankers on these points, but every banker
knows that he would become _persona non grata_ among his brethren if he
should discount certain kinds of paper at less than 6 per cent., or pay
his depositors on their monthly minimum balances more than 3 per cent.
per annum. In Montreal and Toronto large borrowers can get money at 5
per cent., but the average merchant and manufacturer must pay 6. In
Winnipeg borrowers can do almost as well, but farther west the usual
rate is 7 per cent., and in some of the remoter districts merchants and
farmers alike pay 8 per cent. Bankers do not believe in lowering the
discount or interest rate unless they are compelled to do so in order
to find a market for their funds.

Some of the older institutions would like to prevent competition from
absorbing the minor profits which come from collections and transactions
in exchange, but they are not entirely successful. The nominal or
schedule charges for collections and exchange are frequently cut for the
benefit of business men whose favor it is desired to propitiate.

In their efforts to get new business, to be the first to open a branch
in a promising new community, or to keep their regular customers from
being dissatisfied, there seems to be the keenest kind of competition.
Few villages of 500 people can complain that their banking facilities
are less than they deserve, and many of them, with barely enough
business to pay the expenses of one branch, are supplied with two. The
recent rapid increase in the number of branches has been caused by the
great expansion of the West and by the competition among the more
progressive and energetic general managers, each desiring that his bank
shall be the first in a promising field, even though his enterprise lead
him to establish branches which at first do not pay expenses. In a new
mining camp the first bank, like the first saloon or the first boarding
house, usually begins business in a tent. Some of the more conservative
bank managers in Canada think that new branches are being started in
excess of the country's needs, but others are willing to take chances on
the country's future and to charge considerable sums to the debit side
of the profit and loss account in order to keep their institutions at
the front in the great and developing West.

BANKING IN DIFFERENT PROVINCES

It is generally known that the Eastern branches get heavy deposits and
are creditors of the head office, and that the funds they collect are
forwarded to the Western branches, whose loans greatly exceed deposits.
Bankers will admit that this transference of funds takes place, but
there is considerable grumbling about it in the old communities of the
East, and the bankers fear that a monthly or even annual publication of
the facts would keep them perpetually in hot water. A glance at
clearing-house statistics leaves no doubt as to the banking importance
of the Western Provinces or as to the relative financial quietude of the
East. Between 1900 and 1909 the total of Canada's bank clearings
increased 227 per cent., but Halifax gained only 23 per cent., St. John
only 90 per cent., and Quebec only 68 per cent. On the other hand,
Toronto's clearings increased 179 per cent., Winnipeg's 600 per cent.,
and Vancouver's 524 per cent.

EASTERN PROVINCES HAVE SUFFERED

This transference of funds from sluggish to active communities is the
inevitable result of a system of branch banking and is the cause of the
tendency of the rate of interest toward uniformity in all parts of
Canada. Whatever may be said against a system of branch banks, there can
be no question that it does bring about a more even distribution of
capital in a country than is possible under a system of independent
local banks. Canadian bank managers are anxious to put out their money
where it is most wanted, for there they get the best possible rate of
interest and obtain paper of the best quality. No matter where a
manager's headquarters may be, he is most deeply concerned in three
questions: (1) Where is idle money accumulating? (2) How can he best
draw it into his bank? (3) In what parts of the Dominion is money most
needed? In localities of both kinds he establishes branches; in the one
the branches accumulate deposits often much in excess of their loans, in
the others the loans exceed the deposits. Thus it happens that the
savings of the Eastern Provinces, where the growth of industry and trade
is slow and the demand for new capital is not increasing, are sent
westward and loaned out to merchants and manufacturers and farmers of
the new territories. The people of the East supply the capital for the
development of the West, though many of them perhaps are entirely
ignorant of the useful purpose their savings are made to perform. In the
western cities of Canada one hears no talk among business men about the
scarcity of capital. A merchant or manufacturer in Manitoba gets the
money he needs as easily as does the merchant or manufacturer in
Toronto or Montreal.

Justifiable as the bank's policy is from a national point of view, one
can not help believing that the branch banking system has really checked
the development of business and industry in the maritime Provinces. If
Canada during the last thirty years had depended, like the United
States, upon independent local banks, there would have been a plethora
of capital in the East, and Montreal, Quebec, and Halifax, like Boston,
New York, and Philadelphia, would years ago have had 4 and 5 per cent.
money, while Winnipeg and other Western cities, less populous than now,
would still be paying 1 per cent. a month. The relative cheapness of
capital undoubtedly helped build up the prosperous industries of
Massachusetts. The same cause operating in the maritime Provinces of
Canada would doubtless have led to the establishment there of industries
of which the people under existing conditions have not ventured to
dream.

LARGE USE OF DEPOSIT CURRENCY

It is sometimes assumed that a free and large use of bank notes tends to
discourage the use of the check book and the growth of bank deposits. On
the continent of Europe, for instance, where the notes of central banks
supply all the currency the people need, the check book is comparatively
little used. This fact is sometimes explained by the ease with which
people can obtain bank notes for use in making all payments. Experience
in Canada makes one doubt the validity of this explanation. The check
book is almost as popular there as in the United States, and would
probably be used still more than it is if the banks would adopt a policy
as liberal as that in vogue in the United States. The Canadian banks not
only charge exchange on checks and drafts payable in other localities,
but even charge exchange on checks drawn on their own branches. The
charge is a small one and probably has no great effect one way or the
other, yet it certainly does not encourage the increase of deposits or
the use of the check book. When a Canadian starts on a journey it is in
a small way economical for him to fill his wallet with all the cash he
expects to need. The notes of his bank will be taken at par everywhere
throughout the country; his checks, even though he presents them at a
branch of his bank, will be cashed only at a discount.

Notwithstanding this discrimination against the check, the deposits of
Canadian banks have grown much more rapidly than the note circulation
and the inference is that the volume of deposit currency has increased
at the same rapid pace. Since 1900 the volume of notes has increased
approximately 60 per cent., while the deposits by the public showed a
gain of 155 per cent. These figures prove that business men in Canada
appreciate the advantages of the check as a means of payment, and that
the proportion of business transactions settled by it is steadily
increasing.

BANKS SILENT PARTNERS IN INDUSTRY

A large part of the so-called commercial paper of Canadian banks is
secured practically by title to goods in warehouses, factories, and
wholesale stores. Such security is more saleable than stocks and bonds,
and paper having such security back of it is therefore better banking
paper than notes secured by stock-market collateral. So far as would
seem possible the Canadian Bank Act makes merchandise of all kinds a
sort of collateral security for bank advances. It assumes that if a bank
advances capital for the conduct of a business it should have a claim
upon all the assets of the business and upon all goods as they come and
go in the course of trade. No matter how a merchant's stock may change
in character, it all belongs to his bank in case he fails to take up his
paper or meet his engagements. In the same way a manufacturer's stock of
goods, the raw material and the finished products, no matter how they
change from day to day and month to month, will become the property of
his bank if he fails to pay his note. The law practically makes every
bank a silent partner in many wholesale and manufacturing businesses and
gives it many rights which no ordinary silent partner can acquire. It
has the effect naturally of making bankers keep a close eye upon
business conditions as well as upon the affairs of their individual
borrowers. Canadian bankers are interested in the lumber market, in the
prices of metals, in changes in the tariff, and in the acquisition of
foreign markets for Canadian manufactures and products, even as the Wall
Street banker is interested in the prices of stocks and bonds. He is in
a sense the owner of merchandise of all kinds, and both trade and
financial news has equal significance to him.

A CUSTOMER'S LINE OF CREDIT

In Canada the banks are managed by men whose long experience in the
business has taught them to avoid certain banking practices that are in
vogue in other countries. Realizing how important is the relation
between a bank and its customer, they believe that this relation should
be made as intimate and helpful as possible. Among Canadian bankers,
therefore, it is part of the law and gospel of banking that a bank is
entitled to full knowledge of the financial condition and business
operations and prospects of its customers. Hence a bank insists that its
customers shall rely _entirely upon itself_, that they shall make a full
statement of their affairs at least once a year, and that they shall
begin each year with a clean slate.

As a result of this policy a business man in Canada deals exclusively
with one bank. Once a year he arranges with his bank for a line of
credit and learns exactly the amount of paper he will be able to
discount. If he happens to need less than he anticipated, he will not
exhaust the credit allowed by the bank and will pay interest, of course,
only upon such portion of the bank's funds as he actually utilizes. If,
on the other hand, his business is unexpectedly large, giving
opportunity to make bigger profits and creating the need for more
capital, he will find the bank ready to increase his line of credit,
provided the manager is satisfied that business conditions and prospects
warrant expansion. Under no circumstances, however, must the customer of
a bank seek to raise funds elsewhere unless he first gets the consent of
his bank. If he sells his notes in the open market, he must do it with
the full knowledge of his bank or run the risk of being placed upon the
"black list."

As one would naturally expect, there is very little commercial paper
floating about in the Canadian money market. The bill broker is unknown.
Wholesalers and manufacturers, unless shipping to foreign countries, do
not draw upon their customers. If credit is granted, it takes the form
of a book account or of a promissory note.

The promissory notes received by a manufacturer or wholesaler are
deposited with his bank. The book accounts under ordinary conditions
remain entirely at the disposal of the business, but in extraordinary
cases, when the situation is not satisfactory, or if an additional
credit at the bank is desired, an assignment of the book accounts to the
bank may be required.

During the harvest season heavy drafts are made upon the resources of
the banks to provide for the movement of the grain crops of the West. In
its advance of money for this purpose the law makes it possible for a
bank always to have abundant security. Under section 88 of the Bank Act
the buyer makes assignment to his bank of the grain purchased. When the
grain is delivered to a railroad, the bill of lading becomes the
property of the bank. When it reaches Port Arthur, or some other
distributing point, and is stored in an elevator, the bank receives a
warehouse receipt in exchange for the bill of lading; and when shipment
is made to New York, to Montreal, or to Europe, the bank receives on
surrendering the warehouse receipt the shipper's draft on the consignee,
the bill of lading, and other documents. Throughout the entire
transaction, from the purchase from the farmer to the final sale to the
Eastern consumer, the bank practically has title to all agricultural
products which are being moved by means of its funds.

LOANS TO FARMERS

The branches of Canadian banks in agricultural districts quite commonly
lend assistance to farmers. They do not make a practice of taking
mortgages on farm property, but lend outright on the farmer's credit,
depending for their security upon his character as a man and ability as
a farmer, and often as well upon a neighbor's indorsement. Farmers'
paper ranks high among the Canadian bankers and constitutes a
considerable proportion of the assets of some of the banks. The banks,
of course, do not undertake to supply the farmer with anything more than
working capital. They do not help him pay for his land and buildings,
but they do let him have at least part of the money he needs for tools,
wages, seed, stock, etc. Despite the fact that these advances are
unsecured by mortgage, the banks suffer very little loss on farm paper.

CALL LOANS IN CANADA AND ELSEWHERE

After "current loans in Canada" the next largest item among the assets
is "call and short loans elsewhere than in Canada." The call loans
outside of Canada consist mainly of loans in the New York market and are
as a rule secured by collateral easily convertible into cash. These
loans are regarded by Canadian bankers as equivalent to cash and are
figured by them as part of their reserve. Only the larger banks make a
practice of loaning on call in New York.

THE BANKS AS FINANCIAL INSTITUTIONS

That the chartered banks of Canada are financial as well as commercial
institutions is evidenced by their holdings of stocks and bonds. These
securities represent partly an investment carried as a secondary reserve
and partly a business carried on for the benefit of their customers. In
Canada the demand for long-time investments is not large, but whatever
market there is for securities is mainly in the hands of the chartered
banks. An investor seeks the advice of a bank manager and often is able
to obtain from him securities which satisfy his needs. The banks do not
publish a list of their holdings, but it is generally taken for granted
that they carry only gilt-edge securities. If a customer desires to
obtain second or third rate securities, being eager for a high rate of
return, a bank can accommodate him, not by selling him out of its own
stock, but by negotiating the purchase of the desired securities in New
York or London.

As the wealth in Canada increases and idle capital accumulates in excess
of its immediate needs, this financial side of the business of Canadian
banks will doubtless expand. It may, indeed, during the next generation
or two greatly expand and become an important feature of the chartered
banks. They are in a position to take care of the business as it
develops and will doubtless be able to prevent the establishment of any
purely financial banking houses in Canada.

THE REVISION OF THE BANK ACT, 1913[148]

The Canadian Bank Act, as is well known, is subject to decennial
revision. The last revision was due to take place in 1910; but owing to
circumstances which it is not necessary here to describe, it was not
until the present year that the work was finally undertaken. The leading
features of the Canadian banking system are so well known that they may
be passed over, and the nature and causes of the recent changes in the
act alone described. There were many minor modifications, but the
essential changes effected were: (1) provision for a shareholders'
audit, (2) the creation of central gold reserves, and (3) the providing
of additional facilities for making loans to farmers.

In the recent revision of the act the public was most deeply concerned
with the problem of securing an adequate system of bank inspection. The
immediate reason for this was the disastrous failure of the Farmers'
Bank. This institution had gambled away its resources on the Keeley
mine; and had, in its failure, brought many farmers as well as others to
the verge of ruin. For several years previous, however, there had been
an insistent demand for some sort of external bank inspection....

The banks as a whole have been opposed to any change in the method of
inspection. The reason they advance is that the keynote of the
organization of Canadian banks has always been the centralization of
responsibility; and they do not think it wise to divide that
responsibility with any outside authority....

As far as the public is concerned it has no means of judging of the
soundness of a bank except by examining the monthly returns which are
required by law from each bank. These returns are fairly comprehensive,
and have been made more so by the revision of the act this year. The
Minister of Finance may call for supplementary information from any
bank, whenever, in his judgment, such data are required to afford a
fuller knowledge of a bank's affairs. Of course, these returns can be
taken only for what they are worth. In the case of several failed banks
the returns were made with every degree of falsification, because no
independent checking of the figures was possible.

Nevertheless, in obedience to the strong demand for some sort of
independent bank examination, provision was made in the recent revision
of the act for a shareholders' audit of each bank's affairs. The
auditors are to be chosen by the shareholders from a list of forty names
selected by the whole body of the general managers of the banks. The
list must be submitted to the Minister of Finance for his approval. If
one-third of the shareholders of a bank are dissatisfied with the
auditor appointed by the majority, they may appeal to the Minister for
the appointment of another auditor.

The auditors must submit a statement of their findings to the
shareholders at the annual meeting, or on any other occasion the
necessity may require. In addition the Minister of Finance may require a
special return to be made to him, the cost of the service rendered being
paid for by the Government.

Canadians would be wise not to expect too much from this system of
external examination. After all, it can do no more than verify a bank's
statements and books.... In every large undertaking, the soundness of
the transaction must depend, as before, upon the judgment of the general
manager and the board of directors.

The establishment of central gold reserves is the most important feature
added to Canada's banking system by the legislation of 1913.... Under
the new act each bank may issue any amount of notes that it may desire,
provided that it deposits with a board of trustees, at Montreal, gold or
Dominion notes to the full amount of the notes issued. These notes are
to be identical in form with the ordinary notes of the bank. The gold or
Dominion notes deposited with the trustees shall be returned to the bank
whenever the notes which the bank has outstanding do not amount to the
paid-up capital of the bank together with the amount of legal-tender
money deposited with the trustees. In other words, the banks can still
issue their notes up to the full amount of their paid-up capital, and an
additional amount from September 1 to the end of the following February,
which may equal 15 per cent. of a bank's combined capital and surplus.
It is only for notes issued in excess of these amounts that legal-tender
money must be deposited with the trustees at Montreal. It should be
observed, however, that the banks pay a tax of 4 per cent. on the extra
issue during the crop-moving period, whereas there is no tax upon
gold-reserve notes. And as Canadian banks are not required to keep a
legal reserve against their demand liabilities, there is no reason why
the idle gold in their reserves should not be sent to Montreal to form
the basis of new note issues, especially when it is considered that the
gold may be recalled at once when no longer needed to cover notes.

The ability to issue notes to any amount required, on a gold basis, will
greatly strengthen the position of the banks.

The third important new feature in the revision of the act is the power
given to the banks to make loans to farmers on grain which is stored on
the farm and still in the farmer's possession.... The permission granted
them to loan money to farmers on stored grain in the latter's possession
is an attempt to extend to the farmers aid similar to that hitherto
granted to manufacturers and wholesalers alone. It should not be
thought, however, that the banks have not always granted loans liberally
to farmers....

The possibility of making advances to the farmers on their grain is
expected to be of especial benefit to the West.... It is hoped that,
under the new legislation, the farmer will be able to hold his grain for
higher prices; and in the meantime secure accommodation from the banks
to meet his obligations. Many bankers, however, refuse to see any remedy
for the situation in the new legislation. They maintain that it will
involve too much risk to extend loans on grain over which the farmer
continues to assert control. Only the operation of time will enable us
to estimate the value of this feature of the act.

COMPARATIVE FIGURES OF CONDITION OF CANADIAN BANKS[149]

ASSETS

Nov. 30, 1915 June 30, 1914.
Gold and subsidiary coin--

In Canada $41,831,732 $28,948,841
Elsewhere 29,527,921 17,160,111
----------- -----------
Total $71,359,653 $46,108,952
Dominion notes 140,751,331 92,114,482
Deposit with Min. of Finance for security
of note circulation 6,770,645 6,667,568
Deposit in central gold reserves 15,100,000 3,050,000
Due from banks 169,429,330 123,608,936
Loans and discounts 881,101,540 925,681,966
Bonds, securities, etc. 121,953,898 102,344,120
Call and short loans in Canada 83,203,787 67,401,484
Call and short loans elsewhere than in Canada 135,530,562 137,120,167
Other assets 76,993,424 71,209,738
-------------- --------------
Total $1,702,194,170 $1,575,307,413

LIABILITIES

Capital authorized $188,866,666 $192,866,666
Capital subscribed 114,422,866 115,434,666
Capital paid up 113,987,275 114,811,775
Reserve fund 112,718,473 113,368,898
------------ ------------
Circulation 124,153,685 99,138,029
Government deposits 36,001,548 44,453,738
Demand deposits 538,764,279 458,067,832
Time deposits 714,219,286 663,650,230
Due to banks 30,973,072 32,426,404
Bills payable 5,081,059 20,096,365
Other liabilities 14,007,918 12,656,085
-------------- --------------
Total, not including capital or reserve fund $1,463,200,847 $1,330,488,683

NOTE.--Owing to the omission of the cents in the official reports, the
footings in the above do not exactly agree with the totals given.

FOOTNOTES:

[147] Adapted from Joseph French Johnson, _The Canadian Banking System_,
Publications of the National Monetary Commission, Senate Document No.
583, 61st Congress, _2d Session_.

[148] W. W. Swanson. _The Revision of the Canadian Bank Act_, American
Economic Review, Vol. 3, December, 1913, pp. 993-998.

[149] _The Commercial and Financial Chronicle_, Vol. 102, January 1,
1916, p. 13.

CHAPTER XXII

THE ENGLISH BANKING SYSTEM

FOUNDATION AND GROWTH OF THE BANK OF ENGLAND

[150]About the year 1691 the Government of William and Mary experienced
considerable difficulty in raising the necessary funds to prosecute the
war with France; but "the hour brings the man." The man on this occasion
was William Paterson, a merchant of Scotland, who had been educated for
the Church, but had led a varied and adventurous life. The scheme he
presented for the consideration of the Government for the relief of the
situation was the foundation of a public joint-stock bank; which, in
return for certain powers and privileges to be conferred, should advance
money to the Government....

... the bill establishing the Bank of England was successfully carried
through Parliament, and obtained the royal assent on the 25th April,
1694.

The basis of the bill was that £1,200,000 should be voluntarily
subscribed by the public, and that the subscribers should be
incorporated into a body, to be known as "The Governor and Company of
the Bank of England."

The whole of the sum forming the capital of the bank was to be lent to
the Government, for which the bank was to receive interest at the rate
of 8 per cent. per annum, together with an allowance of £4,000 per annum
for management and expenses; making in all £100,000 per annum. It was
also provided that the sum of £300,000 was to be raised by public
subscription, for which the contributors were to receive certain
terminable annuities.

By its first charter, which was for ten years only, the Bank of England
was not allowed to borrow or owe more than the amount of its capital;
which meant that it could issue notes to the extent of its capital and
no more. If this amount were exceeded the members were liable for such
excess, in their private capacities, in proportion to their holding of
stock.

The capital of the bank was subscribed in a few days, and when duly paid
up, the agreed sum of £1,200,000 was handed in to the Exchequer....

The charter originally granted to the bank was for ten years only, as we
have already seen; but this charter has from time to time been renewed,
and also varied--sometimes in favour of the bank and sometimes
curtailing its privileges. The monopoly of joint-stock banking was not
granted to the bank by its first charter, but this monopoly was
practically conferred on it in 1708. The act passed in that year
provides:

That during the continuance of the said corporation of the
Governor and Company of the Bank of England, it shall not be
lawful for any body politic or corporate whatsoever, created
or to be created (other than the said Governor and Company
of the Bank of England), or for any other persons
whatsoever, united or to be united in covenants or
partnership, exceeding the number of six persons, in that
part of Great Britain called England, to borrow, owe, or
take up any sum or sums of money on their bills or notes,
payable at demand, or at a less time than six months from
the borrowing thereof....

We pass on now to the end of the eighteenth century, when the country
was plunged into the throes of war and financial difficulty. Up to this
time the bank, since its foundation, had succeeded in meeting its notes
when presented; but in the year 1796 a steady drain on the reserve of
the bank commenced, owing to the fear of invasion. This drain began to
assume a very serious aspect in the early part of 1797, and it appeared
probable that the bank would be subjected to the danger and humiliation
of a temporary stoppage. The directors, fully aware of this danger ahead
of them, laid the position before the Government, and left the solution
of the difficulty in its hands. After due consideration, an Order in
Council was issued on the 26th February, 1797, requiring the bank not to
pay its notes in gold.... It was not until 1823 that the restriction was
entirely withdrawn, although as a matter of fact the bank really
resumed paying in cash on demand on May 1, 1821, deeming it then safe to
do so.

Although a period of safety and prosperity then appeared to have dawned,
the bank was not quite clear of its troubles. The very prosperity of the
times led imperceptibly to another period of distress and danger,
culminating in the panic of 1825....

In 1826 the Bank of England, by arrangement with the Government, agreed
to establish branches in various parts of the country, and gave up their
monopoly of joint-stock banking, except within a radius of sixty-five
miles of London.

The year 1833, however, saw a further restriction in the powers of the
bank, when, after protracted negotiations, and in return for a further
renewal of its charter, the bank surrendered its monopoly of joint-stock
banking entirely, provided that no bank having more than six partners
might issue notes within the sixty-five-mile limit of London.

It is a curious point that the charter of the bank never did restrict
joint-stock banking in its present accepted form, but only the issue of
notes by joint-stock bankers or banks having more than six partners. Up
to this time the issue of notes by a bank had been thought to be its
main business; so much so, that it was believed to be useless to attempt
to conduct a bank without power of issue, and consequently no
joint-stock bank had been founded. But about this time the need of such
institutions began to be felt, and the presumed monopoly of the Bank of
England was called in question--largely by Mr. Gilbart, the founder of
the London and Westminster Bank. The bank tried to assert their
monopoly, but without success, and in order to settle the matter
effectually, the following clause was inserted in the act passed in 1833
dealing with the bank charter:

Be it therefore declared and enacted, that any body politic
or corporate, or society, or company, or partnership,
although consisting of more than six persons, may carry on
the trade or business of banking in London, or within
sixty-five miles thereof, provided that such body politic or
corporate, or society, or company, or partnership, do not
borrow, owe or take up in England, any sum or sums of money
on their bills or notes payable on demand, or at any less
time than six months from the borrowing thereof, during the
continuance of the privileges granted by this Act to the
said Governor and Company of the Bank of England.

It may be noted that this act of 1833 constituted Bank of England notes
a legal tender, except by the bank itself or its branches....

PEEL'S ACT OR THE BANK CHARTER ACT OF 1844, AND ITS SUSPENSIONS

[151]After the renewal of the charter in 1833, the directors of the Bank
of England laid down as a principle on which their future operations
were to be guided, that one-third of their liabilities should be kept in
cash and bullion, and the remaining two-thirds in securities. If this
principle had been acted on, the bank would have been saved from many of
the troubles which shortly assailed it; but though the intentions of the
directors were good, circumstances were too strong for them, and the
actual proportions of cash and securities to liabilities, respectively,
often differed materially from the standard laid down. This was notably
the case during the periods of financial pressure which were experienced
in the years 1836 and 1837.

In the year 1839 matters assumed a very serious aspect. In the early
part of this year the amount of cash held by the bank was about
one-third of the amount of securities, but during the year the amount
invested in securities increased at the expense of the amount held in
cash; and by September we find that securities stood at nearly
£29,000,000, while the cash was reduced to a tenth of that figure, and
stood at £2,936,000 only. In order to avert a calamity which appeared to
be impending, the bank arranged loans in Paris and Hamburg to the extent
of between three and four millions.

This manifest exhibition of weakness on the part of the bank led to the
appointment of a committee of the House of Commons to inquire into the
matter. The committee condemned the principles on which the bank was
working, but were powerless to effect any alteration, owing to the
charter of the bank not expiring till 1844.

On the expiry of the charter, however, Sir Robert Peel brought forward
his famous act for remodelling the bank, and regulating the issues of
the country banks throughout. England and Wales.

The act was passed on the 19th July, 1844, and continues without
alteration to the present day. The main provisions enacted thereby,
briefly stated, are as follows:

I. The issue department and the ordinary banking department of the Bank
of England were to be entirely separated as from the 31st August, 1844.

II. On such separation taking place, securities to the value of
£14,000,000 (including the [book] debt due to the bank from the
Government) were to be transferred to the issue department, together
with so much gold coin and bullion that the total so transferred should
equal the total amount of notes then outstanding. Thereafter (with the
exception noted below) the issue department must not issue any notes in
excess of a total of £14,000,000 except in exchange for gold coin or
bullion.

III. The issue department might not at any time hold more silver than
one-fourth part of the gold held. As a matter of fact the issue
department holds no silver.

IV. Notes might be demanded from the issue department by any person in
exchange for gold at the rate of £3 17_s._ 9_d._ per standard ounce.

V. If any banker having the power of issue on the 6th May, 1844, should
relinquish such issue, the issue department may be authorised to
increase its issue of notes against securities to the extent of
two-thirds of the issue so relinquished; but all the profits on such
increased issue against securities were to belong to the Government.

VI. The bank must issue a weekly statement of the position of both its
issue and banking departments, in a prescribed form.

VII. Bankers having the right to issue their own notes on the 6th May,
1844, might continue such issue under certain conditions, and to an
agreed amount; but no provision was made compelling such bankers to keep
any reserve either in cash or securities against their issues. If any
issue lapsed, from any cause, it could not be resuscitated; and no
institutions could acquire the right of issue in the future.

VIII. Banks consisting of more than six partners, though within the
sixty-five-mile radius of London, might draw, accept, or endorse bills
of exchange not being payable to bearer on demand.

The first return issued by the bank in accordance with the regulations
of the new act was that of the 7th September, 1844, and was as follows:

ACCOUNT OF THE LIABILITIES AND ASSETS OF THE BANK OF ENGLAND

For the Week ending 7th September, 1844

DR. ISSUE DEPARTMENT CR.

Notes issued £28,351,295 Government debt 11,015,100
Other Securities 2,984,900
Gold coin and bullion 12,657,208
Silver bullion 1,694,087
----------- -----------
£28,351,295 £28,351,295

DR. BANKING DEPARTMENT CR.

Proprietor's capital 14,553,000 Government securities 14,554,834
Rest 3,564,729 Other securities 7,835,616
Public deposits 3,630,809 Notes 8,175,025
Other deposits 8,644,348 Gold and silver coin 857,765
Seven-day and other
bills 1,030,354
----------- -----------
£31,423,240 £31,423,240

... Taken as a whole the act has worked well, and has succeeded, in
combination with greater knowledge and foresight, in maintaining our
banking system in a sound condition....

The main point of contention between the supporters and opponents of the
act lies in its want of elasticity in time of need. Under no
circumstances can the bank increase its issue of notes against
securities beyond the prescribed limit, without a breach of the law; but
on three occasions in the past the law has been broken, though with the
consent of the Government, and subsequent confirmation of Parliament....

We will now briefly review the ... occasions on which the Bank Act was
suspended, and the effect of such suspensions.

The first of these occasions was during the panic in the year
1847--known as the "railway panic." Shortly previous to this year a
great accumulation of capital had led to a demand for new investments,
which were duly provided for the public by those concerned with such
matters. Added to this, interest rates had ruled low for some time, and
this conduced to a period of speculative activity. Too much capital was
put into fixed investments--chiefly railways--and in one session of
Parliament sanction was asked for various railway schemes involving a
total capital of £340,000,000. Wild gambling in railway stocks ensued,
credit was inflated above all reason, and then the turn came. This was
primarily due to a bad harvest and potato crop, causing a heavy
importation of corn, and consequent export of gold.

During the panic which ensued, the reserve of the Bank of England fell
to £1,600,000, but when the panic was at its height, the act, passed
only three years before, was suspended. The bank was authorised to
increase its accommodation to the public by exceeding, to an indefinite
extent, the limit fixed for the issue of notes not secured against gold.
The effect of this suspension of the act was immediate and complete. The
fear that "there was not enough to go round" passed from men's minds. As
a matter of fact, the issue on this occasion did not exceed the normal
limit, the mere knowledge that the bank was empowered to exceed this
limit proving sufficient to allay the panic.

The second suspension of the Bank Act was due to the crisis of 1857, a
crisis that was brought about by reckless overtrading, and came upon the
public very suddenly and with practically no warning....

The third suspension of the Bank Act took place in 1866.[152] Many
elements of disturbance to the money market had been in force during two
or three preceding years. The Civil War in America had resulted in gold
being sent to this country; but the stoppage of the supply of cotton
from America, owing to the war, disorganised one of our staple national
industries, and supplies of cotton had to be obtained from elsewhere at
high prices, and paid for in cash. Hence a drain of gold set in on a
large scale. In addition, a large speculation had been built up on
credit in the stocks and shares of the many new limited liability
companies which were formed at that time.

General uneasiness began to prevail towards the end of 1865; in January,
1866, the bank raised its discount rate to 8 per cent., and a crisis
began to develop rapidly....

On the 9th May the bank rate was raised to 9 per cent. On the 10th May
the failure of Overend, Gurney, and Company--for upwards of ten
millions--was announced, and the bank rate went to 10 per cent. This
failure was not made known till after business hours, so it was not till
Friday, the 11th May, 1866--known as "Black Friday"--that the crisis
reached its height.

The stoppage of this large house affected the whole world, and general
failure seemed imminent, when, in the afternoon of the day on which the
failure became known, it was announced that the Bank Act was again
suspended, and calm began to take the place of mania. But though the
panic was allayed, many failures shortly took place, which delayed the
quick restoration of a sense of security....

From the above brief records of the financial tragedies of the past, we
see that on each occasion reckless speculation and overtrading had been
allowed to reach a dangerous height before any steps were taken to check
them, and on each occasion the check came too late. But we also see the
marvellously quick effect which the suspension of the act had on the
situation....

THE FUNCTIONS OF THE BANK OF ENGLAND

[153]The distinctive functions of the Bank of England consist in its
acting as:

1. Banker to the British Government.

2. Banker to the joint stock and private banks.

3. (a) Sole possessor of the right to issue notes which are legal tender
in England; (b) sole possessor, among joint stock banks with an office
in London, of the right to issue notes at all.

4. Provider of emergency currency.

5. Keeper of the gold reserve for British banking.

6. Keeper of the gold reserve which is most readily available for the
purposes of international banking.

These various functions fit into and supplement one another, and though
their diversity is sometimes pointed to as throwing too much
responsibility onto one institution, it in fact enables the bank to
carry out its duties with extraordinary ease, and with the least
possible disturbance to the financial community. By the fact that it
keeps the balances of the other banks, the Bank of England is enabled to
conduct the payment of the interest on the British debt largely by
transfers in its books. By the fact that it keeps the balances of the
Government and has the monopoly of the legal-tender note issue, the Bank
has a great prestige in the eyes of the general public, which it
communicates to the other banks which bank with it. There is an
impression that the Government is always behind the bank, and that the
bank is always behind the other banks, and this feeling has certainly
done much to foster the confidence of the British public in its banking
system.

A credit in the books of the Bank of England has come to be regarded as
just as good as so much gold; and the other banks, with one exception,
habitually state their "cash in hand and at the Bank of England" as one
item in their balance sheets, as if there were no difference between an
actual holding of gold or legal tender and a balance at the Bank of
England. It thus follows at times when an increase of currency is
desirable, it can be expanded by an increase in the balances of the
other banks at the Bank of England, since they thus become possessed of
more cash to be used as the basis of credit. For currency in England
chiefly consists of cheques, and customers who apply to the banks for
accommodation, by way of discount or advance, use it by drawing a cheque
which is passed on and so creates a deposit; and expansion of currency
thus consists chiefly in expansion of banking deposits. This expansion
is only limited by the proportion between deposits and cash which the
banks think fit to keep, and as long as they can increase their cash by
increasing their credit in the Bank of England's books the creation of
currency can proceed without let or hindrance. Their balances can be
increased by borrowing from the Bank of England, which is generally
carried out not by the banks themselves but by their customers from whom
they have called in loans, and the Bank of England is thus enabled to
provide emergency currency with great ease, by means of loans and
discounts which are used to swell the balances of the other banks, which
thus show an increase of the cash at the Bank of England which they use
as a basis for credit operations. The elasticity of the system is thus
remarkable, and the merchants and bill brokers of London can by taking
approved security to the Bank of England, increase the basis of English
credit in a few minutes by borrowing.

1. Examining these functions of the Bank of England in closer detail we
find that its first and most obvious one, which originally brought it
into being, of financing the British Government and acting as its
banker, is now perhaps its least difficult and important duty. Apart
from the prestige which it thus acquires and its close touch with the
Government and the officials of the Treasury, the bank's position as
government banker is of little direct material advantage. Its duties as
such, besides the normal relation between a bank and a customer, consist
chiefly in making advances to the Treasury in the shape of "deficiency
advances" when the government balances are too low to admit of the
payment of the quarterly interest on the British debt without
replenishment, or against "ways and means" advances at times when the
revenue is coming in more slowly than government expenditure is
proceeding. It also, when the Government has to borrow to a greater
extent, manages its issues of Treasury bills, or any loan operation that
the Government may have to undertake.

2. The second of the Bank of England's distinctive functions--its acting
as banker to the rest of the English banking community--is the one which
throws upon it its most serious responsibilities and gives it most of
its actual power and ease in working. The Government gives it prestige
in the eyes of the multitude, which considers that governments are
omnipotent; the other banks give it the power of providing emergency
currency by making entries in its books, and so acting as the easily
efficient centre of a banking system in which elasticity and the economy
of gold are carried to a perfection which is almost excessive.
Nevertheless, it pays heavily for its apparently privileged position as
bankers' bank. At first sight it would appear that these customers,
keeping a regular balance of twenty-odd millions, which varies little
and on which the Bank of England pays no interest, were a source of
comfortable income and no anxiety to it. But in the first place it is
obvious that a liability which is regarded as cash by the rest of the
banking community requires special treatment by its custodian, and in
practice it is so specially treated that the Bank of England maintains a
proportion of cash to liabilities which is fully twice as high as that
of the strictest of the other banks. This proportion rarely is allowed
to fall below 33 per cent. and generally ranges between 40 and 50 per
cent., and it need not be said that this high level of cash holding
tells heavily on the earning power of the Bank of England. Moreover, it
is its position as bankers' bank that exposes the Bank of England to the
responsibility of maintaining the gold reserve for English banking and
being prepared to meet, in gold, any draft on London that any one abroad
who has acquired or borrowed the right to draw wishes to turn into metal
to be shipped to a foreign country.

The amount of the bankers' balances is not separately stated, but is
wrapped up in the total of the other deposits in the Bank of England's
weekly return. It is believed to average about 22 millions in these
days, and it is often contended that valuable light would be thrown on
the monetary position if this item were separated from the balances of
the other customers of the bank. Many of the outer bankers are in favor
of this change, but there is a serious practical objection to it, in
that a dangerous impression might be created in the public mind if at
any time it were seen that the bank's cash reserve was below its
liability to its banking customers; and the separate publication of the
bankers' balances might thus check the readiness with which the Bank of
England creates emergency credit. Another suggestion that is sometimes
made by the many critics of the existing order of things in English
banking is that the banks should keep their cash reserves themselves;
but this very revolutionary change would deprive the system of its two
great advantages, a centralised organisation with a centre which
specialises on the duties involved by acting as centre, and the extreme
elasticity with which the present arrangements work. At the same time it
must be admitted that the system by which the other banks treat their
balances at the Bank of England as cash leads to the existence of a vast
amount of "cash" in England which on being looked into is found to
consist of paper securities or promises to pay.

3. The Bank of England's monopoly of note issue, which once gave it the
monopoly of joint-stock banking in London, is now a matter of
comparatively minor importance, owing to the change in English banking
habits by which the cheque has ousted the bank note for the purpose of
daily commercial payments, and the regulations which were imposed on the
note issue by the Bank Act of 1844. This monopoly was conferred on the
bank in 1706 and was maintained until 1826, when the implied monopoly in
joint-stock banking was restricted to a sixty-five-mile radius around
London. In 1833 joint-stock banks were established in London itself,
since it had been discovered that the Bank of England's alleged monopoly
only reserved to it the privilege of note issue, and the private bankers
in London had already found that it was more convenient to banker and
customer to work by the system of deposit and cheque.

The development of this system was quickened by the provisions of Peel's
act of 1844, which, under the influence of banking disasters that had
arisen out of reckless note issuing by private banking firms in the
counties, laid down an iron rule for the regulation of note issues in
England. None of the other note issuers were allowed to increase their
issues under any circumstances, and the Bank of England, for every
additional note issued beyond £14,000,000, was to hold metal in its
vaults. Under the terms of Peel's act one-fifth of this metal might be
silver, and in the early returns issued by the bank under the act a
certain amount of silver is found among the assets of the issue
department. But since 1853, no silver has been held in the issue
department of the bank, and in 1897, when the influence of the
bimetallists on the existing Government led to a proposal that the
proportion of silver allowed by law should be held by the bank as
backing for its note issue, public opinion expressed itself so
vigorously that the suggestion was promptly buried. The bank's fiduciary
note issue, thus fixed at £14,000,000, was only allowed to increase by
the lapse of the issues of the existing issuers, the bank being
empowered to increase it by two-thirds of the amount lapsed. The lapsing
process has proceeded steadily by the amalgamation of country banks with
banks which have London offices and so are prohibited by the bank's
monopoly. And the bank's fiduciary issue has thus been raised from the
original £14,000,000 to £18,450,000. Above this line it can not go
except by means of the suspension of the Bank Act, which has been found
necessary occasionally in the past. The English currency system is thus,
as far as the law can rule it, entirely inelastic, but it has already
been shown that even when the law of 1844 was passed, the cheque
currency, over which the law exercises no restriction, was already
driving out the note, and banks without any right of note issue had been
eleven years established in London. The Bank of England's note issue is
now chiefly used by other banks as "till money," or part of the store of
legal-tender cash they keep to meet demands on them. It has thus become
part of the basis of credit in England, since the other banks roughly
base their operations on their holding of cash in hand and at the Bank
of England. Their cash at the Bank of England has already been discussed
above: their cash in hand consists of coin and notes, and since the
latter have thus become part of the foundation on which the deposit
liabilities of the other banks are based, there is reasonable ground for
the contention often put forward by practical expert critics of the
English system, that the fiduciary note issue should be reduced by the
repayment by the Government of the whole or part of a government debt of
£11,000,000 to the bank, which backs the greater part of it, and its
replacement by gold. It is evident that the amount of metallic backing
for a note issue which is intended to circulate as currency is a
different matter from that required in the case of a note issue which is
held by bankers as a reserve and used by them as a foundation for a
pyramid of credit operations.

4. By the ease with which the Bank of England provides emergency
currency, it gives the English banking system the great advantage of
extreme elasticity and adaptability; and it is enabled to do this by the
fact that it acts as banker to the other banks, and that every credit
which they have in its books is regarded by them and by the rest of the
community as "cash" to be taken as practically equal to so much gold.
This cash at the Bank of England in the hands of the rest of bankers can
be multiplied as rapidly as the Bank of England is prepared to make
advances, and as the mercantile and financial community can bring it
bills for discount or securities to be borrowed on. There is no legal
restriction of any sort or kind, and the close relations between the
bank and its borrowing customers enable the necessary operations to be
carried through with a celerity which is unrivalled, at any rate in the
eastern hemisphere. The process works as follows: In every English bank
balance sheet there will be found an item among the assets "cash at call
or short notice," though in a few cases the slovenly habit is adopted of
including this entry along with the cash in hand. This "cash," as it is
called, really consists chiefly of loans made by the banks to the
discount houses, and regarded by the banks as the most liquid of their
resources. As such, it is at once made use of when for any reason, such
as the many payments which have to be made on quarter days, or at the
end of the half year when the preparation of balance sheets by firms and
companies require an abnormal amount of cash for more or less ornamental
purposes, the banks are subjected to extra pressure by their customers,
who both withdraw actual currency from them for smaller payments, and
require advances in order to show cash with bankers in their balance
sheets.

The banks in order to meet this pressure, and at the same time to
preserve an adequate amount of cash in their own statements, call in
their loans from the discount houses; the discount houses, at a point,
can only repay them by borrowing from the Bank of England and
transferring the credit raised with it to the bankers, whose cash at the
Bank of England is thus increased. This book entry takes the place in
their balance sheets of the legal-tender cash that their customers have
withdrawn, and is used as the basis for the increased deposits that have
been created by the loans of the bankers to their customers for
ornamental purposes. Similarly at the time of year when the transfer of
the taxes to the Government's balance reduces the cash at the Bank of
England held by the other banks the gap is filled by the loans made by
the Bank of England to the customers of the other banks. In short, by
discounting and making advances the Bank of England can at any time
create book credits, which are regarded as cash by the English banking
community, and on which the latter can base the credits which give the
right to draw cheques, which are the most important part of the English
currency. The extent to which the Bank of England can create this credit
is a matter for its own discretion, but any creation of it diminishes
the proportion that it shows in its own weekly returns between its
reserve and liabilities. Consequently when it is applied to for amounts
which bring that proportion too low the Bank of England has to take
steps to reinforce its cash reserve.

5. It has been shown that the Bank of England keeps the balances of the
other banks, and from this it follows that the latter look to it for
gold or notes at times when the local commercial community requires an
extra supply. At the end of every month, especially at the ends of the
quarters or at times of national holidays, the bank's note circulation
expands and coin is taken from it. The duty is thus thrown upon it of
keeping an adequate supply of cash for home purposes, and, as has been
already stated, its normal proportion of cash to liabilities is very
much higher than that of the other banks. But these movements are tidal
and regular, and though times of active trade increase slightly the
demand for coin and note currency in England, the extensive and
ever-growing use of the cheque reduces the importance of this part of
the bank's duties.

6. Much more important is the Bank of England's duty as custodian of the
gold store for international banking. London is the only European centre
which is always prepared to honor its drafts in gold immediately and to
any extent. Consequently the Bank of England has to be prepared to meet
demands on it at any time from abroad, based on credits given to
foreigners by the English banking community, and it has thus to observe
the signs of financial weather in all parts of the world and to regulate
the price of money in London so that the exchanges may not be allowed to
become or remain adverse to a dangerous point. The difficulties of this
task are increased by the extent to which the English banking community
works independently of it, by accepting and discounting finance paper,
and giving foreigners credits at rates which encourage their further
creation. For the low and wholly unregulated proportion of cash to
liabilities on which English banking works, enables the other banks to
multiply credits ultimately based on the Bank of England's reserve,
leaving the responsibility for maintaining the reserve to the bank. This
it does by raising its rate when necessary, and so, if it has control of
the market and its rate is "effective"--a phrase which will be explained
later--raising the general level of money rates in London.

When its rate is not effective, the Bank of England finds itself obliged
to intervene in the outer money market--consisting of the other banks
and their customers--and control the rates current in it. This it does
by borrowing some of the floating funds in this market, so lessening
their supply and forcing up the price of money. By means of this
borrowing it diminishes the balances kept with it by the other banks,
either directly or indirectly--directly if it borrows from them,
indirectly if it borrows from their customers who hand the advance to it
in the shape of a cheque on them. The result is that so much of the
"cash at the Bank of England," which the English banking community uses
as part of its basis of credit, is wiped out, money--which in London
generally means the price at which the bankers are prepared to lend for
a day or for a short period to the discount houses--becomes dearer, the
market rate of discount consequently tends to advance, the foreign
exchanges move in favor of London, and the tide of gold sets in the
direction of the Bank of England's vaults, and it is enabled to
replenish its reserve or check the drain on it. That the Bank of England
should have to go through this clumsy ceremony of borrowing money that
it does not want, in order to deprive the outer market of a surplus
which depresses discount rates in a manner that is dangerous owing to
its effect on the foreign exchanges, arises from the want of connection
between bank rate and market rate. In former days the London money
market never had enough money to work without help from the Bank of
England. Bagehot, in his great work on Lombard Street, published in
1873, says that "at all ordinary moments there is not money enough in
Lombard Street to discount all the bills in Lombard Street without
taking some money from the Bank of England."

As long as this was so, bank rate--the price at which the bank would
discount bills--was at all times an important influence on the market
rate. Since then, however, the business of credit making has been so
quickly and skillfully extended that Lombard Street is frequently able
to ignore bank rate, knowing that it will easily be able to supply its
needs from the other banks, at rates which are normally below it.
Currency in England consists of cheques drawn against deposits which are
largely created by the loans and discounts of the other banks. There is
no legal limit whatever on the extent to which these loans and discounts
can be multiplied, and the only limits imposed are those of publicity,
which is applied rarely in all cases and in some not at all, and of the
prudence with which the banks conduct their business. Hence it follows
that competition between the banks often impels them to continue to make
advances or discount bills at low rates when the Bank of England, as
custodian of the English gold reserve, thinks it advisable in the
interests of the foreign exchanges to impose a higher level. This it
does by borrowing some of the credit manufactured by the other banks, in
order to create artificial scarcity of money, and make its own official
rate effective.

It thus appears that the Bank of England's official rate is often
through long periods a mere empty symbol, bearing no actual relation to
the real price of money in London; and only becomes effective, and a
factor in the monetary position (1) when the trade demand for credit is
keen enough to tax the credit-making facilities of the other banks to
their full extent, (2) when the payment of taxes transfers large sums
from the other banks to the Government's account at the Bank of England,
so reducing the "cash at the bank" on which they build credit
operations, and (3) when, owing to foreign demands for gold, the Bank of
England takes measures, by borrowing, to restrict credits in the open
market and to make its rate effective. In other respects its official
rate differs materially from the rates quoted by ordinary dealers in
credit. It does not fluctuate according to the supply and demand for
bills, but is regularly fixed once a week at the meetings of the Bank of
England court on Thursday morning. It is extremely rare for any change
to be made in the Bank of England rate on any day except Thursday.
Instances occur rarely when some sudden change of position makes it
essential, as at the end of 1906, when the bank rate was raised to 6 per
cent. on a Friday morning. In normal times the rate which is fixed on
one Thursday is maintained until the next, though the rate is only a
minimum and the Bank of England occasionally takes advantage of this
fact and refuses to discount at its minimum, which still remains
ostensibly the bank rate, while the bank actually makes a rather higher
charge, which is usually made the official rate on the next Thursday.

But it must not be supposed that when bank rate is ineffective the Bank
of England is doing no business. It discounts bills and makes advances
at market rates at its branches, and also at its head office to its
private customers. Bank rate may be described as the price at which the
bank is prepared to discount in its official capacity as centre of the
London market, and it is because appeal is only made in exceptional
circumstances to the bank to provide credit in this capacity that bank
rate is often ineffective.

THE JOINT-STOCK BANKS

The most obvious function of the joint-stock banks of England is the
business of taking care of money for customers and meeting cheques drawn
against their balances. Customers place money with them either on
current or deposit account. On current account it can be withdrawn at
any time and earns, as a rule, no interest. Many banks make it a
condition that unless the current account is maintained at a certain
figure, generally £100, a charge shall be made for keeping it. A usual
charge is £1 5_s._ 0_d._ each half year, but arrangements vary according
to the terms agreed with different customers, and the keen competition
now prevalent enables many to obtain the convenience of a bank account
for nothing. Sums left on deposit are generally placed for a week or
longer, and if placed for a week the rate paid on them by the banks is
generally 1-1/2 per cent. below bank rate.

Out of this function of meeting checks drawn by customers against the
sums deposited has grown the banker's chief duty, which is now the
provision of cheque currency for the mercantile and financial community.
Currency in England consists of coins, notes, and cheques. The note
issues are almost obsolete as currency, the Bank of England's being used
chiefly as reserve by the other banks, while the issues of the country
banks are so small as to be negligible. Most of the commercial and
financial transactions of England to-day are settled by cheques drawn on
the banks by their customers. These cheques are not legal tender, since
it would obviously be impossible that a cheque drawn by an individual on
a bank could be legally made acceptable by a creditor whether he wished
to take it or not.

There is no legal obligation of any sort on them to maintain any regular
proportion between cash and liabilities, and as their position in this
respect is only subjected to occasional publicity they are not obliged
to consider even the effect upon their customers of any considerable
variation in the proportion between cash and liabilities which they
keep. The system thus works with extreme elasticity and banking
facilities can be provided in England with extraordinary ease. It has of
late years been frequently contended that the ease and elasticity with
which it works have carried the English banking machinery to a somewhat
extreme length in the matter of the economy of gold and legal tenders
and the extent of the credit pyramid which it builds up on them. After
the crisis of 1890, Lord Goschen seems to have been strongly imbued with
the conviction that the system had been carried too far. He therefore
urged upon the London banks that they should make a monthly statement of
their position, and this suggestion was adopted by the majority of them.
The result was that they published a monthly statement showing how they
stood on one day at the end of each month, and it thus followed that on
one day at the end of each month the banks showed a proportion of cash
to liabilities which they considered sufficiently adequate to stand the
light of publicity. But the system has long been seen to be faulty, and
a certain amount of abuse has grown up round it. It is strongly
suspected, for example, that some of the banks which publish these
statements make preparations for them by calling in loans or reducing
their discounts for the day on which the statements are drawn up. As far
as this is done the statement is to a certain extent misleading, and
this practice of "window dressing," as it is called in Lombard Street,
has been subject to frequent criticism, so much so that one of the
leading London banks--the London and County--adopted early in 1908 the
practice of showing its daily average cash holding, thus demonstrating
that it was not in the habit of preparing a statement which did not
represent its position fairly throughout the month. It has been stated
by a president of the English Bankers' Institute that the proportion of
cash to liabilities shown by country banks ranges down to a point as low
as 2.2 per cent. No one can contend that this is an adequate cash basis
for banking to work on, and as long as certain members of the banking
community conduct their business on these lines an obvious hardship is
involved on those which keep a more prudent and strong reserve of cash.
It is contended by the big strong banks that their smaller brethren
compete with them by providing more credit than they have any right to
create, relying on their assistance in times of difficulty.

Apart from this danger of the over-multiplication of credit on an
inadequate cash basis, the complete absence of any legal or other
restrictions on the operations of English banking enables it to work
with extraordinary ease and readiness. As long as good unpledged
security, whether in the form of bills of exchange, commodities, or
Stock Exchange securities, are available in the hands of customers the
banks can advance against them to any extent that they consider prudent.
Prudence dictates in the case of a great majority of them that a certain
proportion of cash to liabilities shall be maintained, but, as was shown
above in dealing with the Bank of England, the cash of English banking
consists partly of credits with the Bank of England. These credits with
the Bank of England, and consequently the cash credits of English
banking, can be multiplied as rapidly as the Bank of England is prepared
to make advances or discount bills, and so give credit in its books. The
Bank of England must publish its account weekly, and it watches over its
proportion of cash to liabilities with a vigilance which is greater than
that of the rest of the banking community as a whole. Nevertheless, its
prudence in this respect is the only restriction on it, and we thus
arrive at the conclusion that the chief function of the English joint
stock banks, that of providing the mercantile community with currency
and credit, can be carried out to any extent as long as their customers
have security to offer and their proportion of cash remains adequate to
their sense of prudence. And further, their proportion of cash can be
increased as rapidly as the Bank of England is prepared to make
advances, which it can and does to an extent which again is only limited
by its own prudence.

Besides this absence of outside regulation, the English monetary system
is also distinguished by a remarkable lack of cohesion and co-operation
among the members of its own body. Except to a certain extent in the
country districts, where the rates allowed to depositors and charged to
customers are to a certain extent a matter of convention, English
banking works almost entirely at the mercy of very keen internal
competition. This extreme development of competition leaves the market
liable to pronounced depression in rates at times when slackness of
trade or other causes decrease the demand for credits. At these times
the adroit bill brokers and discount houses, which are in some respects
the most important borrowing customers of the banks in London, are
enabled by the use of this weapon of competition to obtain loans from
the banks at rates which are often below the price that the bankers are
paying to their depositors. Hence, it follows that in these times of
monetary ease the credit machine goes on turning out its product at
rates which are quite unremunerative and have a detrimental effect on
the market rate of discount, and so on the foreign exchanges, thus
increasing the difficulties of the Bank of England, which at these times
of extreme ease is without any control of the position. Against this
weakness of the system, however, must be set the advantage which the
unrestricted and fiercely competitive manufacture of credit confers on
the mercantile and trading community.

A few words should be said concerning the form of cheques with which the
English banks provide their customers as currency. Legally a cheque is a
bill of exchange drawn on a bank and payable on demand. That is to say,
it is an order signed by a customer of the bank directing it to pay a
certain sum to another party or to himself. The form, however, can be
varied in various methods, increasing or diminishing the ease with which
the cheque can be turned into cash. The cheque can be made payable to A
B or bearer, and in this form can be taken to the bank drawn on and
immediately turned into cash. When drawn to A B or order, a cheque has
to be indorsed, or signed on the back, by A B before the bank drawn on
will pay it. A still further restriction is the English system of
crossing cheques, that is to say, of drawing two lines across the face
of the cheque, by which mark it is shown that the cheque is not to be
paid in cash across the counter by the bank drawn on, but must be paid
into a bank by the payee, and so only becomes credited to him in his own
banking account through the operations of the clearing house. It is
evident that this protection greatly increases the safety of the cheque,
since if it fell into the wrong hands its chance of being made
fraudulent use of is greatly diminished. As the lines drawn across the
face of the check by the bankers' customers are often faint and
irregular, it has been found in practice that they lend themselves to
the ingenuity of the fraudulent, who are easily enabled to erase them
and so obtain possession of money that is not meant for them. Some of
the banks therefore print these crossing lines on all of the cheques
that they issue to their customers to be filled in, and when the
customer wishes to obtain cash from his bank on one of these cheques he
is consequently obliged to write upon it "Please pay cash," and sign
this note upon it. The extensive use of crossed cheques thus tends to
make the cheque still further an instrument which merely transfers
banking credits from the books of one bank to another, since every
crossed cheque implies that it can not be turned into cash directly, but
can only transfer credit with one bank to credit with another. Another
restriction with which custom has protected the English cheque is the
system of writing "Not negotiable" on the face of it. These words do not
mean that the cheque is really not negotiable, but their legal effect is
that the holder of the cheque can not establish a better right to it
than the party from whom he received it. If therefore the party from
whom he received it had no right to it, his claim against the paying
bank is _nil_. With these safeguards, and with the enormous convenience
of being drawn to any amount to fit the exact requirements of each
transaction, the cheque, although not legal tender, has been enabled to
supersede the bank note in English currency.

The chief function of the joint stock banks having thus been shown to be
the provision of currency for the English community, it may further be
noted that a remarkable development of their activity has been the
rapidity with which they have covered England with branch
establishments. It was estimated in 1858 that the total number of bank
offices in the whole of the United Kingdom was just over 2,000; at the
present moment the aggregate branch offices of four of the English joint
stock banks which are richest in respect of branch establishments have
exceeded this total. One bank in England has over 600 offices, one has
over 550, two have over 400, three have more than 200, twelve have more
than 100. This multiplication of branch offices has been carried out
partly by the absorption by the joint-stock banks of the smaller
institutions in the country, whether private or joint stock, and partly
by the rapidity with which they have opened branches in the great
provincial centres and their suburbs, and to a moderate extent in the
small country towns. The result of it is to give the English monetary
system the power of easily supplying the needs of the various parts of
the community as the requirements of others ebb and flow. At the same
time this rapid development increases the competition between the
various English banks, which we have already shown to be carried to an
almost excessive degree, and by the wide local distribution of their
liabilities enhances the possibility of strain on them in times of
difficulty.

Some of the banks include under the heading "cash at call and short
notice" advances which they make to the Stock Exchange for the
fortnightly periods that elapse between its settlements. The funds that
they so use obviously have an important effect upon the marketability
and price of securities in London. On the first day of every settlement
it is usual to see rates quoted as those at which the banks are lending
to their stock exchange clients for the financing of speculative
commitments. In the arrangement of these rates a certain amount of
combination and co-operation among the banks, or some of them, has grown
up as a matter of custom, but since for this class of accommodation the
bankers are subject to competition on the part of the agencies of the
foreign banks and the big finance houses it is often found difficult to
maintain even this amount of harmonious working among the bankers.

It has been shown that the rate at which the banks make advances to the
discount houses has an important effect upon the market rate of discount
in London, but the banks exercise a still more important and direct
effect upon this discount by being themselves large buyers of bills. It
is impossible to gauge exactly the extent to which they hold bills among
their assets, since many of them in their balance sheets include their
discounts along with their loans and advances. Among the many
suggestions that reformers have put forward in the matter of English
banking, one is that this item of the banks' holding of bills should be
separately stated. But though this obscurity in the statements of the
English banks makes it impossible to know the precise extent to which
they hold bills, there is no doubt their purchases of them are on the
whole the most important influence upon the market rate of discount in
London. Nearly all the discount houses, whose functions will be
described later, buy bills, largely with the intention of reselling
them to customers, among whom the joint-stock banks are the largest and
most important and most regular buyers, and it is contended by the
discount houses that the market rate of discount, for which they
themselves are generally supposed to be responsible, is really and in
fact regulated by the price at which the big joint-stock banks are
prepared to buy. This being so, since the market rate of discount is
perhaps the most important influence on the foreign exchanges and so on
the inward and outward movements of gold, it will be seen that this
function of the bankers is one of the greatest possible importance from
the point of view of London's free market in gold.

Besides thus regulating the price at which bills of exchange can be
discounted in London, the banks have in recent years taken an
increasingly large and important part in the creation of bills of
exchange by placing their acceptances at the disposal of their
customers. The increasing extent to which the bankers have in recent
years intruded into this class of business is a grievance that is
resented rather keenly by the merchant firms, or accepting houses, as
they are often called. It is contended by the latter that the business
of acceptance is a special function for which special training is
required, and that the joint-stock banks rarely have available the
special abilities that make for its proper conduct. On the other hand,
the high standing of the joint-stock banks and their big reserve
resource in the shape of their uncalled capital makes their acceptances
an exceptionally fine credit instrument, and it seems natural enough
that they should, to a certain extent and within moderate limits, place
these facilities at the service of their customers.

Finally it may be added that the English joint-stock banks are now
showing a disposition to engage to some extent in the business of
dealing in foreign exchange which has hitherto been left to the finance
houses and foreign firms established in London. The London and County
and the London City and Midland banks have now established regular
foreign exchange departments. This development is generally welcomed as
a sign of a desire on the part of the banks to widen their horizon and
to come into closer touch with the affairs of the financial world at
large, but, as in the case of the banks' increasing interest in
acceptance, there are some critics who consider that it is better for
the bankers to stick to their obvious and highly important function of
providing the community with credit and currency, and taking care of the
money of their customers.

THE PRIVATE BANKS

Any differences that exist between the private and joint-stock banks of
England lie in their ownership rather than in their functions. Their
functions are the same, but the manner in which they carry them out is
perhaps influenced to a slight extent by the fact, which really
distinguishes them, that the private banks are owned by a few partners
who generally conduct the business for themselves or exert more or less
influence on it, while the joint-stock banks are managed by salaried
directors and officials on behalf of a large body of shareholders formed
into a public company, the shares in which can as a rule be bought and
sold on the London Stock Exchange.

Since private enterprise naturally precedes joint-stock institutions, it
goes without saying that the private banks of England were the pioneers
of the banking business. There are still in existence private firms
which were founded before the Bank of England. A goldsmith called Child
was doing business of a banking character soon after 1660, and Child's
Bank still exists. Hoare's Bank was instituted in about 1680, fourteen
years before the Bank of England received its charter. Modern
developments have almost driven them out of the field, and among the
leading banks in the city of London only two are left which can still be
called private in the old sense of the word. There are one or two other
institutions which are on the borderland: and at the west end of the
town several old firms, including Child's and Hoare's, have retained
their old constitutions.

THE MERCHANT BANKERS AND ACCEPTING HOUSES

The most important function of the merchant bankers is not that of
banking, but of accepting. Banking, in the strict sense of the term,
they do not engage in--that is to say, they are not prepared to meet
claims upon them by an immediate payment of cash or legal tender over
the counter, but by payment of a cheque on one of the banks in the
stricter sense of the term. The function of the London accepting houses,
though of enormous importance, is still to a certain extent subordinate
to the judgment of the English banks. They finally decide whose paper is
most readily negotiable, and, in times when the credit machine is felt
to be somewhat out of gear, the bankers occasionally discriminate
against the paper of firms which they consider to have been giving their
acceptance too freely. In this respect, as in so many others, the Bank
of England remains the final arbiter, since the paper of an accepting
house which is questioned by the other banks can be negotiated at the
Bank of England through a discount house, and the Bank of England has
before now intervened with effect when it considered that questions
raised concerning certain acceptances have been without justification.

This business of acceptance is one into which the other banks have
themselves recently intruded with considerable effect, accepting bills
for their customers, home and foreign, for a commission; and there is a
certain apparent anomaly in the position which makes them guardians of
the volume of acceptance created by the private firms and acceptors
themselves on a steadily increasing scale. Nevertheless, this anomaly
has little or no untoward effect in practice. The bankers are naturally
extremely cautious in raising any question as to the security of general
credit in London, and they are in many ways closely connected with the
private accepting houses, so that the system, which appears to be full
of uncomfortable possibilities on paper, works easily enough in
practice.

Other functions of the merchant firms and accepting houses are their
activity in general finance and in exchange business. Both these
functions arise out of their old business as merchants, which gave them
close connection both with the governments and the business communities
of foreign countries.

THE DISCOUNT HOUSES

The great volume and diversity of the bills of exchange which come into
the London market to be melted and turned into present cash before their
date of maturity has caused the existence of a class of dealers in bills
(bill brokers) who specialise in handling them and may be regarded as
intermediaries between the holders of the bills--that is to say,
originally, the drawers of them, or their representatives, or any one
else into whose hands they may have passed them on--and the bankers, who
are the ultimate buyers and hold them as investments until maturity. It
is the business of the discount houses to buy these bills on a wholesale
scale, using for this purpose funds largely lent them by the banks, and
to meet the requirements of the bankers with regard to the date named
and quality of the bill, providing them out of the store that they keep
constantly replenished.

We have also seen that the discount houses fulfill a very important
function by borrowing funds from the bankers at call and short notice.
These funds are regarded by the bankers, and actually described in their
balance sheets, as cash, cash at call, and short notice. It is a
somewhat elastic extension of the term "cash" to apply it to money that
is being lent to any borrower, even of the highest credit and against
the most liquid possible collateral. But it is always assumed by the
bankers that these funds placed in the discount market can be called in
readily at any moment. That they can be called in is practically a fact;
but it arises chiefly from the ability of the discount houses when
pressed for repayment of these loans by the bankers to fill the gap in
credit by an appeal to the Bank of England and the production of fresh
cash, as it is called, by borrowing from it. The discount houses take
security to the Bank of England and raise with it the right to draw
cheques. These cheques they pay to their bankers, whose cash at the Bank
of England, which we have already seen to be regularly used as a part
of the basis of credit in England, is thus increased.

Besides the money that they habitually borrow for short periods from
bankers, the discount houses also have considerable amounts placed on
deposit with them by other lenders, some of which they employ,
especially in times when the volume of bills is comparatively small, by
loans to the Stock Exchange for financing the speculative commitments of
the public, and by holding or carrying securities of a reasonably liquid
character. They also take some part in the underwriting of new loans and
in the general financial business of the London market.

[154]It is impossible to exaggerate the importance of the functions
which the bill brokers discharge in the London money market. They are
only about twenty in number, including three joint stock companies. One
or two of the brokers work on commission, as your brokers do, but the
majority are really dealers in bills. That is, they buy or discount, and
sell, or rediscount, bills of exchange.

Let me illustrate their method of working: A bank in New York may buy
$1,000,000 worth of sterling bills drawn on England and send them
forward to its London agent to be discounted with the bill broker. The
bill broker will discount these bills at, say, 4 per cent. If he thinks
rates are likely to fall, he will hold the bills; if he thinks them
likely to rise, he will try to sell the bills at about 3-3/4 per cent.
or 3-7/8 per cent. discount, thus making a profit on the transaction of
1/4 per cent. or 1/8 per cent. per annum. Similarly he may discount
large parcels of bills for Eastern and South American banks. Many of
these bills will be bills drawn on and accepted by banks and finance
houses. These are known as "bank bills." But on the other hand, the bill
brokers are free buyers of "trade bills." The trade bill in England
arises in the following way: Trader A sells goods to trader B. He will
draw a draft on trader B at, say, three months date. Trader B will
accept the draft and return it to trader A, who will discount it with
his banker or with the bill broker. The rate of discount for trade bills
is usually 1/2 per cent. per annum higher than the rate for bank bills.

The essential feature of almost all the bills on the market is that they
represent a commercial transaction, such as a sale of goods, where value
passes. It is this that lends them their self-liquidating quality; for
they are usually liquidated by the acceptor out of the proceeds of the
resale of the goods during the currency of the bill.

The bill broker not only employs his own capital in buying bills, but
also money which he borrows from the banks and others at call or at
short notice. Enormous sums are employed in this way.

INTERVIEW WITH THE GOVERNOR AND DIRECTORS OF THE BANK OF ENGLAND

[155]Q. When does your present charter expire?

A. The bank's exclusive privileges of banking continue subject to one
year's notice and to repayment by the Government of the debt of
£11,015,100 and of all other public debt held by the bank at the time.

Q. What is the par value and present selling price of your shares?

A. The bank's capital is in the form of stock, £100 of which is at
present quoted at about £267.

Q. How many stockholders have you?

A. There are at present over 10,000 accounts.

Q. Is the stock fully paid?

A. Yes.

Q. Have your shareholders any liabilities in addition to the ownership
of shares?

A. Legal opinion is to the effect that there is no further liability on
bank stock.

Q. Is there any limit to the number of shares which may be held by any
one person, and is your approval required before a transfer of your
stock can be made?

A. There is no limit--the bank's approval is not required.

Q. Does every share have a vote at shareholders' meetings?

A. To have a vote a proprietor must hold £500 of stock, but no matter
how much additional stock a proprietor may hold he can not have more
than one vote.

Q. Is there any custom restricting the class from which the directors
may be selected?

A. There is no legal restriction as to the class from which directors
may be selected, except that they must be "natural-born subjects of
England, or naturalized," but in actual practice the selection is
confined to those who are, or have been, members of mercantile or
financial houses, excluding bankers, brokers, bill discounters, or
directors of other banks operating in the United Kingdom.

Q. How many branches have you?

A. There are eleven branches--two in London and nine in the provinces.

Q. Is the business conducted at your branches of the same class as at
your main office in London?

A. Yes.

Q. Do your branches have business relations with merchants, farmers, and
all classes of people in their respective localities?

A. There are no restrictions of any kind as to the class of people with
whom the bank has business relations.

Q. Is the Bank of England a member of the London Clearing House?

A. Yes; but "on one side only," as it is termed. The Bank of England
presents, through the clearing house, all drafts drawn on clearing
bankers paid in to it by its customers; but the clearing bankers do not
present, through the clearing house, drafts on the Bank of England paid
in to them by their customers. Such drafts are paid direct to the credit
of their accounts at the Bank of England.

Q. Do you at any time allow interest on special deposits?

A. It is not the practice of the bank to allow interest on any deposit.

Q. Can you state approximately the average length of time and the
average size of bills discounted by you?

A. Time, forty to fifty days; size, probably about £1,000.

Q. What is the distinction between what are known as "prime bills" and
other bills?

A. A "prime" bill we should define as a bill accepted by a London or
provincial bank in first-class credit or a merchant or merchant banker
of the first class whose business it is to grant credits.

Q. Do you discount any prime bills?

A. Yes.

Q. Do you discount to any considerable amount for individuals and
merchants?

A. The bank discounts all approved bills offered to it by persons or
firms having properly constituted accounts.

Q. Is it your custom to employ surplus funds in purchase of bills from
discount houses?

A. No.

Q. Do you rediscount bills for the joint stock or other banks?

A. The bank is always prepared to rediscount for other banks at its
official rate, and does a large business from time to time with the
colonial and foreign exchange banks who are from the nature of their
business always sellers of bills.

Q. Would you charge a merchant house having a good account with you the
bank rate or the market rate for prime bills?

A. The market rate.

Q. To what extent does bank rate govern your discount and loan
transactions?

A. The rates for discount and loan transactions at the bank usually
approximate more or less closely to the bank rate.

Q. Do you at times discount bills for parties having no account with
you?

A. No.

Q. Are a considerable number of your loans on call?

A. None.

Q. When and under what conditions is the bank rate changed?

A. The bank rate is raised with the object either of preventing gold
from leaving the country, and lowered when it is completely out of touch
with the market rate and circumstances do not render it necessary to
induce the import of gold.

Q. Does the bank sometimes borrow money in the open market for the
purpose of raising the market rate?

A. Yes.

Q. Do you sometimes sell consols for the same purpose?

A. Yes; on rare occasions.

INTERVIEW WITH SIR FELIX SCHUSTER, GOVERNOR OF THE UNION OF LONDON AND
SMITH'S BANK LIMITED

[156]Q. Your bank is organised under the General Companies Acts as are
all joint stock banks in England?

A. Yes.

Q. You are not under government supervision or examination?

A. No.

Q. The authorised par of your stock is £100, and £15 10_s._ have been
paid on each?

A. Yes.

Q. Are your shares held by individuals and corporations?

A. By individuals, not by corporations. There are upwards of 8,600
different shareholders.

Q. In the transfer of shares, do you require the name of the transferee
to be submitted and approved before the transfer is made?

A. Yes.

Q. That of course is in order to insure the responsibility of your
stockholder?

A. This is in order to insure the responsibility of our stockholder, and
to prevent one holder from securing too large a holding. Furthermore we
give no single proprietor more than 20 votes, however large his holding
may be. Every 10 shares carry one vote, so the holder of 200 shares has
a maximum number of votes.

Q. Is that the usual custom with the joint-stock banks of England?

A. I am afraid I cannot answer offhand. I suppose it is so in some
cases, but the practice varies.

Q. In London there is usually a difference between the rates charged on
loans and bills in favor of bills, is there not?

A. Yes.

Q. Would you say that that difference is perhaps from one-half to 1 per
cent. in favor of the bill?

A. It depends so very much on the circumstances of the moment that it is
very difficult to generalise. At the present moment I would say a three
months' bill is worth 1-7/8, and a three months' loan would be worth
perhaps 3-1/2.

Q. Were most of your branches organised by you or were most of them
other institutions purchased by you?

A. Some of them were other institutions; some of them were organised by
us; most of them were those old banking firms which were carried on as
private businesses and have since become branches of our bank.

Q. The tendency is for the consolidation of banking in Great Britain, is
it not?

A. Yes.

Q. Very strongly in that direction?

A. Very strongly in that direction, yes.

Q. As a matter of fact, a large part of the commercial banking in
England is done by about a dozen institutions, is it not?

A. In Liverpool and Manchester there are very important local banks.
However, it is no doubt the fact that four or five banks do about half
the banking business.

Q. In the main you believe that the banking situation is stronger and
better and the country is better served through the system of branches
than through the independent banks?

A. I am quite convinced of that, if only for one reason, that I do
believe the indiscriminate granting of credits to the individual is
injurious to himself, the private bankers being too much in the habit of
regarding old family associations and not so careful as the joint-stock
company would be, and he has accustomed people to trade on the credit
that they get from the banker. I do not think that is banking business.
The bank ought never to supply the trader with working capital. I think
it is bad for the trader.

Q. Is it not quite essential to the success of a financial institution
doing a commercial business to become a member of the Clearing House if
it is to meet with a large degree of success?

A. No. After all, there are only seventeen banks, I believe, now in the
Clearing House, but there are a great many other institutions who are
not members of the Clearing House and who do not suffer from that fact.
Scotch banks with branches here who do a large banking business are not
members of the Clearing House. There are all the colonial banks with
head offices or branches in London and other large institutions; those
are not members of the Clearing House. There are Barings and
Rothschilds; they are not members of the Clearing House.

Q. Would you say the Bank of England is in any way a competitor of the
other banks in England?

A. Yes. That is a source of very grave complaint by the other banks.

Q. The Bank of England do not pay interest on any accounts?

A. No; but in some cases they act as intermediaries for lending money.
It is a very subtle distinction.

Q. While the bank rate is fixed and is to-day, say 2-1/2 per cent., is
it not a fact that the Bank of England does some business for its
customers and also purchases bills for their account at a lower rate?

A. That is so, and that is one of the matters of complaint. By fixing
the rate at 2-1/2 per cent., or 3 per cent., or 4 per cent., they can
regulate the rate we fix for our own customers. We regulate our deposit
rate in accordance with the bank rate. We also regulate the rate we
charge for our loans in accordance with the bank rate, and we are bound
by it to a certain extent, and they themselves feel at liberty to depart
from it.

Q. What does the bank rate mean; what does it govern in fact?

A. It means the general charge to the trade of the country, because
although we say that bills in the market are discounted at a lower rate
than bank rate, yet there is a vast number of trade bills which are
purely governed by the bank rate.

Q. We found both in Germany and in France the question of the amount of
reserves, either in specie or in bank, was regarded as of little
importance by the bankers. They depend on the Reichsbank and the Bank of
France for rediscount in times of need.

A. Both in France and in Germany banks are much more dependent on the
central institution than we are here. They lean on their central
institution to a very great extent; for instance, the rediscounting of
bills and borrowing from the central institution is, I believe, quite a
usual occurrence. Here it is an occurrence which would only take place
in the last resort. As far as I am aware this bank has never as long as
it has been in existence had one penny from the Bank of England, whether
by way of advance or by way of a discounted bill. We do not rediscount
our bills in the market either; so every transaction we enter into we
have to see through to the very end.

INTERVIEW WITH MR. CHARLES GOW, GENERAL MANAGER OF THE LONDON JOINT
STOCK BANK, LIMITED

[157]Q. Your capital stock is £100 authorised, £15 paid?

A. Yes.

Q. Does your board pass upon a new stockholder?

A. Yes.

Q. Who really conducts the business of the bank?

A. The managers, who are appointed by the directors; that is to say,
myself and all those belonging to me.

Q. Are most of your acceptances secured?

A. Every one.

Q. How are they secured, generally speaking?

A. They are secured in the great majority of cases by bills of exchange,
by first-class securities with plenty of margin, even by cash in hand to
a moderate extent, and to a very small extent by bills of lading for
produce shipped. That is a very small item.

Q. Can you state the reason for accepting bills instead of furnishing
the cash?

A. We accept those bills because it happens to be the custom of the
particular banks to draw a long bill. The customer himself who buys
cotton in Bombay, or wherever it may be, acts according to the custom
there to draw a bill to a certain usance. Now, for instance, with regard
to an inland bill, we would not give credit of that sort to a man in
London, but wherever there is a regular course of business abroad to
draw at long usance we comply with it.

Q. What is the character of your bills discounted?

A. Those are all marketable bills, trade bills; you know what they are;
they are between the manufacturer and the man to whom he sells.

Q. You always require two names?

A. Always.

Q. What does the form of obligation by the borrowers upon collateral
take?

A. Just the same form as your promissory note.

Q. You have branches, have you not?

A. We have about forty-odd branches all in London and close to London.

Q. You do not then endeavor to acquire a country business through your
branches?

A. For this reason, that we commenced as a purely London bank, and we
have so far kept to that original determination of not launching out
into country business, because, as I say, it differs from the ordinary
London business. Country business is not quite so liquid, and can not
be.

Q. If you had an account of a man running, say, a hat store, his account
was satisfactory in character and had been carried with you for several
years, and he wanted to stock up on hats, there would be no way in which
he could go to you and borrow the money with which to buy those goods
unless it was through a guarantor?

A. No. He would go then to the wholesaler from whom he would buy the
goods, and give that wholesaler his bill, and that bill would be a
discountable article, and that is how the money would be raised.

Q. Do you ever allow overdrafts, as they do in Scotland?

A. They are not unheard of, but not a principle of our business.
Overdraft is a principle of country banking.

Q. My observation leads me to believe that the banking situation in
London is practically controlled by twelve or fourteen of what are known
as the London joint-stock banks, through their offices and through their
branches?

A. Yes; I think that is right. However, there are still independent
banks in the country, and I doubt whether amalgamation will go very much
farther than it has gone. You see, these amalgamated banks have already
become so large that they begin to get a little unwieldy. Lloyds Bank is
an enormous thing, with $350,000,000 of current and deposit accounts.

Q. Would you say that the public are better served through these
branches than they were through the independent banks?

A. Some say that they are not so well served, that accommodations are
curtailed now as compared with what they used to be, and that I can
understand to some extent, because, working a very large concern from
one centre, you see, fiats will go forth, "Cut that man's credit off,"
and not listen to taking a large view. They say, "I have enough of that
kind of accommodation; I have 100 shipbuilders or shipowners; I am not
going to give out more than a proportion of my money into that
particular trade; therefore, I will not have any more," whereas the
independent banks would be perhaps a little more accommodating.

Q. If I were to go to you to-day with a ninety-day trade bill, the
acceptor known to you as good, and also with a loan secured by
Pennsylvania Railroad bonds, my loan to mature in ninety days, what rate
would you charge me on those separate items?

A. The bank rate to-day is 2-1/2 per cent. You are a good customer, and
I should charge you 2-1/2 per cent. for discounting that trade bill, and
I might charge you 3 per cent., or even perhaps 3-1/2 per cent. on the
Pennsylvania Railroad collateral for this reason, that one is not as
realisable as the other. When the bill becomes due it has to be paid, or
I give it back to my customer, and say "Give me the money for that." I
can not quite say the same to him about his collateral.

Q. What per cent. of earnings on your capital did you show last year?

A. Roughly, our net earnings were 20 per cent. It cost us 50 per cent.
of our gross earnings to run the business.

Q. What taxes do you have to pay?

A. We pay income tax on all our earnings, and deduct from our gross
profits. We are entitled to deduct, roughly speaking, our expenses, and
then upon the remainder we have to pay the income tax, or whatever it
is, at 1 shilling in the pound, for instance, now.

Q. Would you say that the Bank of England is a popular banking
institution among other banks in England?

A. Yes, I should say so decidedly. Its popularity goes to this extent,
that it is absolutely indispensable to them. Some of them may grumble at
this proceeding or that proceeding, but they have one and all to own
that the Bank of England is indispensable to them.

Q. As a matter of fact, if you had presented to the Bank of England last
fall some bills which had been negotiated through you which appeared to
be finance bills, do you not think they might have gently hinted that it
was not agreeable to them to have you negotiate any more finance bills?

A. I may say they have that recourse, and they might say to me if I gave
them any just cause for doing it, just the same as anybody else.

Q. In other words, the Bank of England has such a commanding position
here among the financial institutions which control all the finances of
Great Britain that they dominate it when they choose to?

A. When they choose.

Q. It is the custom of the bank to co-operate very cordially with the
other banks, is it not?

A. Oh, yes; we are as free as free can be. There is very little
conference, or anything of the kind; we are all pretty good friends all
round.

FOOTNOTES:

[150] F. Straker, _The Money Market_, pp. 7-16. Methuen and Company.
London. 1904.

[151] _Ibid._, pp. 28-40.

[152] [The fourth suspension occurred August 6, 1914.]

[153] Adapted from Hartley Withers, _The English Banking System_,
Publications of the National Monetary Commission, Senate Document No.
492, 61st Congress, _2nd Session_, pp. 3-64.

[154] James H. Simpson, _Some Leading Features of the London Money and
Discount Markets_, an address delivered at the annual banquet of the
bankers of the city of New York, Jan. 19, 1914. (In Banking and Currency
at Home and Abroad, Distributed with the Compliments of the National
City Bank.)

[155] Adapted from _Interviews on Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_,
Publications of the National Monetary Commission, Senate Document No.
492, 61st Congress, _2nd Session_, pp. 7-29.

[156] _Ibid._, pp. 34-55.

[157] _Ibid._, pp. 60-91.

CHAPTER XXIII

THE SCOTCH BANKS

[158]The functions performed by the eight Scotch banks and their 1,245
branches[159] are essentially similar to those already described as
being carried out by their English brethren. The differences between the
currency systems of the two countries are in degree rather than in
essence. In Scotland the note issue has made a harder fight for its
existence than in England, owing no doubt to the fact that the Bank of
England's monopoly did not extend to Scotland and that the great Scotch
joint-stock banks therefore extended the system of using notes as
currency, while the development of joint-stock banking in England was
necessarily opposed to it, since joint-stock banks in England with an
office in London were unable to issue notes. Nevertheless, even in
Scotland the advantages of the cheque have told in its favour, and, as
will be seen below, liabilities of Scotch banks under note issue are now
much smaller than those under deposit as current accounts.

DEMOCRACY OF SCOTCH BANKING

The Scotch note circulation increased from £5,332,000 in 1872 to
£7,173,000 in 1908. This increase, when compared with the fact that the
note issues of the English country banks have during the same period
diminished almost to vanishing point, shows that the bank note is much
more tenacious of life north of the Tweed. This is partly owing to the
fact that in Scotland notes may be issued of the denomination of £1,
whereas in England the smallest allowed is of £5, so that the note was
thus circulated more easily among the poorer classes in Scotland and so
gained and retained a hold upon a much wider circle of the community. In
this respect, as in others, Scotch banking is more democratic than
English, and provides its facilities for a poorer and lower class of the
community, though this distinction between the banking systems of the
two countries is being rapidly diminished. Especially in its early days
it laid itself out much more readily to the encouragement of the small
capitalist and borrower, often granting him facilities against security,
or an absence of security, which would have been only regarded as
feasible under quite exceptional circumstances in England. A very
interesting system was at one time fairly general in Scotland, and is
even now by no means obsolete. It was the system described as that of
cash credits, by which borrowers were able to go to banks and obtain
advances against the joint personal security of themselves and one, or
two, or three friends. By this means, in which a kind of co-operative
responsibility was recognised as a security by the Scotch bankers, very
poor borrowers were enabled to obtain banking facilities, and many
instances are recorded in which by a loan of this kind, of quite small
importance from the banking point of view, foundations of fortunes have
been laid and the general commercial prosperity of the community has
been furthered in a very satisfactory manner. And even now the essential
difference between Scotch and English banking is this readiness of the
former to take into consideration the personal standing of the applicant
rather than the stuff or paper which he brings to it as security for an
advance.

USE OF NOTES AS "TILL MONEY" IN RELATION TO THE ESTABLISHMENT OF
BRANCHES

Banking by branches in Scotland has proceeded even more rapidly than in
England, and the percentage of branches per head of the population is
higher in the northern part of the Kingdom. This wide diffusion of
banking facilities in Scotland has been largely brought about by the
fact that its banks, having the privilege of note issue, were able to
hold their own notes as "till money," so economising in the matter of
cash. The following passage is from a work entitled _Scottish Banking,
1865-1896_, by A. W. Kerr, author of a _History of Banking in Scotland_:

Were it not for the power to issue notes, and the readiness
with which the public receive them, the banks could never
have afforded to open a third of the branches which have
been established. The reason for this is a very simple one.
Without the right of issue a bank must, at every one of its
offices, hold the whole of its balance of cash in the shape
of coin, or of notes of other banks, which, as far as it is
concerned, are as unprofitable as coin. Such balances entail
a complete loss of interest which can only be borne where
the amount of business is of considerable extent. There are
probably not above 100 (at most 200) localities in Scotland
that would satisfy such conditions. When, however, a bank
can hold its till money in the shape of notes, it is enabled
to extend its operations into districts which would
otherwise be quite inaccessible....

The authority of a practical Scotch banker is equally emphatic on the
point. Mr. Robert Blyth, general manager of the Union Bank of Scotland,
read a paper at the thirty-first annual convention of the American
Banking Association, in October, 1905, on the subject of Scottish
banking. In the course of this very interesting paper he made the
following statement: "It is in another quarter altogether that the
Scotch banks find the value of the £1 note. It is the unissued notes in
the tills of the branch offices, forming the till money at more than a
thousand branches, wherein the real value lies. Without them the banks
would require to keep £8,000,000 or £10,000,000 of gold coin, not as a
reserve but as till money. It is these £1 notes which have enabled
branch offices to be planted in every part of the country."

It thus appears, from the highest possible authority, that the Scotch
banks are enabled by their right of note issue to economise gold to the
extent of £8,000,000 or £10,000,000, and it is amusing to observe how
the objects aimed at by Peel's legislation with regard to note issue
have thus been defeated even more completely in Scotland than in
England. In England banking turned the flank of Peel's Act by developing
the use of cheques, which superseded the note as the common form of
payment in daily transactions. In Scotland, banking evaded the spirit
of Peel's regulations, which were intended to insure that every addition
to currency should be secured on an addition to the bullion held by it,
by actually economising bullion to the extent of £8,000,000 or
£10,000,000.

EVASION OF PEEL'S ACT

Scotland used the same weapons as England, namely, the cheque and the
development of deposit banking. The eight Scotch banks have, according
to their latest balance sheets, £7,000,000 of notes outstanding, and
£108,000,000 of liability on deposits and drafts. With regard to the
latter item Peel's regulations had nothing to say, and since ordinary
banking prudence demanded that some cash should be held against it, and
since the gold held against notes was not specially earmarked as such,
Scotch banking was able to treat its cash against deposits as the basis
both of its notes and deposits and so produce the economy which is
boasted of by its champions. The law says nothing concerning cash to be
held against deposits, and the metallic basis of these is probably
extremely slender, if the cash held against notes is set on one side;
but it is impossible to detect its actual amount, since the Scotch banks
include with their cash their balances at the Bank of England, etc. And
the net result is, that when the proportion of its cash to its total
liabilities on notes and deposits is worked out it is found to be
decidedly low, even when compared with English practice. For the eight
banks taken together, gold and silver coin, notes of other banks, cash
at Bank of England, and cheques in course of transmission represent
almost exactly 10 per cent. of their note and deposit liabilities.

It should be observed that the notes which the Scotch banks hold as till
money do not appear in their statements, for until they are issued they
are not a liability, and though they are treated by the banks in
practice as an asset, they can not figure as such in a balance sheet.
That they are practically treated as such is witnessed by Mr. Blyth, as
quoted above, when he says that without them the banks would require to
keep £8,000,000 or £10,000,000 of gold coin. And it is, of course, this
habit of regarding unissued notes as a banking asset in the shape of
till money that accounts for the low reserve of actual cash that the
Scotch banks show.

DEFECTS

Scotch banking is so generally regarded as one of the highest
achievements of the banking intelligence that some hesitation is natural
in criticising the system by which, according to its own evidence, it
has obtained most of its success. At the same time, it is difficult to
avoid the conclusion that a serious danger lurks in a system which
regards a banker's unissued promise to pay in the light of a banking
asset. Mr. Blyth points out that these unissued notes are "not a reserve
but till money," but the distinction between till money and reserve is
one upon which it is possible to lay too much stress. In assessing the
strength of a bank it is usual to compare the amount of its cash in
hand, as a whole, with the amount of its liability to the public on
deposit and current account, etc., and note circulation if any. The cash
in hand, as a whole, consists of the till money and cash reserve. If the
till money consists to any extent of the bank's own promises to pay, it
follows that the bank's cash reserve as a whole is to that extent
weakened, for it need not be said that in case of serious trouble, which
is a contingency of which all provident bankers have at all times to
beware, a bank's own promises to pay would be of little service to it.
If a bank's credit were doubted, these promises to pay would not be
available for it in meeting demands upon it. At such periods the public
requires from its bankers not promises to pay but physical gold. In
Scotland the confidence of the public in its bankers is so great, and
the readiness with which it circulates their promises to pay appears to
be so ingrained in the national character, that the contingency of the
demand of the public for gold seems to be extremely remote. The
criticism therefore which detects a weak point in this asset upon which
Scotch banking prides itself so highly may be said to be merely
academic. Nevertheless, when we examine Scotch banking by the test of
figures, we find that it does actually work, as indeed would be expected
from the statement of its exponents, on a cash basis which is decidedly
narrow.

Though the functions that they perform are practically the same as those
of the English bankers, Scotchmen have succeeded in avoiding the
excessive competition in carrying them out which is a weakness of
English banking. In Scotland, on the other hand, cohesion and
co-operation among the banks are carried to an extreme of which the
mercantile community frequently complains. The banks are few and stand
together like a close corporation; they agree absolutely and arbitrarily
among themselves as to the rates they will allow to depositors, the
rates at which they will advance or discount, and the terms and
commissions for which they will do business for customers. The extent to
which this regulation of the price of the product that they turn out is
carried, is almost incredible from the English point of view, and though
it is contended by the champions of the Scotch system that it encourages
that wholesome democratic influence in Scotch banking which is in favor
of the small borrower of limited resources, who is thus able to obtain
accommodation on the same terms as much larger and more important
customers, yet it must be obvious that the Scotch banks, by making these
hard and fast agreements among themselves as to the price of the
accommodation that they will give, and maintaining it in every case, are
in fact putting the same price upon a very different article. The result
of it is beginning to tell upon them a little in these days, since, when
the big Scotch merchants and manufacturers find that their local bankers
charge them the same rates for accommodation as the small tradesmen of
the towns, they are naturally impelled to make arrangements to provide
themselves with monetary facilities somewhere south of the Tweed, where
rates are ruled by the circumstances of each case, and competition and
higgling often in times of monetary ease deliver the bankers into the
hands of the borrowers. As it is, the Scotch banks in regular conclave
fix their rates in accordance with those current in the London money
market or the Bank of England's official minimum, and, having fixed
them, stick to them. The system is very profitable to themselves, and
their customers certainly can not complain on the whole of the
facilities with which they provide them. Nevertheless, the cast-iron
rigor with which they work hand in hand in combination appears to be an
excessive development of banking unity, and an ideal banking system
would seem to lie somewhere in the middle between the excessive
competition of the English bankers and the cast-iron combination of
their Scotch brethren. Finally, it may be added that it is a little
inaccurate to speak of a Scotch banking system, if the phrase be taken
to imply that Scotch banking stands by itself and works on its own
resources. In fact, it is only an appendage of the English system and
relies habitually on drawing gold from the Bank of England, as its
centre and the keeper of its reserve.

BANK OF SCOTLAND

INTERVIEW WITH SIR GEORGE ANDERSON, GENERAL MANAGER[160]

Q. When was the Bank of Scotland founded?

A. In 1695.

Q. When does your present charter expire?

A. By act of Parliament the "governor and company of the Bank of
Scotland" have "perpetual succession."

Q. How many branches have you?

A. One hundred and sixty-three branches and twelve sub-branches in
Scotland: also an office in London.

Q. How are your branches managed?

A. By agents (managers at London and Glasgow) appointed by the
directors.

Q. Do your branches have business relations with merchants, farmers, and
all classes of people in their respective localities?

A. Yes.

Q. What is the law governing your note issues, and how are note issues
limited and how secured?

A. The bank is authorised to issue, without holding coin against them,
notes to the value of £396,852, but for any excess beyond that amount we
must hold, at the head office, an equivalent value in gold coin,
one-fourth of which may, however, be in silver coin.

Q. Will you state (a) the class of bills usually discounted by you,
giving the number of names required; (b) the minimum size; and (c) the
maximum length of time to run?

A. Mercantile bills, also a few accommodation bills, usually two names;
minimum, say, £10. The maximum length of time to run is six months.

Q. What classes of collateral are accepted by you for loans?

A. Personal security, marketable securities, life policies, mortgages
over ships, shipping documents, etc. In the important banking centers of
Scotland lending against collateral security has become largely
prevalent.

Q. Do you rediscount bills from other banks?

A. No.

Q. Explain the phrase "cash credits," and upon what conditions are they
given?

A. A "cash credit" is a credit allowed, in virtue of which a customer
may draw cheques on the bank until the balance due to us reaches a
certain fixed limit. The account is an ordinary operative one, and
interest is charged on the balances actually due to the bank from day to
day.

Q. Have you in mind how many branches you had ten years ago?

A. One hundred and twenty.

Q. Do you ever buy any shares of railroad or industrial companies?

A. Yes; of the highest class.

Q. Do you ever own bank shares?

A. No.

ROYAL BANK OF SCOTLAND

INTERVIEW WITH ADAM TAIT, CASHIER AND GENERAL MANAGER[161]

Q. When was the Royal Bank of Scotland founded?

A. In the year 1727.

Q. When does your present charter expire?

A. It is perpetual.

Q. How many branches have you?

A. One hundred and fifty-two.

Q. Are all your branches of the same class, or have you main and
subsidiary branches?

A. In some cases there are sub-branches. Some are mainly or almost
entirely deposit branches; others have few deposits, but a large advance
business.

Q. Is the business conducted at your branches of the same class as at
your office in London?

A. No; the London office is itself a branch office and much of the
ultimate settlement of balances takes place there. The conduct of the
ordinary London business is on the same lines as that of any other
London branch bank. No notes can be issued in London.

Q. Do your branches have business relations with merchants, farmers, and
all classes of people in their respective localities?

A. Yes, they have business relations with all classes of people.

Q. What is the law governing your note issues, and how are note issues
limited and how secured?

A. The act of Parliament of 1845 governs our note issue. There is no
limit to the amount of notes that may be issued, but the bank is
required to hold gold (and silver to an extent not exceeding one-fifth
of the total) against the notes in the hands of the public on the
average of each month, and that at its head office in Edinburgh--gold
held at branch offices does not count--to an amount sufficient each week
on Saturday to cover the notes in the hands of the public in excess of a
certain amount specified, £216,451.

Q. To what extent are your notes legal tender in Great Britain?

A. Our notes are not legal tender at all.

Q. What other banks have the right of issue in Scotland?

A. The Bank of Scotland, the British Linen Bank, the Commercial Bank of
Scotland (Limited), the National Bank of Scotland (Limited), the North
of Scotland and Town and County Bank (Limited), the Union Bank of
Scotland (Limited), the Clydesdale Bank (Limited).

Q. Are the notes of your issuing banks secured; and if so, how?

A. They are not secured. In case of the liquidation of the five
last-named banks, however, their shareholders are unlimitedly liable for
their notes and they are liable to contribute a sum necessary to restore
to the general assets the sums that may have been paid out of the same
in respect of claims under notes.

Q. What is the total amount of their outstanding issues?

A. About £7,500,000.

Q. Do you pay the Government in the form of taxes or otherwise, either
directly or indirectly, for your privilege of note issue?

A. Yes, we all pay a license duty of £30 for each place at which notes
are issued, and a tax of 8_s._ 4_d._ per £100, or a penny per £1, on the
average amount of notes in the hands of the public at the close of each
week.

Q. Is it your custom to carry a fixed amount in government securities?

A. Yes, but the amount is not rigidly fixed.

Q. Do you discount any but prime bills?

A. Yes; we do all classes of business.

Q. Is it your custom to employ surplus funds in purchase of bills from
discount houses?

A. Yes; bills accepted by London banks.

Q. Do you rediscount bills for other banks?

A. No; except for foreign or colonial banks who are correspondents.

Q. Is the bank, through its branches, employed by other banks to any
considerable extent for the transfer of funds from one city to another?

A. Yes.

Q. What, if any, artificial means are taken by you to secure changes in
the volume of currency (notes and coin) to make it responsive to
business demands?

A. None are deemed necessary. Our system works automatically. Our note
issue is unlimited; we are only required to provide gold to cover the
amount in the hands of the public at the close of each week and on the
average of each four weeks.

Q. What is the customary charge for acceptance of a ninety-day bill?

A. Five shillings per cent.

Q. Your acceptance constitutes what is known in London as a prime bill?

A. Yes.

Q. Do you pay interest on both current accounts and deposit accounts?

A. It is our custom to pay interest on deposits only. In London,
however, it is different; there interest is allowed in special cases on
large balances on current accounts if left for some time.

Q. How does the bank rate affect the rate allowed by you on deposit?

A. The Scotch banks all allow the same rate and charge the same rates
for discounts and overdrafts, and these are fixed relatively to the Bank
of England rate. Our deposit rate is usually 1-1/2 per cent. under the
minimum bank rate.

Q. Were most of your branches organised by you or were most of them
other institutions purchased by you?

A. Most of them were originated by ourselves.

Q. Have you in mind how many branches you had ten years ago?

A. About 136.

Q. What relations do the Scotch banks bear to the Bank of England? Do
they deal with it directly?

A. The Royal Bank of Scotland has an account with the Bank of England,
which has been in operation since 1728, and it collects bills and
cheques for the Bank of England all over Scotland.

Q. Do you regard your system of currency issue as sufficiently elastic
for your needs?

A. Yes; there never has been any difficulty. Moreover, no Scotch bank
has ever failed to pay its creditors, including the holders of notes, in
full.

COMMERCIAL BANK OF SCOTLAND (LIMITED)

INTERVIEW WITH ALEXANDER BOGIE, GENERAL MANAGER[162]

Q. When was the Commercial Bank of Scotland (Limited) founded?

A. In the year 1810.

Q. When does your present charter expire?

A. It is not limited in point of time.

Q. Has the Government any voice in the management of the bank or any
interest in it through the ownership of shares?

A. None.

Q. Have the managers of the branches full control of the business in
granting discounts, etc.; if not, what discretion is usually given them?

A. Agents have power to grant advances, but subject to the approval of
head office. In advances of considerable amount, an agent's duty is to
get authority from the head office before granting it. The discretion
allowed is dependent on the size of the branch and the nature of the
business and the class of customer, and on the record of the agent. By
our system of reports on advances (weekly, monthly, and quarterly) we
keep in close touch with the advances and means of borrowers. The London
branch is, of course, on different lines, and our manager there has
greater powers than an agent at a branch in Scotland.

Q. Is the business conducted at your branches of the same class as at
your main office in Edinburgh?

A. Yes; very much the same. The head office has administrative work and
supervision of branches, investment, etc., which does not, of course,
arise elsewhere.

Q. Do you discount to any considerable amount for individuals and
merchants?

A. Yes; it would perhaps be well to point out that in Scotland a large
portion of advances made to traders are granted in the form of
overdrafts on current accounts. _The number and amount of bills in
Scotland are less now than in former years. Cash payments for the
purpose of obtaining discount are more frequent, and the number of
bills discounted by wholesale houses is reduced in consequence._

Q. Is it your custom to employ surplus funds in purchase of bills from
discount houses?

A. Only occasionally, when rates suit.

Q. Do you rediscount bills for other banks?

A. It is not our practice to do so.

Q. To what extent does bank rate govern your discount and loan
transactions?

A. In ordinary transactions, altogether. In all transactions the bank
rate governs as regards the minimum.

Q. Explain the phrase "cash credits," and upon what conditions are they
given?

A. A cash credit account is an operative current account in security of
which the principal debtor and two or more co-obligants have granted a
personal bond in favor of the bank. The account is operated upon by the
principal debtor, but all the parties are bound as principals and are
jointly and severally liable to the bank.[163]

Q. Is the bank, through its branches, employed by other banks to any
considerable extent for the transfer of funds from one city to another?

A. We act as correspondents for the large English and Irish banks and
for colonial and foreign banks.

Q. Do you favor the issue of £1 notes? Why?

A. Yes; under the Scottish system, as it enables the banks to plant
branches at little expense and so to open up the trade of the country in
all districts and directions.

Q. It is your practice to employ your surplus funds in the purchase of
prime bills through bill brokers?

A. We occasionally have such transactions.

Q. Were most of your branches organised by you, or were most of them
other institutions purchased by you?

A. All of them were organised by ourselves.

Q. Is the question of the amount of reserves, either in specie or in
bank, regarded as of importance by Scotch bankers?

A. I should think so, though I only know positively my own opinion.

Q. Do you ever buy any shares of railroad or industrial companies?

A. No industrial company shares and only gilt-edged railway stocks.

Q. Do you ever own bank shares?

A. No.

UNION BANK OF SCOTLAND (LIMITED)

INTERVIEW WITH ROBERT BLYTH, GENERAL MANAGER[164]

Q. When was the Union Bank of Scotland (Limited) founded?

A. In 1830.

Q. When does your present charter expire?

A. The bank has no charter expiring at any specified time. It is
incorporated under the companies acts.

Q. Have the obligations of the bank to the public or to the Government
been changed from time to time?

A. The liability of the shareholders was formerly unlimited, but when
the bank became registered under the companies act, 1879, the liability
of the shareholders--unless in respect of notes--was limited to the
amount of the uncalled capital.

Q. The tendency is for the consolidation of banking in Great Britain, is
it not?

A. It is, but this tendency set in at a much earlier period in Scotland
than it has done in England.

Q. Do you rediscount bills for other banks?

A. Yes; but only to a very limited extent.

Q. Is private banking carried on in Scotland?

A. Private banking ceased to exist in Scotland prior to 1845.

Q. Do you ever buy any shares of railroad or industrial companies?

A. No.

Q. Do you ever own bank shares?

A. No.

FOOTNOTES:

[158] Adapted from Hartley Withers, _The English Banking System_.
Publication of The National Monetary Commission, Senate Document No.
492, 61st Congress, _2nd Session_, pp. 41-50.

[159] (September, 1915).

[160] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland and Italy_, Publications
of the National Monetary Commission, Senate Document No. 405. 61st
Congress, _2nd Session_, pp. 142-155.

[161] _Ibid._, pp. 127-139.

[162] _Ibid._, pp. 172-185.

[163] The cash credit system, sometimes pointed to as a unique feature
of Scotch banking, is by no means unknown in England.--EDITOR.

[164] _Ibid._, pp. 157-170.

CHAPTER XXIV

THE FRENCH BANKING SYSTEM

THE BANK OF FRANCE

[165]The Bank of France was established in the year 1800, and was at
first an entirely private concern, with a capital of $6,000,000. Among
the first subscribers were Napoleon Bonaparte, Hortense Beauharnais, and
bearers of names which are still prominent in the French banking world,
such as Mallet, Hottinguer, Seillers, etc.

At that time, the privilege of issuing notes was not confined to a
single bank. But in 1806 the Bank of France was placed under state
control, and, by and by, the other issuing banks disappeared, by
amalgamation or otherwise, and the Bank of France became, and has ever
remained since, the only issuing bank in Continental France.

The present capital is $36,500,000, all paid, divided in $200 shares....
[Francs are given in terms of dollars.]

These shares are held by the public, the average being about 5-1/2
shares for each shareholder. One-third of the shares are held by persons
possessing only one share. They are dealt in freely in the market, their
quotation being at present about 465 per cent.

The profits go to the shareholders, as in every other company. In 1912
the bank earned a net profit of $8,200,000. The last yearly dividend was
paid at the rate of 20.83 per cent....

The governor of the Bank of France and the two sub-governors are
appointed by the State. They are assisted by fifteen regents, nominated
by the meeting of the shareholders. The same meeting appoints three
censors whom you would call auditors.

The board, composed of the governors and regents, decides all questions
concerning the rate of discount on loans, the issue of notes, etc.

Three of the regents, assisted by twelve shareholders chosen from
amongst the prominent members of the commercial and industrial
profession, compose the "discount committee," which meets at least three
times a week and decides upon the acceptance or refusal of the bills
presented for discount....

The notes are ... legal tender, but, of course, may be exchanged, at
sight, against cash--I don't say against gold, as I will explain
presently.

The denominations circulating at present are $10, $20, $100, and $200.
One dollar and $4 notes were issued at critical times, but have been
withdrawn since. In case of need, they would be resorted to again, and
in this respect I should like to mention the fact, demonstrated by
experience, that even where the circulation is already sufficient, a
supplementary issue of small notes--unless, of course, the amount be too
unreasonable--is much less likely to depreciate the currency than an
issue of larger ones. In a certain sense, we may consider that a country
which refrains from issuing small notes in normal times, possesses _ipso
facto_ a valuable reserve in case of emergency....

I need not recall the remarkable rôle played by the Bank of France,
under the leadership of its very distinguished governor, M. Pallain,
during critical periods such as 1907, when that institution succeeded in
keeping the French discount rate on an exceptionally moderate level,
while giving valuable and effective aid, at the same time, to the London
market.

How is this successful policy of the Bank of France materially possible?
Precisely because it has the option to pay in silver as well as in gold.
When the situation is such that withdrawals of yellow metal are to be
feared, the bank quotes a premium on gold. At present, for instance, the
quotation is about one-tenth of one per cent. premium, that is to say,
you will only get $999 in gold against $1,000 in notes. If you want to
get $1,000 cash, you can get them, but in silver.

As a consequence, there is no necessity to raise the discount rate in
order to protect the gold reserve, and French commerce has the
privilege of benefiting, as a rule, by the lowest rate of discount in
the world. Thus the average bank rate, in 1912, was 3.37 per cent. in
France, as against 3.77 per cent. in England, and 4.95 per cent. in
Germany.

If we consider a period of fifteen years, from 1898 to 1912, the average
rates are:

_per cent._
France 3.8
Holland 3.52
England 3.62
Belgium 3.65
Switzerland 4.14
Austria 4.22
Germany 4.50

CASH HOLDINGS OF THE BANK OF FRANCE

[166]The undeniable characteristic of our present currency system is
that it presents a transition between the money system and the clearing
system, the ultimate form of which we are unable accurately to define.
This period of transition, which began when the idea of genuine credit
was conceived, will last for centuries before we can rid ourselves of
money as a medium. The system of purely fiduciary currency, which is in
process of becoming firmly established, is not yet sufficiently stable
to prevent us from being thrust rudely back into the old ways whenever
we exceed the limits of our resources.

Crises afford a striking proof of this fact. The initial period, the
precursor of the crisis, is nothing but an abnormal extension of credit
and of speculation. At such times the need of leaning upon the solid
foundation of metallic currency is felt with a new intensity; and when,
with a blindness resulting from overconfidence, this need has been
neglected, when, from a disregard of the functions of money, a crisis is
brought about by the violent rupture of the equilibrium of credit, gold
at once resumes its rights, is sought for on all sides, and, according
to the seriousness of the offence, exacts complete amends, with the
honors of a premium as high as it may choose to make.

It clearly appears, therefore, that this quest for simplification in the
means of credit, which each nation ardently pursues in the interest of
its own industrial and commercial development, demands the greatest
circumspection. In developing credit, metallic currency must not be too
much overlooked. We must not lose sight of the fact that "credit, in
order to be solid and permanent, must have a solid and permanent
foundation."

The first care of the architect who is about to erect a great building
is to secure for it a broad and firm foundation. Likewise, in the vast
and continuous upbuilding of a nation's credit, the metallic base
requires the most attentive and enlightened consideration. To provide
for it, the entire resources of the State are not too great. It is
difficult to understand how, in certain countries, an undertaking of
such universal interest should be left to private enterprise. How can
the latter be powerful enough to accumulate holdings in currency which
may have to remain idle for long periods, and which can unflinchingly
resist all assaults and all storms?

In France a system which has already passed the hundred-year mark and
has been particularly fortunate as to results, intrusts the Bank of
France with the duty of building up and preserving the metal holdings,
and this great organisation shows itself fully worthy of the confidence
which the Government has always reposed in it. During its long career
the bank has never ceased to control credit with rare foresight and a
remarkably steady hand.

From 1870 up to the present time the cash holdings of the Bank of France
have not ceased to grow. But the bank, of its own volition, could not
have made such an accumulation. The exchanges are usually in our favor,
owing to our position as lenders to foreign countries and to the extent
of our exports, and this for many years past has resulted in the
continual flowing of the precious metal into the vaults of the Bank of
France.

In thirty-five years the amount of our metallic reserves has increased
almost threefold. And it is worthy of note that while the amount of
circulation increases together with that of discounts, loans, and
current accounts, the fact is nevertheless established that the bank
note tends to be more and more exclusively represented by cash holdings.
The silver holdings are continually diminishing, while the total
holdings have increased. Indeed, the Bank of France avails itself of
every opportunity to relieve its coffers of this depreciated currency.
Since 1898 a considerable portion of the holdings have been absorbed by
the recoinage of a certain number of 5-franc pieces into subsidiary
coins.

PLACE OF THE BANK OF FRANCE IN THE DISTRIBUTION OF CREDIT

We purpose now to investigate the organs of French credit, and to assign
to each of these organs its function, in order then to ascertain what
operations the Bank of France can perform and within what limitations.
We have therefore to examine (1) the function of local banks and of
financial institutions; (2) in what manner the Bank of France promotes
the free distribution of credit; (3) in what measure the bank must
control credit.

LOCAL BANKS AND THE FINANCIAL INSTITUTIONS

The natural organs for the distribution of credit are the banks, but not
all are able to spread it or popularise it in the same degree. Thus the
"Haute Banque" (the great banking interests of Paris), solely engaged in
operations of higher speculation or in international financial
relations, does not interest us. The function of distribution is
reserved for the local banks and the financial institutions, while the
function of the Bank of France is to preside over this distribution.

Local banks, pre-eminent less than one hundred years ago, have gradually
seen their field of activity growing smaller, and a large number of them
have been amalgamated with great institutions, possessed of much greater
resources, with branches over the entire country, and, it must be said,
free from the routine which caused the downfall of many provincial
houses. With their decline we greatly regret to see the disappearance of
personal credit, which it is more and more difficult to make available.
The _intuitus personae_ (the judgment of character), which may serve as
a basis for credit granted to a neighbor by a neighbor, can not be
considered by a corporation official who has almost no means of
estimating the solvency of individuals except from the material and
tangible side.

The local banks, as far as they have survived, have adopted methods
which do not bring them into competition with their powerful rivals.
They have been obliged to grant long-term credits or content themselves
with being intermediaries for the Bank of France in granting credits to
parties known to them, generally farmers or small landed proprietors,
with a view to rediscounting the paper. On this point again there is
cause to regret, if not their disappearance, at least their effacement.
The institutions for agricultural credit, in spite of all the attention
they have received, have not yet been able to replace the local banks in
the distribution of personal credit applied to agriculture.

The great financial institutions, of which the four most important are
the Crédit Lyonnais, the Comptoir National d'Escompte de Paris, the
Société Générale, and the Crédit Industriel et Commercial, have a much
more important part in the distribution of credit. Thanks to their
numerous agencies, to their attractive conduct of business, with the
service of a courteous and attentive staff, they have gradually taught
the people new habits in investment and confidence in credit, to such a
degree that he who but yesterday hoarded in a stocking prefers to-day,
if not to speculate on the Bourse, at least to make deposits in the
savings banks. The great financial institutions have done much to give
even the lowest classes confidence in credit, and to introduce a system
of clearing.

In closer contact with the public than the Bank of France, which is
restricted by having to protect the reserve of which we have spoken,
these institutions are able more readily and effectually to reach and to
mould the public. But that is not their only service nor the only reason
for their existence. There are transactions which they alone undertake,
which they alone can undertake, and which must be performed because they
are in the line of progress. These operations are sources of profit in
the same way as are discounts and loans for the Bank of France. Such
are demand deposits, stock-market orders, and the flotation of
securities. These operations cannot be undertaken by the local banks.
Occupied for the most part with long-term dealings, they have no use for
deposits payable on demand. If they should have such deposits, their
total would never reach a sufficient proportion safely to permit the
investing of an important amount.

On the other hand, the Bank of France does not and, even if it wished,
cannot compete with the financial institutions in undertaking such
operations. Neither the acceptance of interest-paying deposits nor the
flotation of securities can come within the province of a bank of issue.
The flotation of securities necessitates a certain contingent
responsibility, and the institutions which place securities on the
market sometimes engage their credit for very large sums, which are
sufficiently guaranteed by their capital, but the credit which is
intended to safeguard the stability of the bank note cannot be pledged
for that purpose.

It happens that the Bank of France sometimes transmits subscriptions,
but this is a gratuitous and entirely voluntary service. In no case can
the bank take for its own account bundles of securities in order to
dispose of them to the public. The purchase and sale of securities,
which is so profitable a business in all financial institutions, could
never, it is clear, be a successful undertaking in the Bank of France.
The staff of the bank has no special information as to the various
securities dealt in on the Bourse, and cannot, therefore, give valuable
advice. Its rôle would apparently be confined to handing out the
financial journals and passively awaiting orders. If it should act
otherwise, the staff would engage the moral responsibility of the Bank
of France; but the bank, evidently reluctant to undertake such
operations, prefers to leave that field to its auxiliaries, the
financial institutions.

However, at the present time, the Bank of France tends to compete with
these institutions for the purpose of maintaining sound conditions of
credit which inclines more and more to speculation. Thus it is extending
its department for the purchase and sale of securities in order to
safeguard a poorly informed public against the excesses of speculation
which dazzle with the hope of an always illusive gain.

IN WHAT MANNER THE BANK OF FRANCE PROMOTES THE FREE DISTRIBUTION OF
CREDIT IN FRANCE

Thus the Bank of France must leave entire freedom of action to the
financial institutions and must not encroach, theoretically at least, on
their functions, which, as has been shown, differ materially from its
own. The bank even owes them its protection, since they are valuable
auxiliaries in pursuing its aim of extending credit as liberally as our
metallic base permits. In the interest of the public the cash holdings
are daily at their disposal. The help and protection of which we speak
are not mere passive professions. Unfortunately, there have already been
numerous cases where the bank has had to interfere in order to bring
effective assistance to private banks. The bank has, of course, acted
thus for the welfare of the entire community, but also for the
satisfaction of protecting its auxiliaries with all its power in the
fulfilment of a difficult task.

Let us recall the failure of the Société des Dépôts et Comptes Courants,
in the beginning of 1891.

"The Bank of France, after exacting such security as the concern could
still offer and, furthermore, the guaranty of several large banking
institutions, for the purpose of limiting possible losses, authorised
discounts to the amount of 49,228,206.87 francs. Thanks to this
assistance, all deposits were paid off, and the dreaded effects of a
panic were once more averted."[167] However, in spite of the precautions
that had been taken, the liquidation was slow.

Whenever the financial institutions have found themselves in need of
effective pecuniary assistance, the Bank of France has regarded it a
duty to help them, and in normal times, by assisting them with its
resources, it facilitates liberal credits.

IN WHAT MEASURE THE BANK MUST CONTROL CREDIT

It may happen that the great financial institutions expand too rapidly
or unwisely this or that branch of credit. Mindful, above all, of their
own interest, which is but natural, they have no especial regard for the
public welfare, their only aim being to make their capital bear fruit
and to pay large dividends to their shareholders.

The Bank of France aspires to a nobler ideal, and many of its policies
are primarily for the public good. The development of credit is an
extremely delicate matter; there are many instances where the
application of this agency has led to great catastrophes. It is
undoubtedly impossible to exercise a strict supervision over the
financial institutions; any such measure would soon appear vexatious and
would be, moreover, contrary to our spirit of liberty and independence.
But we can quite justly ask whether these concerns are fully sheltered
against disasters; whether nothing can happen to them of a nature to
shake their credit; and in such a contingency what should be the
attitude of the Bank of France.

The preceding instance, and others that might be referred to, inform us
sufficiently as to the possibility of failures. The house of Baring
Bros., the Union Générale, and others enjoyed an immense credit, thought
to be unshakable, and the events of a day flatly contradicted that
opinion.

In the course of the discussion concerning the last renewal of the
charter of the Bank of France, much was said as to the possibility of
allowing a certain interest to depositors in the bank.... M.
Burdeau[168] has shown that it is impossible for the Bank of France to
become a bank of deposit. The issue of bank notes and the receipt of
interest-bearing deposits are absolutely incompatible services. Their
union in a single hand "would replace the present organization by an
entirely new one, which, in case of a crisis, would offer much less
vitality and power of resistance." For us it is sufficient to know that
the payment to depositors of 1 per cent. on deposits subject to check
would attract to the bank nearly all inactive funds, and that a sum in
the neighbourhood of 1,000,000,000 francs would leave the private banks.
This would be their death-blow--a result which we are unwilling to
contemplate.

By their very nature the financial institutions are liable to weakness,
and for the public good there must be some means of supporting them. For
this reason the Bank of France, which presides over the distribution of
credit, can permit the expansion of its auxiliaries only up to the point
where its help would suffice to prevent the collapse of the market. Such
a measure appears imperative in a country where the protecting wisdom of
the Bank of France has always been relied upon. Fortunate land,
fortunate institution, which excites the envy of foreigners, especially
of England, where the least failure may result in disastrous
consequences.

Thus the banks of deposit have contributed to progress by gathering and
giving life to sums previously lying scattered and idle. They are
valuable auxiliaries in the distribution of credit. For this reason they
deserve help and protection. The bank, the mission of which is of a
wider and loftier scope,[169] has shown on many occasions that its
helpfulness is not a pretence; daily, in fact, it assists them by
rediscounting their bills. The prosperity of the financial institutions
has continually increased. It is associated with the confidence and
growing security of our times.[170] But the bank must be ready to meet
even improbable contingencies in order to be in a position to recapture
the market with a sure hand as soon as danger threatens it.

Under these circumstances, what can the bank do? In the first place, it
can utilise its powerful reserve which has been accumulated for this
purpose. It can, in the next place, curb the action of the banks by
competing with them when they appear to enter upon a dangerous course,
and by showing them what steps to take.[171]

On the other hand, there is a whole series of operations which private
banks do not undertake, or do not tend to develop as they deserve.
Directed by self-interest toward the more profitable transactions, they
somewhat neglect the others. The Bank of France finds no one engaged in
these less remunerative operations, and is, moreover, the better able to
undertake them itself, because they are not incompatible with the duties
of a bank of issue.

Foremost, perhaps, among these operations is the popularising of credit
by means of an ever increasing number of small loans, frequently
accepting as pledge securities such as State rentes, bonds of the Crédit
Foncier, of cities, railroads, and industrials. An enormous transfer
business is also carried on for both banks and the public at very low
cost. Moreover, the bank clears large sums, annually relieving the
clearing house of this burden.

The small business man, much more than the small rentier, reaps
continually greater benefit from the advantages offered to the public by
the Bank of France. We shall here simply call to mind the dates of some
innovations favorable to the democratisation of credit.

January 15, 1824.--Creation of transfer drafts.

April 29, 1824.--Creation of transferable certificates of deposit.

January 13, 1830.--Reduction of interest on loans against bars and coin
from 4 per cent. to 1 per cent.

1834.--Loans against rentes and public securities.

1837.--Daily discounting of paper except on holidays.

Law of June 30, 1840, article 2.--Option of replacing the third
signature, exacted for discount, by deposit of any French public
securities.

Decree of March 26, 1848.--Similar option of replacing by warehouse
receipts.

Law of November 17, 1897.--Admission of bills for discount carrying the
signature of an agricultural syndicate. The minimum for bills discounted
is reduced to 5 francs.

There is here a whole series of measures, which, with the assurance of a
cordial welcome, should induce the small business man to trade with the
bank.

The bank accepts large quantities of small paper with small signatures,
and it finds itself, accordingly, in normal times deprived of first-rate
paper, of that which is as good as gold in international commerce.
Gilt-edged paper always finds its market at lower rates than in the
bank, and M. d'Eichthal, a regent of the bank, wrote as far back as
fifty years ago: "Whatever may be the discount rate, among the bills
discounted there will be found but few with the signatures of the
Rothschilds, the Hottinguers, and other houses of the same rank. Those
are delicacies which always command a premium."[172]...

The bank has always resolutely undertaken to carry through a whole
series of operations which could not show great profit; above all, it
has unremittingly aimed to be of service to the greatest number. The
number of bills discounted grows continuously, while the total amounts,
smaller during the most prosperous periods, invariably increase in
periods of tight money. The average amount and term of bills is 600
francs for twenty days. This result would be considerably modified, if
we were to take into account the bills handed in for collection only,
the average value of which hardly exceeds 200 to 250 francs.

TERRITORIAL EXPANSION OF THE BANK OF FRANCE

With its growth in extent the bank has not only developed its services
to meet new business needs, by providing an increased staff, and larger,
more attractive, and better conducted offices, but it has also
endeavored to reach a more and more widely extended territory. Indeed,
the mere fact that the bank has entered a place, if only to make
collections there, gives a favorable turn to credit conditions; credit
becomes cheaper, in that the basis for money rates becomes the official
discount rate, because the financial institutions have then a more
economical method of replenishing their cash. The smallest provincial
town where the bank has entered is, therefore, in regard to low money
rates, as favored as Paris.

Exchange between cities, particularly when joined with a special
commission, reaches sometimes a considerable sum. As soon as the bank
opens its branch, exchange is no longer possible. Therefore, whenever
the charter of the bank has been renewed, the legislator, in response to
the wishes of the public, has wisely required new territorial expansion
of the bank. If the bank has not always taken the initiative in this
mode of expansion, it is because it has been restrained by several
motives. In the first place, the opening of new offices entails
considerable expense. It is necessary to count upon several years of
deficit, during which the running expenses, including salaries of staff,
are just as high as if the profits were large. We could name several
cities which for years have shown constant deficits. It can therefore be
understood that the Bank of France, which is already established in the
200 towns most important from a commercial standpoint, and which, by
means of its collecting department, touches 265 towns of less
importance, extends its service only with caution to new localities,
since each new branch must necessarily produce a larger and more
persistent deficit. Thus territorial expansion is for the bank an
ever-increasing burden; it is equivalent to an additional tax imposed by
the legislature at every renewal of the charter. The bank submits to
this with good grace for the benefit of the public.

In the second place, there is a limit to that expansion. Where the bank
has no branches, the financial institutions may take root and develop
among a population which appreciates their services. Their profits come
largely, it appears, from small towns, where competition is less keen.
We have already said enough concerning the service of these institutions
in the development of French credit to show the danger of inflicting
upon them fresh injury. On whatever side the bank desires to expand it
finds this limit. If the bank encroaches a little on all sides, the
result may be very appreciable.

The territorial expansion is further perceptibly increased by what is
known in the bank as the exterior accounts. This system, of quite recent
origin, allows any person not residing in the town where the branch is
established to enjoy the same privileges as residents. Business may be
transacted by mail with the aid of certain accounting forms, which often
differ from those used for ordinary accounts. Each transaction is the
subject of a special report, addressed to the customer by the branch.
Not only is the transaction itself reported, but useful information as
to the position of the account is also given, thus permitting the
customer to follow the movement of the account until the half-yearly
statement is sent.

This department is highly esteemed by the suburban public, and renders
many services to landed proprietors and to farmers, especially in the
cattle-raising trade.

Thus the direct expansion, which, as has been seen, meets with serious
obstacles, is assisted by this indirect expansion.[173]

Evidently we are far from realising the attractive dream of a France no
longer deprived in part of banking facilities, but with all bills taken
at par because the bank would reach everywhere. But for the sake of this
end, no doubt desirable in itself, is it worth while to go to extremes
for a scarcely perceptible advantage, to disturb an institution in other
respects strong and useful, and thus perhaps to risk disorganising the
general credit system of France? On the contrary, we should be content
with and even congratulate ourselves upon a progress which leads us,
slowly perhaps, but surely, toward the realisation of credit on low
terms everywhere and for all.

THE BANK OF FRANCE AND AGRICULTURAL CREDIT

"There is no such thing as agricultural credit; there is only credit,"
said M. Dupin in 1845.[174] Matters have not changed since. It is
certain, for instance, that Scotland, which for a long time was the
classical land of pauperism, owes its prosperity to the banks, which, by
developing credit in favor of agriculture, have entirely transformed the
soil and the country. Indeed, more than any other, the Scotch farmer
needed credit, and more than any other he has benefited by it. It may be
said that personal credit is peculiar to agriculture. Thus it suffered
as a result of the evolution already mentioned, which, by causing the
disappearance of local banks or by giving them a new direction, struck a
fatal blow to personal credit.

We know that "agricultural credit" includes loans from seed-time to
harvest. The first labor done, the first loan made to the land can only
be repaid much later. The average time necessary for agricultural loans
is five or six months at least. Now, for other reasons the by-laws of
the bank prohibit the discounting of paper having more than ninety days
to run. By a special favor which would not be accorded in business,
where each loan has a different object, the bank allows the renewals
necessary for agricultural loans, which almost exclusively take the form
of bills payable to order. The bill returned to the maker on the day of
maturity is renewed the following day. The date of maturity alone is
changed.

A very important agricultural industry, which we have already mentioned,
is that of cattle-raising. The cattlemen are, for the most part,
customers of the bank wherever it has a branch. This customer of a
somewhat special kind appears, by the very nature of his trade, to be
indicated as a suitable client for the bank and not for the financial
institutions. The bank permits the cattlemen to indorse each other's
paper, and thus can accommodate them without intermediaries. There
results a very useful co-operation. Moreover, by using the bank the
cattlemen effect great savings, the full value of which they alone can
estimate.

After the law of July 18, 1898, and the legislation that followed, it
might have been expected that the use of agricultural warehouse receipts
would be greatly extended. This legislation makes a serious exception to
the common law for the benefit of agriculture. It "constitutes the
landowner, so to speak, a public warehouse. It is he who, without any
other controlling appraisement, makes declaration as to quantity and
commercial value to the clerk of the justice of the peace. In short, the
agriculturist enjoys a confidence which so far has been denied to
industry and commerce." Notwithstanding this favor, the agricultural
warehouse receipts are little used,[175] and the bank, despite its
willingness to take them freely, regrets to find them among its
discounts in such very small number.

Our survey would not be complete should we fail to say a word concerning
the agricultural credit associations, of which also much was expected
and which have only in a very limited measure fulfilled the high hopes
of their founders.[176]

For the support of agricultural credit the State draws from two sources
the funds required to supply the organs of distribution, the local and
regional associations. The first source is the loan of 40,000,000 francs
made by the bank on November 17, 1897, when the charter was renewed.
This amount, like the 140,000,000 francs already advanced in 1857 and
1878, bears no interest. The second source is the yearly payment made by
the Bank of France on the profit-yielding circulation. This payment
cannot be less than 2,000,000 francs yearly, and more often it is in the
neighborhood of 5,000,000 francs.

All these sums, intended for agriculture, are distributed by the
Government, and are used in endowing the associations of agricultural
credit. The regional associations, which are the pivot of the present
organisation, are self-governing societies, with a capital of their own.
This capital, added to the advance made by the State, is invested in
first-class securities, which are then deposited in the Bank of France,
as discount guarantee to take the place of the third signature, if need
be. The local offices send their paper to the regional office, which
then takes it to the bank, as the needs of funds are felt.

Such is the part of the Bank of France in the distribution of
agricultural credit. Effective intervention was obviously very
difficult, yet the bank has contrived, even beyond its legal
obligations, to give the benefit of its credit to agriculture, which so
justly deserves the care it is receiving.

THE BANK OF FRANCE

INTERVIEW WITH M. PALLAIN, GOVERNOR OF THE BANK OF FRANCE[177]

Q. Is the Bank of France ever attacked in the controversies between
political parties?

A. No charge has ever been made that the bank favored or aided any
political party. There is never any claim that politics enters in any
degree into the management of the bank.

Q. Is the capital entirely private property?

A. Yes. All the shares are divided between 30,000 shareholders, of whom
about 10,000 have not more than one share.

Q. How are your branches managed?

A. All branches are managed by a manager, assisted by a local board of
directors, selected from among the best qualified commercial,
industrial, and agricultural representatives in the region.

Q. Do the branches have business relations with the merchants, farmers,
and all classes of people of the locality?

A. Yes, they are open to everybody.

Q. You have, I suppose, in the branches regular clients who have an
account with you?

A. Yes, and a considerable number of them.

Q. Do your branches do the same kind of business as the branches of the
Crédit Lyonnais?

A. The Bank of France and its numerous branches do all banking business
consistent with the laws properly regulating a bank of issue.

Q. A bill drawn in New York on France, on a bank, for instance, the
Crédit Lyonnais, at Paris, and accepted by it, would it be admissible
for discount?

A. Yes, if it bore, besides the signature of the French establishment
accepting it, at least one other French signature; that of the person
presenting it, for instance, having a current account at the Bank of
France.

Q. A part of your portfolio comes from rediscounting for banks?

A. Certainly, and it is an important part.

Q. Could you give us an estimate of the proportion of bills which are
discounted for banks and those discounted for other customers?

A. I should estimate that about 70 per cent. of the paper now held bears
the signature of some bank as one of the indorsers; but it is manifest
to us that the number of merchants and manufacturers who appreciate the
facilities given by the bank for direct discounting and who profit by it
increases perceptibly every day.

Q. Does the Bank of France make the same charge for the discount of
bills and for loans upon collateral?

A. The bank usually charges somewhat more for loans upon collateral than
for the discount of bills. The rates at present are 3 per cent. and 4
per cent., respectively.

Q. Could we obtain an estimate of the percentage of the deposits of the
other banks at the Bank of France in comparison with the whole of such
deposits?

A. In the credit establishments which you will visit you will be able to
establish the fact that the liquid cash is, in comparison with their
turnover, relatively very small. In France we consider that the strength
of a bank consists more in the composition of its portfolio, _i. e._, in
the value of its commercial bills, rather than in the importance of its
cash reserve.

Q. Is the amount of all taxes paid by the bank to the State included in
your report?

A. Yes. The public charges of the bank in 1907 were more than
11,000,000 francs, whereas the profits distributed were 31,000,000
francs.

Q. Have you a system of transfers similar to that used by the
Reichsbank?

A. Yes, this system, in France, dates as far back as a century or more.

Q. What is your method of transfer?

A. Transfers from place to place are made by simple notification to
branches.

Q. Are the other banks accustomed to use the Bank of France in order to
transfer their funds?

A. The greater part of the banks use no other method, even to increase
the cash in one of their branches in a remote part of France.

Q. Is the Bank of France subject to examination by the Government?

A. There is no regular system of examination, but the Minister of
Finance has the right to ask for information whenever he chooses.

Q. Is the Bank of France regarded as a bank for banks or as a bank for
the people?

A. The Bank of France remained for a long time, indeed, the bank for
banks, but since it has covered so much territory with its numerous
branches; since the minimum amount of all its operations has been
lowered; since it has opened deposit accounts to all, it is already and
it tends to become more and more--as you ask--the bank of all the French
public.

Q. Is there any contention in banking or economic circles that it is
necessary to restore or extend the right of issue to banks, other than
the Bank of France, to enable them to increase their own profits or to
afford adequate facilities to borrowers or to meet legitimate business
demands?

A. The unity of issue was achieved in France in 1848, and at no time
since then has there been any question, in responsible circles, of a
possible return to plurality of issue. The same tendency is leading,
little by little, to an absolute monopoly in England, Germany, and even
in Italy. I think that it would also be interesting for you to examine
the recent example of Switzerland, which had its note-issue system
founded, as in America, on the plurality of banks and which has now
substituted for this system one single privileged bank. This
transformation has received popular approval by referendum.

Q. Does the export of gold reduce the volume of notes?

A. Not necessarily. It may happen that among our assets a certain
fraction of the gold is replaced by an equal amount of bills in our
portfolio, and that without changing the total of notes in circulation.

Q. There is nothing in the law requiring your notes to be covered by a
certain proportion of gold?

A. No regulation of this kind exists in our legislation.

Q. Do you rely upon raising the rates of discount to stimulate the
importation and to prevent the exportation of gold?

A. It is a principle consecrated by experience that the supreme means of
defence for an issue bank, to protect its metallic reserve, is to raise
the rate of discount, and we never lose sight of this principle.
However, the extent of our reserves allows us to contemplate without
emotion important variations of our metallic stock, and we only
exceptionally have recourse to a measure which is always painful for
commerce and industry. The stability and the moderation of the rate of
discount are considered as precious advantages, which the French market
owes to the organisation and traditional conduct of the Bank of France.

Q. Would you like to express an opinion as to why the Bank of France is
able to hold its gold with a bank rate of 4 per cent. when the rates
elsewhere are higher?

A. The causes of this phenomenon are multiple. Theory teaches us that
capital goes where it can obtain the highest remuneration, but in
considering this remuneration account must be taken of risks; these are
numerous and of different kinds; I mean, of course, commercial risks;
risk of losing on exchange when the capital is brought back, etc. This
at once explains why it is possible in France to maintain a rate of
discount lower than elsewhere. French capitalists might fear, perhaps,
that the higher interest obtainable outside might be offset or more than
offset by the risks incurred. Account must be taken, secondly, of the
situation always held by France as a creditor nation, and which by the
constant income of capital which it assures to us certainly contributes
to counter-balance the current of exportation which might result from
the lowering of the rate of discount.

Q. Does the Bank of France sometimes take steps to maintain the bank
rate by the purchase of bills in the market or otherwise?

A. No, never.

Q. The tradition and the reputation of the Bank of France make it
important that it should hold a larger reserve than any other bank in
the world?

A. It is true that France keeps locked up in its bank a proportionately
larger amount of specie than any other country, but this policy is not
without important compensations. Suppose the French public, changing its
mind, should reduce by one-half its monetary reserve of which the bank
is the guardian. It would gain thereafter the interest on perhaps two
milliards of francs released and which would have become
productive--that is to say, a saving of from 80 to 100 millions of
francs per year at the maximum--but if one reflects that it would lose
the advantage of the reduced rates of discount which the extent and
character of our reserves enable us to maintain and from which all
French production profits; that it would lose, in addition, the
sentiment of absolute security, of complete financial independence,
which every crisis has strengthened, one would be less tempted to
conclude--with certain critics--that the policy of maintaining heavy
reserves, the natural expression of the country's instincts, is an
unwise policy from an economic and practical standpoint.

Q. You have, I believe, no requirement of law by which the Bank of
France is obliged to purchase gold at a certain fixed price?

A. The bank buys gold according to the tariff of the Mint, but it is not
obliged to do so. Private individuals, instead of having their money
coined for themselves, find it more advantageous to sell their ingots to
the bank, which has them coined when needed.

THE CRÉDIT LYONNAIS

INTERVIEWS WITH BARON BRINCARD, ADMINISTRATEUR DÉLÉGUÉ, AND OTHER
OFFICIALS OF THE CRÉDIT LYONNAIS[178]

Q. What is the date of the organisation of the Crédit Lyonnais?

A. July 6, 1863.

Q. Under what law was it organised?

A. We are under the general law, a general companies law.

Q. What is the minimum amount of capital required?

A. There is no minimum, but at least one-fourth of the capital is
required by law to be actually paid in.

Q. How many shareholders have you?

A. Our capital is divided into 500,000 shares, but as many of these
shares are issued to "bearer" we do not know how many shareholders we
have.

Q. The cash in hand is merely carried for the necessities of business?

A. Yes. Any bank, if it has need for additional cash, may present for
rediscount at the Bank of France the bills and other commercial paper
which it has in its vaults.

Q. What per cent. of your deposits do you intend to carry in cash either
in your own vaults or in other banks?

A. Eight to 10 per cent. on the average.

Q. Does the Bank of France ever loan below its published rate?

A. No. It never does.

Q. It is not, I believe, the policy of your bank to buy public
securities in large amounts?

A. No. Our idea is to buy all the commercial paper that we can get. That
is our business. At present it is almost impossible to get any
commercial paper because business is so slack; therefore, we are obliged
to go outside and buy treasury bills.

Q. To what kinds of banks do you lend on collateral?

A. Mostly foreign banks; for instance, banks in New Orleans during the
cotton season. It is not to our interest to lend to French banks. We
lend money to foreign banks and to French merchants, but never to
foreign merchants or to French banks. We never lend on real estate. That
is the business of the Crédit Foncier.

Q. Do you own all of the securities you sell, or do you take orders and
buy and sell them on commission?

A. The greater part of our transactions are made on commission.

Q. In your statement of liabilities you show deposits about
$132,000,000, and current accounts about $168,000,000. Will you kindly
explain the difference between these two accounts?

A. Deposits are sums of money deposited, especially by private people.
Accounts current represent the balances to the credit of business
people.

Q. If I come here and open an account with you and make a deposit and
say I want to transact business with you, borrowing money from time to
time, and depositing and drawing daily, would you put that account in
your "accounts current"?

A. If you were not a merchant, you would have a deposit account opened
for your daily deposits and drawings. Your account could never show a
debit balance and the amounts which you might borrow would have to be
secured by deposit of securities and would be placed under the item
"loans on securities." If you were a merchant, an account current would
be opened for the requirements of your business, and this account could
become debtor.

Q. Deposits and current accounts are payable on demand?

A. Yes; on demand. Deposits are made up of sums deposited by customers
whose accounts are not active; they are more in the nature of reserve
deposits, whereas current accounts represent deposits made by customers
mostly in active business.

Q. Do you pay interest on practically all of your deposits and current
accounts?

A. Yes.

Q. Do you find that the Bank of France competes with you in any way?

A. In no way.

Q. They receive accounts from individuals and small tradesmen in the
branches, do they not?

A. Yes; but they do not grant uncovered credits. There is no competition
between the Bank of France and the other banks, because they do not do
the same kind of business. The Bank of France receives deposits, but
does not allow interest upon them; it only discounts bills with three
signatures; it is the bankers' bank; it acts as the regulator of the
money market.

Q. Do its branches receive deposits?

A. Yes; they receive deposits, without allowing any interest. In times
when money is cheap the rate of discount of the Bank of France is rarely
below 3 per cent., and in the Crédit Lyonnais and other banks the rate
may be sensibly below that of the Bank of France.

Q. Can you state the number of employés in the Crédit Lyonnais?

A. About 14,000. It varies according to the time of year.

Q. Are all of the important banks in the City of Paris members of the
clearing house?

A. Yes; about 13 of the most important.

Q. How frequently are the clearings made?

A. Three times a day. As a matter of fact, our clearing house is not so
important as yours in America.

Q. The clearing houses in the cities of France are in no sense a factor;
they are merely the machinery through which the cheques are cleared, are
they not?

A. To our knowledge there is but one clearing house; it is in Paris and
is merely a mechanism for settling balances.

Q. Are you examined at any time and in any way by the Government?

A. No. The control of the Government is limited to the supervision for
taxes, to which every company is subject.

Q. Your relations with the Bank of France are very intimate and cordial,
are they not?

A. Yes.

Q. Is that true with all the banks in France?

A. The Bank of France is quite impartial; it gives no preference to any
one; there is no favoritism.

Q. I understand none of the farmers or peasants will use cheques.

A. The use is extremely rare.

Q. How about your tradesmen all through the small towns, and the doctor
and lawyer and professional man; would they draw the money out and pay
their bills in cash?

A. Certainly; most of them.

Q. When you establish a branch in a small town, you generally find a
local independent bank there. Can this local bank compete with you?

A. There are certain places where the private banks have kept on, but
the tendency is for the private banker to disappear. We take small sums
and have numerous branches. One great distinction is that the private
bank is always in the hands of a family. A man who originally starts a
private bank may be a good banker, financier, and business man, but it
does not always follow that his son, who in all likelihood will inherit
the business, will be capable of running it. Our joint-stock banks do
not go from father to son, but are always under efficient management.

Q. What proportion of your own payments are made in gold?

A. A very small proportion. The people prefer notes.

Q. Do the French people hoard money as much as formerly?

A. No; it is becoming more the custom to put money in the banks. Thirty
years ago they kept the money at home.

COMPTOIR D'ESCOMPTE

INTERVIEW WITH M. ULLMANN, DIRECTOR OF THE COMPTOIR D'ESCOMPTE[179]

Q. One of the things that we have in mind is to inquire in regard to the
character of the business done by your branches.

A. Yes. We are especially a discount bank and our customers are mostly
commercial people engaged in commerce and industry, so that our
principal business in our branch offices consists in discounting
commercial paper, in making advances against securities, goods, or
warehouse receipts, or sometimes giving blank credits to our customers
for commercial requirements.

Q. Have you stock in other banks which you control?

A. We are interested in the Banque de l'Indo Chine, which is an issue
bank in the French colonies, but we do not control it; we hold a certain
amount of shares.

Q. Are there any other banks which you control?

A. No.

Q. You have not been in the habit of buying up other banks?

A. No. The system here is to establish agencies of our own; the Germans,
on the contrary, control other banks in order to arrive at the same
result, viz., to get as much influence as possible throughout the
country. We try to come to the same result by establishing our own
agencies.

Q. Is that true of the Crédit Lyonnais?

A. The Crédit Lyonnais and the Société Générale have the same system.

Q. Is it usual for large banks in Paris to confine their underwriting
operations to bond syndicates?

A. Yes; banks receiving deposits, such as the Crédit Lyonnais and the
Société Générale, do not usually participate in syndicate operations
covering the _shares_ of industrial concerns; other banks, such as the
Banque de Paris et des Pays-Bas, do so, but they are not deposit banks.
They have more liberty to engage their own capital in any enterprise.

Q. You are not restricted by law in doing any business you please?

A. No; it is only the custom and rules of our society.

Q. If there were a large industrial corporation in France which wanted
to develop its business and issue bonds upon it, and if they were
customers of yours of unquestioned financial standing, would you take
their bonds and sell them?

A. Yes.

Q. But not their stock?

A. If they were a well-known concern we would sell their shares too; we
have done so.

Q. Is there co-operation between the large banks?

A. We meet very often and often have common interests in business.

Q. Do you, in a sense, divide the field? I suppose you have a certain
field in which you do business and other banks do not; Turkey, for
instance?

A. Turkey is reserved for the Banque Ottomane.

Q. Take the electrical business, for instance.

A. As far as we are concerned we are connected with the Thomson-Houston;
and it is natural if the Thomson-Houston and their friends have any
business to do, that they deal with us.

Q. There is nothing in the law which restricts you to any class of
investment?

A. No.

Q. And nothing that requires you to keep any reserve; that is, any
amount of cash as against your liabilities?

A. No.

Q. Is the Bank of France your principal reliance in case you need money?
Do you think it necessary to carry any additional reserve?

A. Under our French system we consider the commercial paper we keep in
the portfolio a cash reserve, as we can rediscount it at the Bank of
France. We know the Bank of France will discount these bills and thus
enable us to convert the bills instantly into cash; this is the basis of
the French banking system.

Q. Outside of Paris it happens that you have branches at many of the
same places as the Bank of France; is there competition between the
branches of the Bank of France and your own branches?

A. No; the Bank of France does more rediscounting than discounting, and
the Bank of France also has more conservative rules than the other
banks. We may lend under the Bank of France rate, so our clients have an
interest in keeping their accounts with us.

Q. You do not consider the Bank of France as an active competitor?

A. No; competition is greater with the Crédit Lyonnais and with the
other private banks than with the Bank of France.

Q. You do considerable rediscounting of bills, I take it?

A. Yes.

Q. At a lower rate than the Bank of France?

A. Frequently.

Q. Is the development of branches a matter of recent times?

A. Yes; we began the system of establishing branches about twenty years
ago.

Q. How many employés have you?

A. Including the country, something like 5,000.

Q. Have you a pension system for your employés?

A. Our clerks consent to a rebate of 5 per cent. on their salaries, and
we duplicate this rebate by a voluntary contribution, in order to
constitute a pension fund; it amounts now to about 7,000,000 francs.

Q. If a new bank were to be organised here, would it be admitted as a
member of the clearing house?

A. Certainly.

Q. You have no new banks except the Union Parisienne?

A. There is also the Banque Française, managed by M. Rouvier, who
formerly was Premier.

BANQUE DE PARIS ET DES PAYS-BAS

INTERVIEW WITH M. MORET, MANAGER OF THE BANQUE DE PARIS ET DES
PAYS-BAS[180]

Q. We assume that your business is in many respects quite unlike that of
the other joint-stock banks?

A. Yes; in some respects.

Q. What is the difference?

A. The Société Générale, Crédit Lyonnais, etc., receive deposits from
the public; they invest these deposits and try to make the most of them,
paying a small rate of interest on them; they also loan money on
commercial paper which can be rediscounted at the Bank of France. Here
we are more a business bank; we do not care for deposits from the
public; we work with our own money, with the money which is the capital
of the bank, and we are occasionally assisted by the capital of the
directors, the people who sit around this table, who are all rich people
and some of them bankers. As a rule we do not receive deposits from the
public.

Q. But you do receive some deposits?

A. We receive the deposits of big companies which we have created or
promoted or whose stocks we have issued--they are our customers--but we
do not receive deposits of small accounts from the public.

Q. What is your capital?

A. 75,000,000 francs.

Q. You have current accounts--190,000,000 francs?

A. They are current accounts, from manufacturing concerns, railway
companies, big organisations of any kind.

Q. You have a considerable foreign business?

A. We have connections all over the world, and very often we take an
interest in business abroad.

Q. Do you operate more particularly in one part of the world than in
another?

A. No; although we have only three branches--one in Brussels, one in
Amsterdam, and one in Geneva.

Q. Do you endeavor to carry any special amount of cash at the Bank of
France? Or are you indifferent as to the amount of balance you have
there?

A. We always calculate what sum each day will be likely to be withdrawn;
besides which we always have a large amount of commercial paper which we
could rediscount at the Bank of France at once. Therefore we keep just
enough cash in vault to meet any cheques which may be presented.

Q. Do you carry an account in New York?

A. We lend money to bankers there. Different kinds of loans, some are at
sixty days or ninety days.

Q. You are not restricted in any way as to the character of the
undertakings you may make?

A. No; we can do as we like.

Q. Do you specialise in practice or do you consider propositions of
various kinds?

A. All sorts of propositions, railway building, harbors, tramways,
electrical enterprises, etc.

Q. Do you sometimes take an interest in business such as placing
Pennsylvania Railroad and Union Pacific bonds?

A. Yes.

Q. You frequently act as managers of syndicates which might include the
other banks of France?

A. Very often we take the head of syndicates.

Q. You are the leading bank in that business in France?

A. They say so.

Q. Is there cordial co-operation between the banks of Paris and the Bank
of France, generally speaking?

A. Yes; business as a rule is done, when it is a big business, with
several of these big societies or banks, and perhaps with all of them
together.

Q. Are there particular corporations in which you have a permanent
interest?

A. Yes; so as to have some control in certain large companies.

Q. What do you think of the attitude of the Government toward the Bank
of France? That is to say, are they exacting more and more from it?

A. I do not think that they exact too much from it. The shares of the
Bank of France are always very high in price; it has not hurt at all the
development of the bank.

CRÉDIT FONCIER DE FRANCE

INTERVIEW WITH M. TOUCHARD, SECRETARY[181]

Q. Is the Crédit Foncier a public institution?

A. Yes, it is a mixed institution; it is at the same time a joint-stock
company and a society under the control of the Government by reason of
privileges which the Government has granted to it.

Q. Who are the shareholders?

A. Any one; the shares are dealt in on the Bourse. The firm capital is
at present 200,000,000 francs; the shares are issued at 500 francs.

Q. What dividend do you pay?

A. We now pay 6 per cent.; for several years it was only 5 per cent.

Q. Does the Government receive no income from it?

A. No; on the contrary, the Government began by giving us a subsidy of
10,000,000 francs; that was at the beginning, in 1852, in order to help
us make loans at a rate advantageous for that time. This subsidy was not
renewed, and the State does not intervene now, except occasionally to
exercise its control.

Q. Does the company appoint the officers?

A. The Government appoints the governor and the two sub-governors. There
must also be three treasurers-general among the 23 members of the
council of administration. These treasurers, as well as the other
administrators, are named by the general assembly of stockholders; but
before presenting their names to this assembly, it is customary to
obtain the approval of the Minister of Finance.

Q. Do you pay the same taxes as the other banks?

A. Yes. We are treated like any ordinary bank. We have the special
privilege of issuing bonds secured by mortgages. It is a very
complicated system in France; there are legal complications which would
render it impossible for any corporation to undertake the business
unless it had special privileges.

Q. Are you confined by law to business with mortgages?

A. We have two principal kinds of operations--mortgage loans and
communal loans. The total business of the two branches of operations
amounts at present to about 4,000,000,000 francs. Operations on so large
a scale involve a considerable transfer of funds, and make necessary a
treasury service requiring, of course, the use of banking methods. Our
statutes, therefore, recognise our right to carry on ordinary banking
operations, within certain rather sharply defined limits.

Q. How is your banking business limited?

A. We are allowed to receive deposits up to a maximum of 100,000,000
francs.

Q. Do you invest in securities other than mortgages?

A. We employ our deposit funds in discounting commercial bills on
condition that they have two signatures and can be presented to the Bank
of France; that is to say, they must not run over three months.

Q. You take mortgages on private estates?

A. Our mortgages may be on houses or on rural property.

Q. What is the precise relationship of the stockholders to the business
of the company? Have they really a voice in the administration?

A. The two hundred largest stockholders meet once a year to ratify
accounts, vote the dividend, and consider the questions docketed for the
day of the meeting.

Q. What is the usual length of time for mortgages on real estate?

A. Our statutes allow us to loan for seventy-five years on ordinary
rural or city property. In the case of summer resorts and certain other
property liable to depreciate rapidly, for the sake of prudence we do
not generally lend for more than thirty years; besides, the borrowers
always have the right to repay at any time, and they often avail
themselves of this right, so that the average length of our loans is
much less--hardly exceeding fifteen or twenty years.

Q. What is the cost for amortisation in the long mortgages on property
in the country?

A. The amortisation is spread over the whole duration of the loan, so
that the total of the interest paid and the capital reimbursed forms a
constant yearly annuity.

Q. Do you employ your amortisation funds to buy new mortgages?

A. Yes; we lend again.

Q. May you call your bonds at par? Are they payable at par at your
option?

A. In our recent issue we have put that clause in, viz., that we can
redeem our bonds at par. Generally we only redeem a certain portion of
them each year, which are drawn by lottery.

Q. What is the minimum size of your mortgages on private estates?

A. There is no minimum; but we do not care to make very small loans
because it costs too much to foreclose.

Q. What percentage of your total business is in the country and what in
the city?

A. About one-half in Paris, and our best business is in Paris. The urban
mortgages cause us less difficulty, and the tendency is for the
proportion of them to increase.

Q. Who are the subscribers to the bonds, and what are the usual sums
subscribed? Are they small or large?

A. They are bought by small people, and generally remain in the hands of
persons of small capital. This is one of the reasons why their
quotations show so little fluctuation.

Q. Do you lend on farms?

A. Yes. Up to one-half, except on forest land, vineyards, and the like,
on which we lend only one-third. We do not lend on mines. On factory
buildings we lend only on the value of the ground and of the building,
independently of its industrial value.

Q. What other institutions of this character are there in France?

A. There are no others; we no longer have a _legal_ monopoly, but we
very nearly have a _practical_ monopoly. There are private individuals
who make mortgage loans, but no large company makes this the principal
feature of its business.

Q. How long has it been the privilege of the Crédit Foncier to add
lotteries to its loans?

A. It has done so from the beginning, although we are obliged to ask the
permission of the Minister, but it is on that account that we have been
able to place our bonds so low.

CAISSE DES DÉPÔTS ET CONSIGNATIONS

INTERVIEW WITH M. DELATOUR, GENERAL DIRECTOR OF THE CAISSE DES DÉPÔTS ET
CONSIGNATIONS[182]

Q. We should like to know the general character of the business
conducted by your institution.

A. The mission of the Caisse des Dépôts et Consignations is to receive,
hold, and repay all private funds intrusted to the State either
voluntarily or under compulsion.

Q. You say that you also do an insurance business. What do you mean by
that?

A. The insurance office, managed by the Caisse, issues policies of life
insurance, insurance payable after death or in case of accident, like
any private insurance company. As regards accidents to employés while at
work, it insures only against such accidents as cause death or permanent
total or partial incapacity for work.

Q. Is this a corporation?

A. The Caisse des Dépôts et Consignations is not a corporation. It is a
state organism, but, while charging the Caisse with the management of
all private funds, which may be turned over to it by the State under
different headings, the legislature bestows upon it full autonomy, in
order to avoid even a semblance of possible confusion in the handling of
private moneys with the handling of public moneys. Moreover, it has
placed the Caisse under the direct supervision and the guaranty of the
legislative powers.

Q. What is done with the profits realised from the business?

A. Profits earned by the Caisse on deposits of the savings banks are
turned over to the reserve and guaranty fund of savings banks.

Q. What restrictions govern the investment of your funds?

A. As long-term investments, we make loans to departments and
municipalities, sometimes to the State; we take government rentes,
treasury securities, guaranteed railroad bonds, etc. As short-term
investments, we take treasury bonds, bonds of the Monte de Piété of
Paris (municipal pawnshop), etc. Finally, we keep large sums in cash,
either in our own vaults or to our credit in the treasury and the Bank
of France, which, for that purpose, keep account currents on demand for
us.

Q. You do not, as a rule, invest in mortgages?

A. No; owing to the difficulty in disposing of such investments.

Q. You purchase no bills and do no commercial business whatever?

A. No; that rôle is played by the Bank of France. Sometimes we make
advances on securities, but only on treasury bonds.

Q. Your organisation is quite unique in the world, is it not?

A. There is nothing like it in England or America, but there are similar
institutions in Belgium and Italy, for instance. In France this
institution is highly appreciated by the lawmakers, who steadily
increase its functions, and the number of laws and regulations governing
the Caisse is ever growing.

Q. It is customary in France for savings banks to carry their reserve
with this establishment?

A. The savings banks are bound to turn over to us all they receive from
their depositors, except such sums as may be required to meet immediate
demands.

Q. Then, as a matter of fact, this is a central bank for the savings
banks of France?

A. Precisely.

CRÉDIT AGRICOLE

INTERVIEW WITH M. DECHARME, CHEF DU SERVICE DU CRÉDIT MUTUEL ET DE LA
COOPÉRATION AGRICOLE AT THE MINISTÈRE DE L'AGRICULTURE[183]

Q. What is the nature of the business of the Crédit Agricole and when
was it instituted?

A. The first law was in 1899. The first bank was opened in 1900. The
Crédit Agricole is based upon local organisations. France is divided
into 86 departments, in each of which we are to have a regional bank
(_caisse régionale_); and we hope eventually to have a local office
(_caisse locale_) in each commune of each department. Among these 36,000
communes there are many which are cities, which naturally would not have
agricultural banks. There are only 2 out of the 86 departments in France
which have not already established a regional bank.

Q. Who furnishes the capital?

A. The basis of the system is the local office of the Crédit Agricole in
which each member--local farmers--has one or many shares of 20 francs,
but on which he has to pay only 5 francs down. On payment of these 5
francs he becomes a stockholder. When a local office has been
established it turns all of its capital over to the regional office.
Then comes the State which advances to the regional bank an amount four
times the capital which has been subscribed by the local banks. The
money given by the Government is not really given; it is lent without
charge, without interest.

Q. For what purposes can this capital be used?

A. The regional office does not lend directly to the farmers; it lends
to the local office, and the local office has a board of directors which
examines the demands of the various members.

Q. Under what conditions do they make loans to farmers, and are their
loans confined entirely to people engaged in agriculture?

A. The State loans to the regional office without interest; the regional
office loans to the local office at 3 per cent.: the local office loans
to the farmers at between 3-1/2 and 4 per cent.; in the northern region
at 3-1/2 per cent.; in the southern at 4 per cent.

Q. Under what conditions?

A. The farmer who wants to borrow from the local office draws a bill
upon himself, takes it to the local office, and the board of
administration there considers it. If they approve it, the president
signs it--and it has then two signatures--and then sends it to the
regional office; if the regional office has plenty of money they will
lend the money directly; if not, the president of the regional office
signs it--it has then three signatures and is bankable paper--and it is
taken to the Bank of France. During the crisis in the south of France
last year in the wine-growing region at Montpellier, the centre, the
regional office had one million capital; the Government then added 4;
that made 5, but they lent at that office all together 16 millions, and
the difference was obtained from the Bank of France in the way described
by using paper with three signatures. Before the founding of these
agricultural societies it would have been difficult for a farmer to
obtain the three signatures necessary to borrow from the Bank of France,
and what happened last year in the south of France could not have
occurred before the organisation of the Crédit Agricole. It should be
added there has never been one cent lost by the Crédit Agricole.

Q. Are all loans made to members?

A. Yes; exclusively to members.

Q. Who can become a member?

A. Farmers; agricultural workmen are excluded. We do not lend to people
for nourishment to support themselves. We lend them money to increase
the production of the land.

Q. Must a man have some share in the crops?

A. We lend money to buy a horse, a cow, or to buy fertilizer. We will
lend to a man who rents a farm, but does not own it, to buy machinery,
cattle, etc., but we will not lend to a man who wants to borrow the
money for his own consumption; we do not lend money for a man to buy a
coat, for instance. These local offices are in communities where
everybody knows everybody else, and they always ask what the man wants
to borrow for, and if he says he wants 400 francs to buy a cow, they
watch him, and if four or five days afterwards he has no cow, they know
it. As the liability is without limit, the other members of the locality
would be responsible. At the beginning the farmers were afraid of
unlimited liability, and on that account they had to make it limited,
but now, in all of the new offices, the responsibility is unlimited.

Q. What are your co-operative societies?

A. They are societies for the production, preservation, sale, or
transformation of agricultural products. There are co-operative
agricultural societies in the wine-growing regions which have their own
wine cellar; there are co-operative dairy societies for making butter
and cheese; there are also co-operative societies which use waterfalls
and electricity; co-operative mills to grind corn; co-operative railways
to bring beet roots to the sugar refinery; co-operative distilleries and
co-operative warehouses for corn. To these co-operative societies we
make loans for twenty-five years. The Government loans without charge to
the regional office and the regional office lends to these co-operative
societies for twenty-five years at 2 per cent.

Q. What is the security?

A. The guarantee is the consolidated liability of all of the members of
these co-operative societies and also a mortgage upon their real estate;
their responsibility is absolutely without limit.

Q. Do you compete at all with the branches of the other banks or with
the Bank of France?

A. No; we have an entirely different class of customers.

Q. Is there any other institution of this character in France, or do you
practically cover the field?

A. The members of these local offices are people who up to the time
these local offices were organised had never had any banking connection
at all. The only persons with whom the local offices compete are
individuals who used to loan to farmers at very high rates of interest.

FOOTNOTES:

[165] M. Robert Masson, Sous-Directeur du Crédit Lyonnais, _The Bank of
France_, an address delivered at the annual banquet of the bankers of
the city of New York, January 19, 1914.

[166] Adapted from Maurice Patron, _The Bank of France in Its Relation
to National and International Credit_. Publications of the National
Monetary Commission, Senate Document No. 494, 61st Congress, _2d
Session_.

[167] "Compte rendu de l'assemblée générale des actionnaires de la
Banque de France," 1891.

[168] Burdeau, "Discours sur le renouvellement du privilège de la Banque
de France," June 29 and July 6, 1892, in the Officiel of June 30 and
July 7.

[169] The Bank of France, during periods of quiet and prosperity, aims
at a gradual effacement, at a more complete retreat toward a very high
but very restricted sphere of economic activity. But as soon as the
least trouble appears ... the Bank assumes again its place at the head
of our great financial institutions. (Brouilhet, "Le nouveau régime de
la Banque de France." Revue d'Economie Politique, 1899.)

[170] The discounts and loans of the financial institutions are growing
in importance, and are steadily increasing in proportion to those of the
Bank. This condition, revealed by statistics, is in itself not alarming,
but it once more justifies that intervention, so many motives for which
we have brought out.

[171] It seems that this protective mission especially applies to the
department for stock market orders, originally reserved for the
customers of the Bank, and later opened to everybody. Thus it prevents
the financial institutions from driving us toward excessive speculation.
This purpose explains, according to our notion, the growth and
broadening of the business of stock market orders at the Bank of France.

[172] P. Coq, "Les circulations en Banque," Paris, Guillaumin, 1865, p.
38.

[173] The indirect expansion might be increased by wider use of the
"crossed check." It will be long before we may expect good results from
this practice, since we are as yet too far from the time when this
check, almost unknown in France, will be currently used.

[174] Journal Officiel, 1845, p. 2471.

[175] The main reason lies in the numerous formalities which the law of
April 30, 1906, has simplified but not suppressed, in the many expenses
caused by the organisation, and also, it appears, in the inexperience of
some of the officials. The clerks of the justices of the peace,
intrusted with the delicate and novel functions of registrars of chattel
mortgages, are, as a rule, little fitted to perform them.

[176] The model of these institutions came to us from foreign countries;
but the foreign differ from ours materially, because of the diversity of
their origin. With our neighbors, the movement began slowly in the
lowest levels of the rural population. With us, on the contrary, the
system of agricultural associations began at the top. Thus, these
institutions penetrate only with difficulty into the rural districts,
where economic education has but just begun.

[177] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_.
Publications of the National Monetary Commission, Senate Document No.
405, 61st Congress, _2nd Session_, pp. 189-218.

[178] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland and Italy_. Publications
of the National Monetary Commission, Senate Document No. 405, 61st
Congress, _2nd Session_, pp. 219-248.

[179] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_.
Publications of the National Monetary Commission, Senate Document No.
405, 61st Congress, _2nd Session_, pp. 249-267.

[180] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_.
Publications of the National Monetary Commission, Senate Document, No.
405, 61st Congress, _2nd Session_, pp. 268-276.

[181] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_,
Publications of the National Monetary Commission, Senate Document, No.
405, 61st Congress, _2nd Session_, pp. 277-291.

[182] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_,
Publications of the National Monetary Commission, Senate Document, No.
405, 61st Congress, _2nd Session_, pp. 296-308.

[183] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_.
Publications of the National Monetary Commission, Senate Document, No.
405, 61st Congress, _2nd Session_, pp. 309-322.

CHAPTER XXV

THE GERMAN BANKING SYSTEM

BANKING ARRANGEMENTS IN GERMANY

[184]Various systems can be adopted in the banking profession for the
transaction of business. The most lucrative method, at all events the
one in which the power of large capital is most effectively turned to
account, is that of the Rothschild firms, whose example was followed by
many large private concerns at home and abroad. These firms avoid
troublesome current business, maintain only a few connections, and
concentrate their whole energies on isolated but important ventures and
undertakings in which, owing to the large amount of means immediately
required, no competition worth mentioning existed before the growth of
capable joint-stock banks. Up to the middle of last century these firms
actually possessed a monopoly so far as the loan issues of most European
States were concerned, and they earned enormous profits according to
present-day ideas. In the course of the last decades, however, this
monopoly has been done away with so far as European States are concerned
and only prevails to a limited extent in some foreign countries. Since
that time the Rothschilds have devoted themselves to several large
industrial enterprises, such as the Russian naphtha industry, the
Spanish copper and quicksilver mines, etc.

Another system consists in the division of work and specialisation,
customary in England, but which has been frequently abandoned of late.
In England the issuing and syndicate business is carried on by special
houses which, like Rothschild, do not call themselves bankers, but
merchants. Brokers and jobbers carry on stock broking on the stock
exchange and in the open market, the former (theoretically at least) on
account of third persons and the latter on their own account. It is the
exclusive business of other firms to place credit at the disposal of
home and foreign firms by giving acceptance to bills. These firms,
strange to say, are mostly of German origin (Frühling & Goschen,
Frederik Huth & Co., Kleinwort & Sons, etc.), and carry on business in
such a reliable manner that they are allowed to enter into bill
obligations amounting to more than five times their estimated means. The
clearing and deposit banks manage moneys on account of third parties.

It must be noted that the division of labour and its operation are based
on free business practice in England without any legal compulsion.
Consequently, no opposition is offered in that country to the different
methods of carrying on business employed by the so-called foreign banks,
_i. e._, the numerous branches of continental banks, including the
branch offices of the Deutsche Bank, the Dresdner Bank, and the
Disconto-Gesellschaft, despite the fact that their competition is
unpleasant for the English institutions. In Germany, in consequence of
business requirements and also of the small amount of capital in the
country at the beginning of its modern economic development, the
peculiar system has developed that credit banks combine all kinds of
financial business (generally with the sole exception of mortgage-credit
transactions), so that every customer can settle all his financial
affairs in one spot on comparatively the cheapest terms possible.

Account-current transactions form the fundamental branch of business.
The bank undertakes all the financial business of its client in return
for a moderate commission on the turnover calculated on that side of the
account which happens to be the greater, makes and receives payments,
collects bills, checks, and other documents, and pays, or charges,
interest on the balance, generally at 1 per cent. below the Reichsbank
discount rate for credit balances and 1 per cent. above the Reichsbank
discount rate for balances debited. The bank discounts the bills
received by its customers, special arrangements being made as to the
limit of the amount and terms, according to the quality of the bill, _i.
e._, according to the trustworthiness of the other persons figuring on
it. Should a customer require foreign bills to settle his liabilities
abroad, _i. e._, checks or bills payable in the country concerned, the
bank provides them from its own stock or draws bills or checks to the
amount desired on its agents or correspondents in the country in
question.

Should the debit balance not be a merely temporary one, or one soon
covered by fresh receipts, the granting of special credit is necessary,
and arrangements have to be made as to the amount and conditions of the
same. Such credit is either covered or uncovered credit. The cover
consists principally of current securities with a margin against
fluctuations according to the nature of the security, and which is
higher for shares than for securities bearing a fixed rate of interest.
Uncovered credit is only granted in exceptional cases to others than
business men--as a rule only to first-class mercantile firms of repute,
whose affairs are in strict order.

Bankers and other firms with large cash transactions keep a so-called
"cheque" account at their bank in addition to the chief account, in
which no debit balances may occur; no interest is paid on the amount
deposited, which is always kept in suitable proportion to the payments
made, but, on the other hand, no turnover commission is charged.

Those customers are appreciated most who claim credit during their
buying seasons, but who not only pay back the borrowed money during
their selling season, but who have balances to their credit. This is the
case with a great number of commercial firms and in many branches of
industry, more especially in Berlin. The seasons in different branches
occurring at different times of the year, it follows that a large bank,
with branches and connections in all industrial parts of Germany, has
the advantage of a suitable distribution of accounts among all branches
of trade, etc., and the best possible adjustment of its debit and credit
arrangements.

The debtors in a bank's balance sheet comprise not only those who have
received advances of ready money but also those to whom the bank has
granted credit by bill acceptance; the bill drawn by the debtor and
accepted by the bank is discounted elsewhere. It is the duty of the
drawer of the bill to cover it before it matures, and when the bill is
accepted he is booked simultaneously as a debtor to the bank under _the
date of maturity_.

Whether the general public will make an extensive use of checks is
doubtful. In England the conditions necessary for check transactions
exist, as every one has a banking account, and all payments to be made
or received are effected through the banks. To Germans this seems very
strange; a large part of the public cannot keep a banking account, and
when it is in a position to do so either expects high rates of interest
or keeps no permanent balances and pays no commissions. Under such
circumstances there is no sense, from a business point of view, in the
shoemaker, who has no banking account, accepting a check, which he has
to cash, instead of ready money; for the shoemaker has to take an
unprofitable walk, and the bank has to examine the check, pay and book
it, and in some cases notify by letter the customer of its payment. The
ingenuous idea prevails that by some cabalistic method of procedure the
bank earns something by such transactions that in reality only cause
irksome work.

The Reichsbank, with a creative and organising spirit, laid the
foundations of the system of payments by means of transfers to, and
deductions from accounts current that obtains in Germany, the so-called
giro system.[185] It was in every way preordained for this creative
work, for at the time of its foundation it was the only financial
institution whose activities extended over the whole Empire, while in
the territorially restricted and immature banking systems of those days
the conditions were lacking for the development either of a giro
business or of a system of payments by means of checks. In the giro
system, with its splendid organisation, the Reichsbank has created an
institution that has given the German system of payments its
characteristic stamp, just as the apparatus of checks and clearing
houses has imparted a typical character to the system of payments in
other countries, like England and the United States. The giro business
in Germany, however, is far from having attained the dimensions that the
use of checks has in England and America.

The number of long-distance transfers is about double that of the
locals. This is as it should be, as it is mainly in the matter of
long-distance transfers that the giro system has the advantage over the
method of payment by check. In the matter of local transfers, on the
other hand, giro and check are probably about on a level with respect to
the number of transactions.

To prevent themselves from being ruined by the competition of the
Reichsbank, the private banks of issue[186] have been obliged to offer
various inducements to their customers in the matter of the giro
business. They make no demands in regard to a minimum balance, pay
interest on deposits, do not oblige their customers to domicile bills
drawn on them at the bank, and exact no charge from persons having no
account with them who desire to have sums placed to the account of
depositors (to some extent also making cash payments free to third
parties who are nondepositors for account of depositors). The private
banks of issue sustained a severe blow in 1900 on the occasion of the
renewal of the bank laws through the provision prohibiting them from
discounting bills at a lower rate than the Reichsbank whenever its rate
reaches or exceeds 4 per cent. and not allowing them to go more than
one-fourth of 1 per cent. below the official rate and one-eighth of 1
per cent. below whatever private rate the Reichsbank may have whenever
the bank rate is below 4 per cent. These trammels imposed upon the
principal business of the banks was bound to affect their giro business
injuriously in spite of the efforts made to counteract the mischief by
the establishment (especially in Württemberg) of many new branches and
agencies. These banks of issue have never had any great importance as
regards the giro business, and even at the present day the volume of
their transactions is relatively insignificant.

The post-check system supplements in a most effective manner the giro
system of the Reichsbank in that it brings in connection with the five
hundred establishments (more or less) of the Reichsbank about 39,000
post-offices and post agencies. As all the post stations are included in
the post-check system, the Reichsbank's network of branches is spread
out uniformly in a compact manner over the whole Empire.

The post-check system, inaugurated January 1, 1909, would more
appropriately be termed the post giro system. For at bottom its purpose
is to become a giro system, a system of monetary transfers by means of
assignments to, and deductions from accounts current. What it is aiming
at is to make it unnecessary for German letter carriers to be lugging
around millions in cash every day. The money sent through the German
post-office in 1907 amounted to no less than 13-1/3 billion marks. The
post-check system has this in common with the giro system of the
Reichsbank that it extends over the whole length and breadth of the
German Empire, while the activity of all other institutions carrying on
a system of giro, as well as check, payments, with the exception of the
union of the Schulze-Delitzsch credit associations, is territorially or
locally restricted. The giro network and that of the post-check system
are connected with each other by certain channels that render it
possible for payments to travel unhindered from the one system over to
the other without the intervention of cash.

GENERAL SKETCH OF BANK AND CREDIT ORGANISATION IN GERMANY

[187]Germany witnessed a tremendous economic expansion during the
twenty-year period 1888-1907. There occurred a considerable increase and
extensive circulation of capital. This movement of capital naturally
passes through the banks and is brought about by them. As collectors and
distributors of capital, the banks are, so to speak, the focal points of
economic life.

We are here concerned with three kinds of credit institutions--the note
banks (banks of issue), the credit banks, and the land credit
institutions (mortgage banks and land mortgage associations).

BANKS OF ISSUE

The present organisation of the note-bank system is based on the bank
act of March 14, 1875, and the supplement to this act of June 7, 1899.
Even previous to the founding of the German Empire the greater part of
Germany had become united commercially through the formation of the
Customs Union (Zollverein). Similar further movements toward union,
however, had met with but little success in the domain of currency and
with none whatever in that of banking. In the newly founded German
Empire seven different monetary systems were in existence, and as all
German States, with the exception of the free city of Bremen, were on a
silver basis, there was above all a great want of a well regulated and
adequate circulation of gold coin. The prevalence of paper circulation
was felt in the most annoying manner.

Thirty-two banks had the right to issue notes, and in the absence of
adequate legislation, it was found on many occasions that the notes
issued were not sufficiently secured.

The first step which the Government took to improve these conditions was
the act of December 4, 1871, concerning the coining of imperial gold
pieces. The coinage act of July 9, 1873, which proclaimed the gold
standard for the Empire, formally completed the organisation of the
German currency system. It was recognised more and more that, in order
to give effect to the gold standard, which for the time being existed
merely on paper, and in order to regulate and supervise the entire
currency circulation, the establishment of a central bank was an
absolute necessity. This consideration finally led to the establishment
of the German Reichsbank, which came into being on January 1, 1876,
absorbing at the same time the Bank of Prussia (note bank).

The predominance of the Reichsbank over the private note banks was
secured through its considerably larger capital, further through the
volume of its tax-free note contingent, which exceeded considerably the
amount of all the other contingents, and which subsequently was to
increase still more through the accretion of the contingents of the note
banks which might renounce their rights of issue.

COMMERCIAL BANKS AND THEIR RELATION TO INDUSTRY AND COMMERCE

The close relation of the so-called regular banking business to that of
the floating of enterprises, the trading in and the issue of shares is
typical of the organisation of the German credit-bank system. The
development of the railroad system beginning about the middle of the
last century, which caused a considerable demand for and circulation of
capital, and the greater extension of state credit, induced the banks to
turn to the flotation and issue business.

The period following the founding of the German Empire, as mentioned
before, witnessed a vigorous development of German industry, especially
of the mining and (beginning with the nineties) of the electrical
industries, which required a continuous inflow of new capital. At the
same time German foreign commerce, particularly with oversea countries,
kept on steadily increasing. Under such conditions the economic policy
of the banks of placing the funds entrusted to them at the service of
the new development must be regarded as perfectly proper. The banks
furthered this development by forming stock companies, granting
long-term credit, assuming shares and bonds, placing the new industrials
on the stock market and selling them to the public. There is no doubt
that but for their policy of furthering the industries, the economic
development of Germany would have taken considerably longer than has
been the case.

In order to obtain the means for granting industrial credit and to
dispose of the enormous amounts of newly created industrial securities,
it was and is necessary to attract in as large a measure as possible the
surplus funds of the community available for capital investments. For
this purpose the joint-stock banks spread a network of deposit branches,
destined to serve as reservoirs for the inflow of available funds, and
at the same time as distributors for the industrial securities created.
With the same end in view the large Berlin banks, either through the
acquisition or exchange of stock (for permanent investment), entered
into friendly alliances with the provincial banks.

It cannot be said that the banks created our industries, since the funds
which are gathered by the banks in increasing volume are mainly the
result of the increasing productivity of capital invested in industrial
undertakings. It is true, however, that the creative power which in a
comparatively short time placed German industry in its present
commanding position took its origin with the men who put to practical
use and in the interest of economic progress of the nation the
achievements and inventions in the domain of science and technique. It
is the undisputed merit of the persons at the head of the banks that
they appreciated those endeavours and supported them by advancing the
requisite capital, oftentimes incurring great risks for the banks. It is
almost self-evident that the banks, which in carrying out their policy
of furthering industry had often to assume considerable risks, have
tried to secure, and in a large measure have succeeded in securing, a
lasting and decisive control over industrial corporations.

Until the seventies of the last century the financial regulation of
German foreign oversea trade had been almost exclusively in the hands of
London banks. The establishment in 1870 of the Deutsche Bank at Berlin
meant a turning point in this regard. The founders of the Deutsche Bank
had recognised that there existed in the organisation of the German
banking and credit system a gap which had to be filled in order to
render German foreign trade independent of the English intermediary, and
to secure for German commerce a firm position in the international
market. It was rather difficult to carry out this programme during the
early years, the more so, because Germany at that time had no gold
standard and bills of exchange made out in various kinds of currency
were neither known nor liked in the international market. The
introduction of the gold standard in Germany in 1873 did away with these
difficulties, and by establishing branches at the central points of
German oversea trade (Bremen and Hamburg) and by opening an agency in
London the Deutsche Bank succeeded in vigorously furthering its
programme. Very much later the other Berlin joint-stock banks,
especially the Disconto Gesellschaft and the Dresdner Bank, followed the
example of the Deutsche Bank, and during the last years particularly the
Berlin joint-stock banks have shown great energy in extending the sphere
of their interests abroad.

Among the customers of the joint-stock credit banks figure chiefly
members of the commercial and industrial classes, who obtain from these
banks both their long- and short-term credit, and in the second place
holders of medium-sized and large agricultural property, who apply to
them for short-term "operation" credit. The credit demands of the
members of the small-farm class and of the small independent producers
are generally met by the co-operative credit societies.

LAND CREDIT INSTITUTIONS

As regards the credit on landed property there is hardly a country with
an organisation as perfect as Germany. The beginning of this
organisation dates back about one hundred and thirty years. The Prussian
State had emerged from the storms of the Seven Years' War (1756-1763) as
a recognised European power, but the sacrifices of the years of war had
completely exhausted the country.

As the landed nobility was then the principal support of the State and
was so regarded by the Government, it became a matter of public
interest to relieve the financial distress of the landed proprietors by
enabling them to pay off systematically their mortgage debts.

The efforts in this direction, in which the Prussian King, Frederick the
Great, personally took an active part, led to the creation of the
land-mortgage associations (_Landschaften_), which must be considered
the first important step toward the organisation of land credit.

"Landschaften" are associations endowed with the rights of a corporation
and operating under state control. Their boards of directors have the
attributes of official authority. They are autonomous institutions
within the limits set by the state supervision.

The Landschaften obtain the funds for the granting of credit through the
issues of letters of mortgage or mortgage bonds--_i. e._, as a rule, the
borrowers receive the loan in the shape of mortgage bonds of the
association, and it is left to them to negotiate these bonds on the
stock exchange. At first the letters of mortgage were made out on a
certain estate (estate debentures). But as the purchaser of such letters
of mortgage was forced to keep watch over the condition and management
of the mortgaged estate--even though the association itself maintained
permanent control of the debtor--the sphere of circulation and the ease
with which these bonds could be sold were naturally limited.

It was only when the issue of corporate mortgage bonds was started, the
security of which was guaranteed either by the entire mortgage claims of
the association or the collective responsibility of their members, and
when these bonds were given a large market through their admission to
exchange transactions, that the highest degree of mobility was reached.

It was mainly to meet the needs of credit on urban real estate that
mortgage banks (_Hypothekenbanken_) were created, and thus a special
organisation of city real estate credit was formed. The greater number
of the mortgage banks now in existence was founded during the decade
1862 to 1872; practically all the others were founded during the
building boom of 1894-1896. Most of the mortgage banks cater
exclusively to the demand for real estate credit; some others combine
this specialty with other lines of banking.

While the land-mortgage associations are based on the principle of
co-operation and do not pursue a profit-making policy, the mortgage
banks have been founded as joint-stock companies. The capital stock
serves as working capital as well as guaranty fund.

Bonds are issued against acquired mortgages and secured by the latter.
Almost all these banks issue their bonds to bearer, a privilege granted
them by the State. Inasmuch as the bonds are held in many cases by small
investors, the State, in order to protect the interests of these
bondholders, from the very beginning secured to itself the right of
control, limiting at the same time the field of operation of these banks
by certain legal enactments and regulations.

On the whole, interest rates on mortgage loans are subject to but slight
variations. It should be remarked, however, that the borrower when
obtaining a mortgage loan has to pay a bonus the rate of which will be
considerably higher in times when money is scarce than in times when its
supply is redundant.

In times of a large increase in the supply of bonds the mortgage banks
may go into the market to buy their own bonds. Such action prevents
serious fluctuations in the quotations of these securities and fits them
to be objects of permanent as well as temporary investments, including
the investment of funds which must be kept in liquid shape.

In the present day when complaints are urged against the great
indebtedness of country landowners, the fact must not be lost sight of
that the transition from extensive to intensive operations in
agriculture could not have been accomplished without a wide use of
mortgage credit, and that such development was necessary to feed the
rapidly increasing population of the country. Moreover, through this
great growth in the population a basis was created for industrial
activity on a large scale.

RAIFFEISEN AND SCHULZE-DELITZSCH BANKS

[188]The Raiffeisen bank is the Schulze-Delitzsch bank applied to the
country, with the variations required and justified by the difference of
environment.

The model rules of the Raiffeisen societies state that: "the object of
the society is to improve the situation of its members both materially
and morally, to take the necessary steps for the same, to obtain through
the common guarantee the necessary capital for granting loans to members
for the development of their business and their household, and to bring
idle capital into productive use, for which purpose a savings bank will
be attached to the society." One word in the above, viz., "morally,"
intimates at the outset a distinctive trait. Raiffeisen always kept the
moral aspect very prominently before him. He insisted that all the
members of his institutions should profess the Christian virtues. In his
propaganda he used to the full the one intelligent power in rural
districts, the parish priest or pastor. With their help he developed a
new parochial life around the village bank. With their help he touched
in the peasant the chord of neighbourly affection and stirred him to
give it practical effect.

What is the structure of a Raiffeisen bank? and, first of all, whence
comes the working capital?

The subscribed capital of the bank is practically nil; there is nothing
but the universal unlimited liability of the associating members.
Schulze-Delitzsch, dealing with industrialists subject to unseen risks,
who operated in trade matters out of sight and control of the society,
obliged his associates to subscribe a considerable share capital, not
only as a proof of thrift, but as a material guarantee for their
individual and corporate debts. Raiffeisen, dealing with agriculturists
and villagers, demanded no such security, since each member possessed in
his little farm, his cattle or implements, material guarantee far beyond
those of any subscribed share. In addition he avoided the danger to
which a share bank is always exposed, namely, that the concern may be
run for the benefit of a few non-borrowing shareholders, rather than
for that of the general credit-seeking members.

Unfortunately this natural difference was elevated, or rather dragged
down, into an issue of principle; and the law of 1889, drawn up under
the guidance of the Schulze-Delitzsch party, insisted that every
co-operative society should have shares. The Raiffeisen societies comply
with this by nominal shares of (say) 10 marks[189] on which no dividend
is declared; though, occasionally, some of the annual profit is
indirectly returned to individuals in the shape of a slight addition to
deposit rates and a slight deduction from loan charges, calculated at
the end of the year.

Because Raiffeisen wished to create credit among small agriculturists
out of the immaterial asset of mutual knowledge, he limited the size of
each society to a single village. For his purpose he was right, but his
partisans are not right when they look askance at the larger areas of
the town bank, where the nature of the members' business and the
society's control is different.

All profits remain the collective property of the society, to be used
for the society's good. They are divided into two classes of reserve
fund--(1) reserve fund proper; (2) foundation fund. The former is
regulated in the same way as in town banks. The second corresponds to
the shareholders' dividend. It is undesirable to have nothing beyond an
ordinary reserve fund, because money thus placed can only be withdrawn
to cover losses: while if placed in the foundation fund it can be used
for positive improvements, such as the extension of premises or the
establishment of a burial fund. In actual figures, the reserve funds are
not so strong as in the town bank, owing in part to the lower loan
charges.

The loan capital, as in the town banks, is made up of small savings and
deposits. It is drawn, either from within the area covered by the bank,
in which case it comes both from members and non-members, the former
being where possible rewarded at slightly higher rates in order to
encourage membership; or from without the area, in which case it of
necessity comes from non-members. Savings are received in sums from one
mark upwards: the smaller amounts being collected by penny stamp books,
similar to those used in the Post Office Savings banks of England. The
willingness with which the peasants bring their savings to the bank is a
triumphant proof of Raiffeisen's contention that the small
agriculturists by a combination of unlimited liability and close
supervision can become absolutely credit-worthy. No savings since the
foundation of the first village bank have ever been lost through
bankruptcy.

In addition the bank obtains credit from a central bank with which it
has a current account.

The funds thus raised are utilised for three kinds of credit--(1) Simple
loans; (2) current accounts; (3) property transfers.

Current accounts are rare except in villages where there is a little
industry. With regard to the simple loan, the security, as in town
banks, is personal pledge, land mortgage, or (very rarely) deposit of
collateral. The personal pledge, as with Schulze-Delitzsch, is the most
frequent. But Raiffeisen interpreted it more strictly than
Schulze-Delitzsch. Not only must the credit-seeker produce an outside
testimony to his character: he must also convince his society that he
really merits this testimony. The member of the Schulze-Delitzsch bank
is accepted on the strength of his general business reputation, added to
his security, personal or material. The member of the Raiffeisen bank,
though he have the best of pledges, is rejected unless he is known in
his private life to be virtuous and industrious. The man of doubtful
sobriety has no chance of obtaining anything from a country bank.

If it happen that an applicant is little known or new in the district,
so that no one will go pledge for him, then the society, provided it is
convinced of his good character, will grant a loan against land
mortgage. This is not to be confused with the real credit granted by a
land bank, where the value of the estate alone is considered. It is
personal credit with a material caution, and it is not a long-term loan.

Furthermore, the society requires to know not only the character of the
borrower, but also the specific object for which his loan is destined.
It must be satisfied not only that the borrower wishes to employ the
loan in his business, but also that the operation proposed is likely to
turn out successful.

Property transfers are not strictly credit business. They are in the
nature of investments for superfluous money, just as a town bank might
invest in railway shares, with the difference that the investment is
local and designed to meet indirectly the credit wants of members. The
nature of the operation is as follows: A dies, leaving his estate to his
heirs; and these, perhaps because they wish to leave the neighbourhood
or because they want ready money for other reasons, put up the estate
for sale in allotments. Or perhaps A during his lifetime wishes to get
rid of a part of his estate. X, Y, Z, neighbouring peasants, are buyers,
but they can pay only gradually--which they are allowed to do by law.
The credit bank steps in as intermediary. It pays to the heirs of A or
to A himself, as the case may be, the price of the estate minus a small
commission. X, Y, Z become the debtors of the credit society, paying off
their debt by regular instalments, which include principal and interest.
The bank cuts out small traffickers in land, usually Jews, to the
benefit of sellers and buyers. It benefits the sellers by charging them
a moderate instead of an extravagant commission: the buyers by saving
them from permanent relationship with land dealers who seek their ruin.
The bank insists on regular payment of the instalments, because it wants
its money back, while the dealer is constantly tempting the buyers to
fall into arrears in order that he may eventually acquire the land
himself.

There is a second form of property transfer, where the bank not only
acts as intermediary but itself holds the estate for a time. Some land
dealer, having obtained a mortgage on the estate of A, demands payment.
A cannot pay and is forced to sell his estate by public auction. The
dealer forces the sale, just when the estate market is likely to be most
unfavourable, hoping to buy the estate for himself at an absurdly low
rate. Thereupon the bank steps in; it bids against the dealer, and if he
does not offer a good price, buys the estate itself and resells it later
in the year, when the market is more favourable. In this way A can pay
off his debts at once. Moreover, the bank does not keep the difference
between the price of purchase and final resale. After the deduction of
a moderate commission, it is handed over to A, who thus obtains a
further sum with which he can make a fresh start.

These dealings in property transfers are confined to Southwest Germany,
where estates are sold to be split up into little lots. The banks only
enter on these transactions where the following conditions are
satisfied--(a) where they have a superfluity of money over and above
that needed in their ordinary loan business; (b) where some party to the
transaction is a member of the society: either the seller or the buyer
or the creditors of the seller holding second and third mortgages, who
would obtain nothing were the estate sold below its real value.

What is the nature of the machinery by which this work is conducted? A
Raiffeisen bank is never what a Schulze-Delitzsch bank sometimes is; a
handsome building with barred windows, within which are a number of
clerks discharging a constant round of business, while the directors
interview special clients in a room apart. It is a small single room,
probably at the back of a farm building, opened twice a week and
presided over by a single occupant--the accountant. Business is apt to
proceed desultorily; a small child brings in a few savings; an hour
afterwards a palsied old man, signing by a cross, draws out a couple of
pounds, and so on to the end of the day. But this is the unimportant
part of the business. The really important part is the weekly meeting of
the directors, half a dozen in number, who meet to discuss the various
credit claims which have arisen. They are unpaid, as by the nature of
their work they can afford to be. The accountant, their executive clerk
who keeps the books, "the soul of the society," as Raiffeisen called
him, is the only salaried official. The committee of supervision and the
general assembly function as in the town banks; except that their
control is more decided, probably because their knowledge is more on a
level with that of the directorate, which is itself unspecialised.

What are the results achieved by the rural bank, thus operating and thus
controlled?

More than ten times the number of country banks grant only one-sixth of
the credit afforded by the town banks. The total membership of the
country banks is nearly twice as large, but the average membership per
bank is nearly seven times as small.

The average credit advanced per member is 500 marks. The average rate of
interest is not exactly known; it appears to be between 4 and 5 per
cent., _i. e._, nearly 1 per cent. cheaper than in the town bank. The
duration of loans varies between one and ten years in accordance with
the requirements of agriculture. They are repayable in small
instalments, covering principal and interest, although the member may
repay in lump if he wishes. The loan can always be called on four weeks'
notice, but the right is never exercised, unless the borrower is
allowing his property to deteriorate or is becoming insolvent through
extravagance or has misapplied money lent for a particular purpose. The
inculcation of punctuality in payment, as a moral duty, was the hardest
of Raiffeisen's tasks, as it was his greatest triumph.

If it be asked finally what Raiffeisen banks have done, which other
banks have not, it may be replied that Raiffeisen created out of
hopeless chaos the only kind of credit organisation possible for the
small agriculturist. Industry necessarily brings business men together
to some extent. Agriculture in itself holds the farmer apart, and
preserves him in lonely ignorance to be the victim of the perambulating
money-lender. To-day more than 50 per cent. of the independent
agriculturists of Germany are members of rural banks; and another 10 per
cent., chiefly the larger farmers, are members of town banks. The
non-co-operative agriculturist is becoming the exception. The Raiffeisen
banks are thickest in the southwest of Germany, the home of the small
peasant proprietors. Indeed the change wrought in many of these villages
is nothing short of a revolution. The experience of the parent village
bank may serve in illustration:

"About an hour's walk from Neuwied on the Rhine is situated on a plateau
bordering the Westerwald the little village of Anhausen. The district is
not very fertile and the inhabitants are mostly small peasant
proprietors, some with only sufficient land to graze a single ox or cow.
An owner of ten acres is a rich man. Before the year 1862 the village
presented a sorry aspect; rickety buildings, untidy yards, in rainy
weather running with filth; the inhabitants themselves ragged and
immoral; drunkenness and quarrelling universal. Houses and oxen belonged
with few exceptions to Jewish dealers. Agricultural implements were
scanty and dilapidated; and badly-worked fields brought in poor returns.
The villagers had lost confidence and hope, they were the serfs of
dealers and usurers. To-day Anhausen is a clean and friendly-looking
village, the buildings well kept, the farmyards clean even on work days.
The inhabitants are well if simply clothed, and their manners are
reputable. They own the cattle in their stalls. They are out of debt to
dealers and usurers. Modern implements are used by nearly every farmer,
the value of the farms has risen and the fields, carefully and
thoroughly cultivated, yield large crops." And this change, which is
something more than statistics can express, is the work of a simple
Raiffeisen bank.

Both town and country banks are formed into higher unions for general
organisation and educational propaganda; the country banks also unite
for credit business.

The partisans of the town banks are apt to pride themselves on their
complete self-sufficiency. They forget that this is possible for them,
not because they have sufficient funds in their own coffers to supply
every credit need, but because an increasing part of their business is
conducted through the trade bill of exchange, which is a marketable
commodity that can be rediscounted by any outside bank, the Imperial
Bank, the Dresdner Bank or any other. But agricultural societies,
inasmuch as their loan papers cannot readily be bought and sold on the
open market, require a special organisation. Hence central organisations
act as money equalisers between the different societies. In some
districts money is superabundant, in others it is deficient. The central
bank acts as a channel through which the abundance of one district can
be drawn to supply the scarcity of another, the operations being
conducted by means of current accounts with both parties. In Germany as
a whole the societies of small agriculturists of the Southwest have
always an abundance of money, which is one reason why they dispense so
much of their funds in the purchase of property transfers. The societies
of large agriculturists in the Northeast (the Ost-Elbien Provinces),
where the capital employed on each farm is large and the population
thin, are as a whole in continual want of it.

INTERVIEW WITH HERR KLEEMANN, DIRECTOR OF THE DRESDNER BANK

[190]Q. When were the first of your co-operative societies organised?

A. In 1848. They were organised on a voluntary basis and for
philanthropic purposes. They developed very rapidly. The first form
which developed was for the purchase of means of subsistence, such as
sugar, coffee, grain, wine, cigars, etc. Then they bought agricultural
machinery, threshing machines, etc., which they would rent to small
farmers in the country who could not purchase such machinery. They also
formed societies to build houses for peasants and working people. There
might be six or seven with different purposes. Later on
Schulze-Delitzsch came to the conclusion that it would serve working
people and small tradesmen to have co-operative societies founded simply
for the purpose of extending credit to them. That was the last
development in the system.

Q. How many kinds of co-operative societies are there in Germany?

A. It is very difficult to classify them. The Raiffeisen societies are
confined to Prussia. There are other organisations in Saxony, Bavaria,
and different States in Germany.

Q. The attitude of the Reichsbank is the same toward them as toward any
other bank?

A. Yes; and their bills are frequently offered and taken by the
Reichsbank as from other institutions.

Q. Do they carry their reserve with the Reichsbank or with the Dresdner
Bank?

A. Principally with the Dresdner Bank, because they get interest upon
it.

Q. Do they pay interest on deposits?

A. They pay an average of 4 per cent., which may be considered as an
almost permanent rate. The money they get is in most cases money for a
long period. They have to compete with the savings banks.

Q. Are the small societies at all in competition with the Reichsbank,
where they have a branch?

A. No. There is no competition. They do a business which the Reichsbank
would not do. They give credit to people who would not suit the
Reichsbank, because they could not give the guarantee.

THE REICHSBANK

INTERVIEWS WITH HERR DR. VON GLASENAPP, VICE-PRESIDENT, AND HERR DR. VON
LUMM, DIRECTOR, OF THE REICHSBANK[191]

Q. By whom are the shares of the Reichsbank owned?

A. It is all private ownership. The shares are held mostly in Germany
and Holland, and distributed in small lots.

Q. Would the bank discount a bill drawn by one merchant and accepted by
another?

A. Yes. The Reichsbank is not only a bank for banks, but for the
commercial and industrial enterprises of the Empire.

Q. If a railroad finds it necessary to make improvements and wants to
borrow money could they get money at the Reichsbank?

A. Only on collateral acceptable by the Reichsbank. The railroad would
probably in such a case go to private banks to be financed.

Q. Assume that there is a manufacturer in Bremen, making well-known
articles, which he ships to a merchant in Berlin and draws a bill
against that merchant, would it be a satisfactory bill to the
Reichsbank?

A. Yes; but in that instance also the merchant would probably go to the
private bank, where he would get a better rate of discount.

Q. If there were a severe money stringency, would he still go to his
bank?

A. Yes; that would probably be the case, and his bank might afterwards
take his bills to the Reichsbank.

Q. What is the smallest bill the bank will discount?

A. We have no minimum. We discount bills as low as 10 marks.

Q. Upon what kind of a bill does the farmer secure an advance from the
bank?

A. He sells his produce, draws a bill upon the purchaser, and takes the
bill to the bank as any other man would do, or a bill might be drawn
upon a farmer and accepted by him.

Q. When he borrows money in the spring with which to buy seeds, how does
he secure the cash?

A. He goes to his own bank for that. There are co-operative societies
for this purpose, which are a great factor in Germany.

Q. Will the manager of a branch of the Reichsbank renew a farmer's three
months' bill if desired?

A. Yes; an exception is made for the farmer. Other bills are not
renewed.

Q. The bank rate is 4 per cent. Does that mean 4 per cent. is charged on
three months' bills?

A. The Reichsbank has only one rate of discount. There was a time when
the Reichsbank did a similar business to that which the Bank of England
does now, _i. e._, that they would purchase in the market prime bills at
a more favourable rate, but in 1896 it was decided to have but one rate
for everybody.

Q. Please state the reason for the change of policy.

A. The most important reason was that it was thought that a great
central institution like the Reichsbank, with its tasks and duties to
the whole of the community, ought not to make a distinction of any
class, or make an exception in favour of any one. It is the policy of
the bank to serve all alike.

Q. Is the Reichsbank disposed to favour every application for discount
or loans if the character of the offering be satisfactory?

A. It is their duty to listen to every one who comes for accommodation,
whether he has an account or not. The principle of the Reichsbank is not
to serve a part of the community, but the whole. The Reichsbank is for
everybody.

Q. Are your deposits subject to check?

A. The money is drawn against check. There are two kinds of check--white
and pink. The white is for withdrawing cash over the counter, the pink
for making transfers.

Q. Have you different classes of deposits?

A. No.

Q. Do you pay interest on your deposits?

A. The Reichsbank does not pay interest on money deposited with it. It
receives money on deposit and for transfer. Most large houses keep an
account with the Reichsbank. The Reichsbank does a large transfer
business for them.

Q. Is it the custom for banks in Berlin and other important centres to
carry balances in the Reichsbank as a part of their reserve?

A. It is the custom for the banks to keep a large part of their cash
with the Reichsbank. They keep only a small amount of cash in their
tills.

Q. Is that true of banks in other cities than Berlin?

A. Yes.

Q. Does the Reichsbank pay the same taxes that the other banks do? For
instance, income tax and other taxes?

A. No; we are free from the government income tax, and the license fees,
but we must pay the real-estate tax.

Q. What is the relation between this bank and other banks, such as the
Deutsche and the Dresdner--that is, as to the character of business
transacted? Are you not competitors?

A. It may be said that the Reichsbank is more restricted by law. At a
private bank the rate of discount may be much cheaper than at the
Reichsbank. The private banker knows his clients, and he may be willing
to accept from them a bill that the Reichsbank would not and could not
accept.

Q. Then there is to some extent competition?

A. Yes; but that competition is not large. It is not felt that the
Reichsbank is a competitor of other banks, but it is a public
institution. The Reichsbank has its official rate, which is higher than
the private rate. A bank will take bills on its own account running
three months or more and hold them, and in case of need will take bills
running ten days or less to the Reichsbank for discount. The Reichsbank
pays no interest and acts as agent for transfer of currency and credit
to all parts of the Empire without charge.

Q. Has there been any feeling that your branches were supplanting the
private local banks in small towns?

A. There may have been some instances where a banker may have been
dissatisfied at the Reichsbank opening a branch in his locality, but as
a rule the banks at such a place are quite pleased to have the
Reichsbank open a branch in order that they may have the benefits of its
facilities.

Q. The government deposits are received and treated exactly the same as
the deposits of farmers?

A. Yes. The business for the Government and its departments is handled
the same as for others, and no interest is paid on deposits. There is,
however, one exception; every private institution is required to keep a
minimum balance to its credit, but not so with the departments of the
Government. The Empire keeps in the aggregate sufficient to compensate.

Q. Do you always charge a higher rate of discount for bills when you
have a large amount of taxed notes outstanding?

A. No. On occasions the Reichsbank has not increased its rate of
discount above 5 per cent. At times we have discounted even at 3 per
cent., when we have had to pay a tax of 5 per cent.

Q. It has been suggested to us as a matter of policy in times of stress
that it would be better for you to add the 5 per cent. tax to the rate
of discount.

A. The Reichsbank must be considered in the first place as a public
institution which has to take care of the public interest, and
secondarily as a money-making institution.

Q. Is there any restriction as to the percentage of silver in your
reserve?

A. No; but there is another law, the coinage act, by which the amount of
silver coined depends upon the population. They do not coin more than 20
marks per capita.

Q. What steps do you take to increase your gold reserve or to protect
it?

A. We always have a large amount of bills of exchange payable in foreign
countries, payable in gold. We also increase the rate of discount. We
consider that the latter measure is the only effective one. We also make
advances without interest to importers for the time the gold is in
transit; we do that even in times when the ordinary gold import point is
not reached. Then we may raise our tariff for the purchase of foreign
gold coins, as the Bank of England does.

Q. Do you take any steps to prevent exports of gold? We have been told
that it is the habit of the Reichsbank, in case of large exports of gold
from Germany, to suggest to the other banks that it is not agreeable to
have the gold exported.

A. It has never been the case and never will be the case that any such
suggestion has been made by the Reichsbank to anybody.

KÖNIGLICHE SEEHANDLUNG

(ROYAL SEA-TRADE SOCIETY)

INTERVIEW WITH HERR GEH. OBERFINANZRAT LOTTNER, DIRECTOR OF THE ROYAL
SEEHANDLUNG, PRUSSIAN STATE BANK[192]

Q. When was this bank organised?

A. In 1772.

Q. What is the capital of the bank?

A. One hundred million marks.

Q. By whom are the shares owned?

A. There are no shares; the capital is owned by the bank, which may be
regarded as a juristic person, an independent legal subject.

Q. Who invested the money?

A. The money was originally invested by stockholders in the time of
Frederick II, but afterwards the shareholders gave up their stock, for
which they were paid. The shares were mostly owned by the King and by
his associates, and they handed them over to the bank, so the capital is
really owned by the bank itself. The proceeds in excess of all the
expenses are paid to the Prussian State.

Q. Who is responsible for the conduct of the business?

A. The president.

Q. Has he associated with him directors?

A. No; he is personally responsible.

Q. By whom is the president appointed?

A. By the King of Prussia for life.

Q. What are the particular functions of the bank?

A. In the first place, it is an organisation to help the State of
Prussia. The principal part of the business is to finance the loans of
the State. It may undertake the loans alone, but as a rule it heads a
syndicate of the large banks.

Q. Do you compete for deposits from merchants, manufacturing concerns,
banks, etc., with the Deutsche Bank or the Dresdner Bank?

A. Yes, to some extent. It is not our intention to do so, but of course
we practically compete in some ways. Our rates on deposits are less
favorable than those of these banks.

Q. Do you take real estate mortgages?

A. No.

Q. You are known as the sea-trade (Seehandlung) society. Why is that?

A. Frederick the Great founded the Seehandlung to promote Prussian
trade, especially the oversea trade. At one time this company had a salt
monopoly and a wax monopoly. The salt which came into the different
ports of Prussia and the wax which came from Poland were bought up by
the Seehandlung. At one time the Seehandlung also had mills, spinning
and weaving plants, iron foundries, and river steamers. We still own two
industrial establishments, the flour mills in Bromberg and a linen
spinnery in Landeshut in Silesia.

Q. A large percentage of your funds is loaned on the stock exchange?

A. Yes.

Q. And your discount business is comparatively insignificant?

A. Not insignificant, but small compared with our loans on the stock
exchange.

Q. Do you receive promissory notes from customers?

A. No.

Q. Do you transact business of any other character than that heretofore
mentioned?

A. We have a branch known as the Royal Loan Office, which lends money in
small amounts upon the pledge of different kinds of goods as security.
This was established in 1834. In 1906 we made 99,000 loans upon watches,
jewels, clothing, etc., at an average of 31 marks per loan. Two-thirds
of the borrowers are labourers; last year about 16 per cent. were widows
and spinsters, also a few were mechanics--occasionally professional
men--artists, actors, and the like. Our rate is very low, 12 per cent.
for the year, which is low compared with the ordinary pawnshops. No
other banks conduct a business of this class.

DEUTSCHE BANK

INTERVIEWS WITH HERR PAUL MANKIEWITZ, DIRECTOR, AND HERR A. BLINZIG,
ALTERNATE, OF THE DEUTSCHE BANK[193]

Q. When was your bank organised?

A. In the year 1870.

Q. How is your stock owned?

A. By a large number of shareholders. Our shareholders are principally
in Germany, but also in England, France, Austria, and elsewhere.

Q. What does the item "Shares in other banks," $19,000,000, represent?

A. This represents the purchase by us of practically the controlling
interest in 13 independent banks in the Empire. We are represented upon
each board and we are kept closely informed of the business. Our return
is in the dividends.

Q. A large percentage of the stock exchange business is really handled
through the incorporated banks, is it not?

A. Yes. We ourselves have fifty members on the stock exchange.

Q. You mean that the Deutsche Bank has fifty men, members of the stock
exchange, who trade there on the floor?

A. Yes. There is quite a difference, however, in our method of handling
the business from that followed in New York. We do not have the margin
system. Most of our customers who do not pay in full pay at least for
half the amount involved in the purchase.

Q. Are the clearing-house associations important factors in the cities
in Germany?

A. No. They are not associations of importance or power, but merely
pieces of machinery through which cheques are cleared.

Q. You all go to the Reichsbank to clear?

A. Yes; once a day. There are 14 clearing houses and 160 members in the
Empire.

Q. What taxes do you have to pay?

A. We pay to the State 4 per cent. on our income remaining after
deduction of 3-1/2 per cent. of our share capital, which is exempt, and
to the city of Berlin 4 per cent. on our income. All banks pay on the
same basis.

Q. Is there a limit to the amount of discretion given to the branch
directors on first-class bills?

A. Each of the main branches has a fixed capital arbitrarily set aside
by the Deutsche Bank. They have a sum according to the importance of the
branch, and they must do business according to it.

Q. The Reichsbank has branches everywhere?

A. Yes; in every place where there is sufficient business. It has about
500 branches. We transferred through the Reichsbank last year
21,000,000,000 marks. Our strength is the Reichsbank. Our branch in
Bremen, for instance, wants money when cotton shipments start, and the
money is transferred to them. The importers in Bremen sell the cotton to
the large manufacturers. When they get the money the money comes back to
us.

Q. In London the joint-stock banks usually pay interest at about 1-1/2
per cent. below the bank rate. In the country they have to pay more.
What is the custom here?

A. There is no strict rule. The bank rate is now 4 per cent. and we
allow 1-1/2 per cent. on call money. In the interior our branches allow
a little more. It is the same as in England.

Q. Does the bank rate influence your rate for discounts?

A. Yes; we are influenced. The bank rate is now 4 per cent. and our
private discount rate is 2-1/2 per cent.

Q. If a mercantile customer came with a four months' bill satisfactory
in character, what would be the rate to him?

A. We have no fixed rate. It depends upon the man and the bill.

Q. How do you invest your surplus funds when you have no demand from
customers?

A. We buy bills in the open market, or accept offerings made to us from
houses desiring to borrow.

DRESDNER BANK

INTERVIEWS WITH HERR SCHUSTER AND HERR NATHAN, DIRECTORS OF THE DRESDNER
BANK[194]

Q. What is the date of your organisation?

A. 1872.

Q. In practice, you and all other banks endeavour to fully employ all
available funds?

A. Yes; we only carry in the Reichsbank and other banks sufficient cash
for the conduct of business.

Q. You regard your item "Bills discounted" as one of practical reserve?

A. Yes; it is immediately convertible into cash at the Reichsbank.

Q. Referring to the item "Shares in other banks," $6,662,753, do you
control all banks in which you have any interest?

A. Yes; practically. We probably have not the majority of the stock in
any bank; but our holdings are sufficiently large to give us control.

Q. Is the tendency toward bank consolidation? Are the smaller banks
becoming more closely affiliated with the larger banks?

A. Yes; because it serves a mutual advantage. The smaller bank needs
better facilities to take care of the increasing business. If a bank
wants to increase its capital, and the shareholders do not care to
subscribe for the increase, the new shares are frequently offered to us.
We look out for the business of these banks in the centres and give them
participations in some of our important undertakings.

Q. In Great Britain we found that banking interests were practically
controlled by from 15 to 20 large banks. Does that condition prevail in
Germany?

A. No; but the tendency is in that direction. One difference between the
banks of England and Germany is this--in England the primary purpose of
the banks seems to be to secure large earnings for their shareholders.
In Germany our banks are largely responsible for the development in the
Empire, having fostered and built up its industries.

Q. Would it be any reflection upon a bank if it should go to the
Reichsbank for discounts or loans in easy times?

A. No; we seldom go in easy times, however, because there is no need of
our doing so.

Q. Is there strong competition between the important banks of Berlin or
do they work more or less together?

A. Of course there is strong competition between the large, important
banks, but there is no lack of harmony, and they very frequently work
together in syndicate operations. While it is the desire and endeavour
of each bank to build up its business, it must be recognised that each
institution has more or less its own field of operation, which is in a
measure respected by the other banks. As, for instance, the Deutsche
Bank has done a very large volume of business with Turkey, and business
emanating from that source is expected to and naturally does go to the
Deutsche Bank, while another institution may have been largely
identified with Roumania, or another with some large local interest. We
ourselves are recognised as representing the Krupp interest and have
just recently formed a syndicate to finance one of their operations.

Q. Our understanding is that a merchant, a customer of yours, may
arrange with you for a credit of, say, 100,000 marks, which may or may
not be secured, and may draw a ninety-day bill upon you for that amount.
He may send that bill to the Deutsche Bank for discount. If the Deutsche
Bank will discount it, they present it to you and you accept it. Will
you kindly state why this custom prevails?

A. One reason is that it makes a bill which is acceptable at the
Reichsbank and is a prime bill. We receive one-fourth of 1 per cent., or
more, for our acceptance, and the Deutsche Bank, or any other bank
discounting, invests its money at a rate for the period. It might be
that we would prefer to give our customers a cash credit rather than to
accept his bill, in which event we would so arrange.

Q. Then this practically enables you to sell your credit without using
your cash?

A. Yes.

Q. We understand this is the usual custom in Germany.

A. Yes.

Q. Is it not a fact that in the last analysis the customer who uses the
money usually pays more than the bank rate--that is, would it not cost
him, in such a transaction to-day, say 5 or 6 per cent., while the bank
rate is 4 per cent.?

A. Yes.

Q. Is it your endeavour to reach the small country towns?

A. No.

Q. In the United States we have brokers who handle commercial paper, and
many of the banks purchase it to employ their surplus funds. In London
we found discount houses whose sole business was to handle paper for
sale to banks to employ their surplus funds. What corresponds to that
agency in Berlin?

A. In Berlin there are two brokers who handle prime bills, but they are
not an important factor.

Q. How do you employ your surplus funds?

A. We buy bills in the market or through these brokers.

Q. In employing your surplus funds do you buy any other bills than those
which the Reichsbank would accept?

A. No.

Q. Would you consider the issue of taxed notes by the Reichsbank in a
sense an evidence of an abnormal condition?

A. No: on the contrary, it is quite normal. Last year it happened
twenty-five times.

Q. In times of trouble do the large banks, like your own, the Deutsche
Bank, and Disconto, co-operate with the Reichsbank in an endeavour to
prevent the exportation of gold?

A. Yes. Opinions are divided as to whether it is for the good of our
country to do so or not. Last year, for instance, many people asked for
gold. It was refused at first in some quarters; later we shipped freely.

Q. Are you members of the stock exchange?

A. All banks and bankers are members of the stock exchange.

Q. By virtue of their being banks?

A. Yes; they have to pay a tax for the exchange.

Q. Are the seats expensive?

A. No. You do not buy a seat. There is no limit to the number of people
admitted. We have from twenty to thirty people go to execute our orders.

BANK DES BERLINER KASSEN-VEREINS

INTERVIEW WITH HERR HOPPENSTEDT[195]

Q. When was this bank organised?

A. In 1823, under the general companies act.

Q. What are its particular functions?

A. This bank might be called strictly a clearing bank. It clears
transactions made on the stock exchange and also cheques on banks which
do not clear through the Reichsbank Clearing House. As you know, our
banks do a large stock exchange business. It is their custom to send to
us all securities sold to others clearing through us with a list of the
purchasers. We charge the purchasers the amounts due from them and
credit the amounts received from them, balancing every night. The
securities are delivered to the various purchasers. _Some settlements
are made daily and others monthly._ A large volume of cheques and bills
are also cleared. This is simply a clearing business.

Q. You show loans and discounts in your statement. What is the character
of these?

A. We invest our funds in first-class loans and prime bills.

Q. Is this bank owned by the other banks?

A. It is partly owned by other banks. There is also a commission of
shareholders of the bank, among whom are the first banks of our city.
These are members of our board.

Q. Is it the custom for all banks which clear through you to have a
balance in order to facilitate the payment of debits through clearing?

A. Yes.

FOOTNOTES:

[184] Adapted from Geh. Oberfinanzrat Waldemar Mueller, _The
Organization of Credit and Banking Arrangements in Germany_; Max Wittner
and Siegfried Wolff, _The Method of Payment by means of Bank-Account
Transfers and the Use of Checks in Germany_. Publications of the
National Monetary Commission, Senate Document No. 508, 61st Congress,
_2nd Session_, pp. 117-271.

[185] In order to facilitate its giro business and reduce the friction
to a minimum, the Reichsbank has special printed forms prepared for the
various kinds of transactions, the use of which is made compulsory on
the public. For a simple transfer of money from one customer to another,
whether they be in the same town or in different places, the "red check"
is employed, which is filled out by the party making the transfer and
handed in to the bank. It is not a check in the proper sense of the
term, but is so called because the printed forms resemble checks and are
put up in books in the same way as checks. The word "check" does not
occur in the printed matter of the blank; neither is the instrument
transferable. When a number of payments are made simultaneously the
party making the transfers is furnished with a blanket form on which the
names of the individual firms and the various sums are entered and which
has to be accompanied by a red check covering the aggregate amount. For
the so-called "great banks" of Berlin, some of which have a volume of
transfer transactions amounting to as much as one hundred transfers for
each bank per diem, there are blanket forms which are of a different
colour for each bank. When cash is wanted the so-called "white check" is
employed. This is a legally constituted check. There are special printed
forms for the use of those who have no account with the Reichsbank.

[186] Banks of issue were formerly numerous in Germany. Gradually,
however, nearly all of them renounced the privilege of issue, as the
laws relating to banking made their existence as banks of issue more and
more difficult. At the present time there are only 4 such banks besides
the Reichsbank, viz.: the Bayerische Notenbank, the Wurttembergische
Notenbank, the Sachsische Bank, and the Badische Bank.

[187] Adapted from Robert Franz, _The Statistical History of the German
Banking System, 1888-1907_, Publications of the National Monetary
Commission, Senate Document No. 508, 61st Congress, _2nd Session_, pp.
7-115.

[188] Adapted from C.R. Fay, _Co-operation at Home and Abroad_, pp.
42-51, 56. P.S. King and Son, London. 1908.

[189] Occasionally even as low as 1_d._ or less.

[190] Adapted from _Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland, and Italy_,
Publications of the National Monetary Commission, Senate Document No.
405, 61st Congress, 2d. Session, pp. 452-468.

[191] _Ibid._, pp. 335-358.

[192] _Ibid._, pp. 359-370.

[193] _Ibid._, pp. 371-391.

[194] _Ibid._, pp. 392-418.

[195] _Ibid._, pp. 486, 487.

CHAPTER XXVI

BANKING IN SOUTH AMERICA

[196]The special interest in South American banking which exists at this
time is the product of at least four distinct factors:

First. It has been evident for some years that the trade between North
and South America is rapidly developing. In the ten years, 1903-1913,
the exports from the United States to the ten Republics of South America
increased 274 per cent. against an increase of all our exports during
the same period of 73 per cent. In spite of inexperience, crude methods,
lack of banks and of ships we have made notable gains in South American
trade. There seems to be no reason to question the probability of a
continued rapid increase during the next few years.

OUR GROWING SURPLUS FOR FOREIGN INVESTMENT

Second. Other forces have gradually been bringing this country more and
more into the position of looking for investment opportunities abroad.
While it is true that the United States is a debtor nation in the sense
that a large amount (estimated at $3,000,000,000 to $6,000,000,000) of
European capital is invested here, it is also true, on the other hand,
that the national income has for some years been sufficient to meet
annual payments abroad, to make large fresh investments in our own
enterprises, and still to leave a considerable surplus for investment in
neighbouring countries. It is estimated that American capital in Mexico
and Canada amounts approximately to $1,500,000,000. In South America
there are already American investments of perhaps $300,000,000 to
$400,000,000.

As the national income and savings expand and as the opportunities for
exceptionally profitable investment within this country decrease, it is
clear that there must be a stronger and stronger tendency toward
investment abroad. The immense sums, for instance, that have been
flowing into railroad construction and rebuilding will not be needed to
so great an extent in future. A considerable proportion of this overflow
of capital may certainly be expected to spread into South America.

GREATER LENDING POWER OF BANKS

Third. The adoption of the federal reserve system has made a remarkable
improvement in the handling of gold and of credit. It has released and
made available for other forms of financing great sums which were
formerly tied up in scattered reserves. We have only to look at the
monetary history of the German Empire during the last forty years to see
how powerful an influence on industry, trade, and investment is exerted
by the centralisation and control of bank reserves. The London _Statist_
has calculated the ultimate increased lending power of American banks,
under the federal reserve system, at $3,000,000,000.

EUROPEAN WAR

Fourth. The European war has suddenly stimulated the tendencies which
were previously evident. It has temporarily cut off a considerable
amount of European trade in South America, thus leaving an opening for
even more rapid development of our trade than would otherwise have taken
place. It has deprived South America for a period of several years of
the steady inflow of European capital. It has enormously increased the
exports and decreased the imports of this country, thus placing suddenly
at our disposal greatly enlarged financial power, possibly as much as
$1,000,000,000 per annum above normal. Its ultimate effect, we may
safely assume, must be to increase considerably rates of interest the
world over, thus stimulating the tendency toward an enlarged outflow of
capital from the United States into neighbouring countries.

By reason of the war the same kind of a situation that would otherwise
have developed slowly in a period of years now confronts us suddenly
when we are as yet in a state of financial unpreparedness. The new
machinery provided by the federal reserve act is not yet fully utilised
or adjusted in its final form. It will require careful study, combined
with prompt action, to utilise the financial opportunities now before us
with greatest advantage to all concerned.

ENGLISH BANKS IN SOUTH AMERICA

Although English interests have share holdings in other institutions,
there are only five banks in South America that stand out as
unmistakably British. In the order of their development, these are the
London and River Plate, London and Brazilian, British Bank of South
America, Anglo-South American Bank, and Commercial Bank of Spanish
America. Each institution, with one exception, has concentrated on one
country, in which it has established most of its branches and to which
it has devoted its first efforts. The exception is the British Bank of
South America, which has followed the contrary policy of having only a
few branches strategically located in important cities; in other words,
this bank has concentrated on selected cities rather than on a given
territory.

ENGLISH TRADE AND BANKS DEVELOP TOGETHER

The development of commercial banking by British interests has
everywhere gone hand in hand with the development of British investment
and British trade. The accounts of the railways, mercantile firms,
steamship lines, public utilities, and other enterprises conducted by
their fellow countrymen form the great bulk of the business of the four
leading institutions; the Commercial Bank of Spanish America is,
however, operating under different conditions. Indeed, it may even be
said--again speaking in broad terms--that the English banks have made
comparatively little effort to secure the accounts of domestic
enterprises. It is certainly safe to say that they have not made efforts
in this field at all comparable with the efforts of the German, Spanish,
French, and Italian banks. It is interesting to note also in this
connection that the management and even the clerical force are, with
few exceptions, brought over from England. After more than fifty years
the three leading institutions remain as distinctively British as they
were at the beginning.

GERMAN BANKS IN SOUTH AMERICA

To understand the energetic development of German banks in South America
during the last forty-five years we must consider the conditions
prevailing in Germany during that period and the strong forces working
toward industrial and banking expansion.

Beginning immediately after the Franco-Prussian War of 1870-71, German
industrial interests, with the strong support of the German Government,
began to struggle more vigorously and more effectively than ever before
for a larger share of trade in international markets, particularly in
the Far East and in South America. It was clearly realised that Germany
needed a large and rapidly growing export trade in order to maintain her
own prosperous development. In order to get this trade it was necessary
to follow a definite programme which included the provision of better
shipping facilities and of better facilities for financing. Up to that
time Germany had been fully as dependent as the United States is to-day
upon foreign ships and foreign banks.

It was also clearly realised that the tendency was toward large scale
production in most industries and that those concerns which could secure
large sales in the world-wide markets would soon come to enjoy an
overwhelming advantage over smaller competitors. The German industries,
in conjunction with the great German banks, began to follow, therefore,
a programme of concentration, which has since gone steadily forward.

These two forces--expansion in foreign markets and concentration at
home--have had a controlling influence on Germany's foreign trade, and
incidentally on her foreign banking.

OTHER INFLUENCES IN BANK EXPANSION

Another influence of importance is the fairly well-marked division of
German industrial interests into a small number of groups, each one of
which centres about and is allied to one of the great banks. To some
extent this is true in other countries, especially where banking is
centralised--notably in Canada, for instance--but it is especially clear
and well recognised in Germany. Hence each one of the great banks is
under especially strong pressure to foster and develop the interests of
its important clients, even at the expense of some temporary risk or
sacrifice for itself. This is doubtless the primary motive which has
induced the great German banks one after another to enter foreign
fields.

There is a wide-spread notion outside Germany that the German Government
has itself actively intervened for the purpose of stimulating foreign
trade expansion and has brought pressure to bear on German banking
interests, leading them to push ahead more rapidly than their private
business interests would have required. This idea may or may not be
correct; so far as the writer is aware there is no special evidence
pertaining to South American banking development to sustain it. At any
rate, it is easy to explain the policy of these banks as being based
upon purely business considerations.

As a matter of fact, there has probably been much exaggeration of the
thought that the German banks are primarily self-sacrificing instruments
of an ambitious national programme rather than ordinary business
enterprises. The statement is frequently repeated that the English banks
in South America aim first and all the time for profits, while the
German banks aim for development of their national interests.

Of the four large German banks in South America only one is remarkable
for energetic and successful expansion. The others have been moderately
successful. The difference is to all appearances chiefly due to
management.

Although these four banks were presumably designed primarily to advance
the business interests of the banks which organised them, they have
incidentally had a powerful influence on investment of capital and on
trade. The German manufacturers of machinery, steel products, and the
like, have been especially helped by the ability of the German banks,
both in South America and at home, to help in finding capital and in
financing.

The German banks have not found political or economic conditions in
South America which were insuperable obstacles to sound or profitable
banking.

OTHER BANKING INSTITUTIONS

Other nationalities besides the English and the Germans have invaded the
banking field in South America. The French, the Italians, and the
Spanish have all been active, particularly on the east coast, and are
represented by large institutions.

AMERICAN BANKS

Only after the federal reserve act went into force in November, 1914,
was it possible for any bank organised under the national-bank act of
the United States to establish branches abroad. The act restricts this
privilege to institutions having capital and surplus of $1,000,000 or
more, and gives the Federal Reserve Board discretion to withhold its
consent. Up to this writing the only institution which has taken
advantage of the powers granted by the federal reserve act to enter
South America is the National City Bank of New York, which has
established branches in Buenos Aires, Montevideo, Rio de Janeiro,
Santos, and São Paulo. Other branches will probably be established in
the near future. Especial attention is being given to the collection of
credit information. The bank also maintains a foreign trade department,
which gives information and advice to its depositors as to building up
business abroad. This department is now equipped to make specific
reports on trade openings in Argentina, Uruguay, Brazil, Colombia, and
Venezuela.

The Buenos Aires branch, which was the one first established, is
understood to have done a satisfactory amount of exchange business. It
stood ninth in volume of clearings in January, 1915, among the
twenty-odd commercial banks of that city. The other branches have not
been in operation long enough to show clear results. The branches in
Argentina (including the subbranch at Montevideo) and Brazil have each
$1,000,000 allocated to them--though this is purely formal, as the
bank's whole capital and surplus are behind the obligations of every
branch.

The expansion of the National City Bank in South America has been much
more rapid than that of any preceding institutions, including even the
aggressive German banks. As a natural result, there is apparently less
effort at this stage to build up local connections and influence in each
city. So far the policy of the National City Bank appears to be to
furnish foreign trade facilities to American exporters over as wide a
territory as possible, rather than to concentrate its activities in any
restricted region.

Other national banks in this country are known to be desirous of aiding
in the financing of foreign trade, but have not up to this time found it
practicable to take action under the provisions of the banking law as it
now stands.

DOMESTIC BANKS

There are many important and successful banks in South American
countries which are strictly domestic institutions, not only
incorporated under the laws of the country in which they do business,
but owned and managed by local interests. The notion sometimes seriously
put forward that South American banking is almost wholly in the hands of
foreigners is quite unfounded. It is true that trading operations are
generally handled either by foreign houses or by houses in which there
is a strong foreign influence and that the financing of nearly all
foreign trade and of much local trade is likely to go to foreign banks.
But the accounts of the rest of the domestic trading firms, of land
owners, and of governmental corporations, as a rule, gravitate toward
the domestic banks.

Following is an approximate statement of the total of deposits and
credits in account current in each South American country on or about
December 31, 1913, and an estimate of the distribution between foreign
and domestic institutions:

---------------------+-------------+------------------+------------------
Countries. | Total bank | In | In
| deposits. | European banks. | domestic banks.
---------------------+-------------+------------+-----+------------+-----
| | Amount. | Per | Amount. | Per
| | |cent.| |cent.
| | | | |
Brazil | $190,000,000| $78,000,000| 40|$112,000,000| 60
Uruguay | 42,500,000| 14,000,000| 33| 28,500,000| 67
Argentina | 626,000,000| 173,000,000| 28| 453,000,000| 72
Paraguay | 3,500,000| | | 3,500,000| 100
+-------------+------------+-----+------------+-----
Total, east coast | 862,000,000| 265,000,000| 30| 597,000,000| 70
| | | | |
Chile | 104,500,000| 29,500,000| 28| 75,000,000| 72
Bolivia | 8,800,000| 1,500,000| 17| 7,300,000| 83
Peru | 28,500,000| 7,500,000| 26| 21,000,000| 74
Ecuador | 4,000,000| | | 4,000,000| 100
+-------------+------------+-----+------------+-----
Total, west coast | 145,800,000| 38,500,000| 26| 107,300,000| 74
| | | | |
Colombia | 5,800,000| | | 5,800,000| 100
Venezuela | 6,200,000| | | 6,200,000| 100
+-------------+------------+-----+------------+-----
Total, north coast | 12,000,000| | | 12,000,000| 100
| | | | |
Total, South America |1,019,800,000| 303,500,000| 30| 716,300,000| 70
---------------------+-------------+------------+-----+------------+-----

The great Banco de la Nación Argentina (Bank of the Argentine Nation) is
an official institution, all the shares of which are owned by the
National Government. It is a successor of the former national bank,
which was driven into insolvency in the great financial crisis of 1890
and was afterwards liquidated. Although it was organised during a period
of disaster and there were many prophecies of its certain failure, the
Bank of the Argentine Nation has had a wonderful development and to-day
ranks as the seventeenth in size among the great banks of the world.

The bank pays no dividends, but carries 50 per cent. of its profits to
the credit of capital account and 50 per cent. to reserves. Entirely
through this process the capital and reserve funds have increased from
approximately $22,000,000 in 1892 to over $100,000,000 at the present
time. During the same period deposits have grown from $21,000,000 to
$205,000,000, and discounts and advances from $47,000,000 to
$208,000,000. There are now more than 150 branches.

The bank differs from most other governmental institutions in that it
carries on distinctly a commercial banking business more or less in
competition with private commercial banks. Until the crisis of 1914 it
did no rediscounting for other banks, and even during the crisis its
activities in assisting other banks were much restricted.

LAND MORTGAGE BANKS

In several of the South American countries there is a well-organised
system of land-mortgage banks following European models. In some cases
the banks are owned and operated by the National Government and in other
cases receive some special support or guarantee. The plan under which
they all operate is the following: The owner of land who desires to
raise money on mortgage approaches the bank and requests an
investigation and appraisal, the expenses of which he usually pays. If
the property is shown to be unencumbered with prior claims and meets
other conditions, the bank delivers to the owner the mortgage bonds in
convenient denominations up to a given proportion, usually 50 per cent.,
of the appraised value. These mortgage bonds are part of a series and
are themselves secured, not by any specific piece of property, but by
all the property covered by the series; they are also backed by the
credit of the issuing bank. The owner of the property then offers the
bonds for sale through a broker, and in this way obtains the desired
funds. He pays the bank a small commission, from one-fourth of 1 per
cent. to 1 per cent., for its services.

In Argentina, where this system is developed to its highest extent,
these land-mortgage bonds are known as "cedulas," and are issued by the
Banco Hipotecario Nacional (National Land Mortgage Bank). At the present
time the Argentine "cedulas" tend to sell on a 7 per cent. basis, more
or less.

Uruguay, Brazil, and Chile all have similar issues, which sell on bases
ranging from 7 to 9 per cent. or even higher. Broadly speaking, and
without attempting to assign a definite value to any one of these
issues, they are sound, conservatively issued, well protected, and under
normal conditions readily marketable. The more important issues have
been widely sold in England, France, and Belgium. If they were properly
introduced and made well-known in the United States, there is no reason
to question their finding a good market here also.

Side by side with the land-mortgage banks there are operating in the
Argentine a number of English mortgage companies, which directly invest
their own funds in land mortgages and have earned highly satisfactory
profits.

In several countries there are state-owned savings banks, a large
portion of the funds of which also go into land mortgages.

CONDITIONS OF COMMERCIAL BANKING

A banking business, like any other, must adapt itself to surrounding
conditions, including laws, business customs, precedents created by
older banks, and the like. In South America these conditions differ in a
number of respects from those which prevail in the United States.
Probably the first impression of most observers gives an exaggerated
idea of the differences. However, they should be fully and carefully
considered.

The chief differences that directly affect banking operations are the
following: (1) Comparative absence of banking regulation on the part of
governments or associations; (2) national colonies; (3) social character
of business relations; (4) lack of highly developed economic
organisation; (5) relatively high and stable rates of interest; and (6)
in some countries fluctuating currencies. The first five of these
circumstances call for brief comment.

LITTLE CONTROL OR CO-OPERATION

Not only is there a marked absence of laws directly applicable to
banking concerns, but there is also an equally noteworthy absence of
control exercised either by the Government or by associations among the
banks. Even the large governmental or semi-governmental banks in Brazil,
Uruguay, Argentina, Chile, and Bolivia are competitive with the other
banks. Whatever influence they exercise is secured through their active
and direct competition, not through any special authority over the other
banks conferred upon them. In the fall of 1914, for the first time,
there was some rediscounting of the paper held by other banks on the
part of the Bank of the Argentine Nation and of the Bank of the
Republic of Uruguay; but this tendency did not go far. The other banks
objected to placing information as to their relations with customers in
the hands of the governmental institutions. In other countries there has
not been even this much of an attempt toward fulfilling the functions of
a central bank of rediscount.

It is difficult to secure in most of the South American cities even the
most elementary kind of co-operation among the banking institutions. How
is it possible that they should continue to stand apart when they would
obviously gain so much by coming together? A partial answer is to be
found in the peculiarity that has already been pointed out, namely, the
fact that many of the more powerful institutions are the offspring of
European countries. Each one is fighting to support the trade of a
certain well-defined group of clients. The national antagonisms among
them are deep-seated and sometimes virulent. All this was true even
before the European war. It will be tenfold true for a number of years
to follow.

NATIONAL COLONIES

This leads to mention of the second condition, one which operates in
favour of European-owned banks to the relative disadvantage perhaps of
American banks. This condition is the presence in some of the large
South American cities, notably Buenos Aires, of a large colony
representing each one of several important European nations. Naturally
the tendency of each colony is to support banks of its own nationality.

On the whole, although this matter of national affiliations is
undoubtedly a factor to be reckoned with, it appears to be by no means
decisive. The German banks, for instance, have been able to expand with
much greater rapidity than we should have been justified in expecting on
the basis of their national trade and national colonies alone. This is
true likewise of the Italian and French banks. A great proportion of the
business men of South America, even those of foreign origin, are
governed less by their national sentiments than by their business
interests.

PERSONAL CHARACTER OF BUSINESS DEALINGS

To an observer accustomed to European or American methods, one of the
most striking features of business life in the South American cities is
its strongly personal and social flavour. We are accustomed in this
country to emphasise the principle that friendship is not a safe guide
in business dealings. In South America the contrary is more nearly true.
Family ties are apt to be a controlling factor in choosing partners and
employés. If one's ultimate object is to have business dealings with a
firm, he must first cultivate the personal friendship of the head of the
firm. Social relations and business relations become confused, and it is
hopeless to expect the purely impersonal view of a business proposition
that is considered correct in this country. Like all sweeping
statements, this one is subject to exceptions. There are many American,
German, and English firms, especially in Buenos Aires, which prefer what
we denominate "businesslike methods," but they are not numerous enough
to give the tone to business life.

This is a condition which directly affects banking practice. It makes it
very difficult, for example, to introduce the custom of securing full
financial statements from all applicants for credit. The request for a
statement is apt to be construed (as was the case in this country not
many years ago) as a reflection on the personal honesty and credit
standing of the applicant. For the same reason it is difficult, and may
frequently be poor policy, for a bank officer to ask a customer a direct
question as to the status of his business. He is likely not to take an
impersonal attitude toward the question, but to resent it as if it were
an attempt to pry into his purely personal affairs. Consequently, all
business men, including bankers, are forced to rely to a great extent in
estimating the credit standing of individuals and firms on their
personal impressions, on such information as they are able to secure
through indirect hints and questions and on the business gossip which
they pick up. It must be remembered that, except for Buenos Aires, most
of the business communities are comparatively small and isolated. There
is little opportunity, therefore, for long-continued fraud. A man who
shows traces of dishonesty is much more plainly marked than in larger
communities. As a consequence, the lack of the machinery and the customs
that we consider indispensable in extending credit does not prevent the
formation of correct ideas as to the wealth and character of a business
man.

UNDEVELOPED ECONOMIC ORGANISATION

Most of the South American countries, we should keep in mind, are still
sparsely populated and have no need for the elaborate machinery of trade
and finance which exists in Europe and North America. The region
farthest advanced in its economic development, the River Plate Basin,
may be roughly compared to agricultural States like Iowa, Kansas, and
Nebraska as they were thirty years ago. Farming methods are usually not
economical. The small farmers have little money of their own, their
lands are heavily mortgaged, and they are "carried" from one crop to
another by the local general retailer, who makes advances to them both
in goods and in money. The retailer must in turn secure liberal credits
from wholesalers, who are in their turn partly "carried" by the banks.
There is no clear-cut distinction between dealers in commodities and
bankers, for the dealers are forced to finance most of their own sales.
Such an arrangement of course favours extravagant credits, high prices,
speculation, and crises, just as it did in the United States. It is
rapidly giving way to a more complex organisation, in which the farmer
has funds of his own, does his short-term borrowing at a bank, and pays
cash for his purchases.

Without attempting to comment on intermediate grades of organisation we
may consider briefly the manner in which trade and finance are conducted
in the north coast countries. An officer of a bank there asserts that
banking in the north coast countries is not to any great extent a matter
of handling currency or money funds. The intermediary system of brokers,
merchants, and other middlemen between the producer and his market, to
which we are accustomed, is lacking, and the banker must take the place
of all of them. He must himself inspect and sell produce. Loans are
made, for instance, secured by growing crops; the bank sends a man to
the plantation to look over the coffee or cocoa, or whatever the crop
may be, and report on its condition and prospects; to protect itself the
bank sees that it is properly prepared for shipment, and takes care of
the sale in the New York, London, or Hamburg market. The bank collects
the proceeds and credits the customer with his share. Interest rates run
from 8 to 15 per cent. and commissions for selling from 1 to 3 per cent.

INTEREST RATES

Interest rates average considerably higher--even making allowance for
increased risk--in South America than in the United States. They are,
however, much more stable and more uniform over the whole continent. The
uniformity is no doubt to be ascribed chiefly to the large English and
German banks, with their branches in several different countries and
their ready access to European financial centres. The stability in rates
over a period of years is presumably due in part to the relatively
gradual development of banking, commerce, and production, so that sudden
shifts in the demand for and supply of banking capital are not frequent.

There are, however, a number of exceptions to the general stability. In
Argentina the crop-moving season creates, though to a much smaller
extent, the same kind of extra demand for currency as in the United
States, and tends to make some seasonal variations in discount rates.
They vary from as low as 6 per cent. to as high as 12 per cent., but do
not normally move far from 8 or 9 per cent.

COMPENSATION OF DIRECTORATE

The German, French, Italian, Spanish, and many of the domestic banks,
especially in Argentina and Peru, follow the European custom of
compensating the home office directorate by allowing them a fixed
percentage of the net profits. The president, manager, founder, and
others may also be compensated in the same way. The net profits of the
Banco Español del Río de la Plata are distributed: 2-1/4 per cent. to
certain specified charities, 1 per cent. to the founder, 12 per cent. to
the reserve fund, 2 per cent. to the directors and managers, 2-3/4 per
cent. to the fund for employés, 80 per cent. to the shareholders for
dividends and dividend reserves; those of the Banco de Italia y Río de
la Plata: 1/2 per cent. to charity, 5 per cent. to the reserve fund, 7
per cent. to the directorate, 1-1/2 per cent. to the fund for employés,
86 per cent. to the shareholders. There is apparently no general rule
which governs the distribution except possibly that the larger the bank
the smaller is the percentage for the directorate and management. In
England the directors are more likely to receive a fixed compensation.
Whether this plan of having a paid directorate works better than the
American method of having a directorate made up usually of some of the
larger shareholders, whose payment is purely nominal, is an open
question. It is largely a matter of national custom.

CLASSES OF BUSINESS OF FOREIGN BANKS

First. The foreign banks in South America usually start by devoting a
large proportion of their energy and capital to operations in exchange.

Second. In this connection they purchase and make advances against
commercial bills drawn on importers in the countries where they are
doing business.

Third. At the same time the home office in London, Hamburg, or Berlin is
probably developing a business in acceptances which involves
comparatively little direct expense and allows considerable profits.

Fourth. All South American banks are called upon to handle collection of
drafts and sometimes to take care of ordinary mercantile transactions,
both on a commission basis.

Fifth. An activity which may be of some importance from the beginning
consists of underwriting and selling securities.

Sixth. As quickly as possible the foreign banks build up a local account
current and loan and discount business.

Seventh. Some of the banks, especially the German banks, have
participations in syndicates and in industrial enterprises.

Eighth. In some branches they receive money and securities for
safekeeping or rent safe-deposit boxes.

Ninth. Many banks have savings and mortgage-loan departments.

None of the distinctively foreign banks in South America has as yet
issued circulating notes; this is being done, however, by some of the
domestic banks in which foreign capital is heavily interested.

There may, of course, be other miscellaneous activities.

FOOTNOTES:

[196] Adapted from William H. Lough, _Banking Opportunities in South
America_, Department of Commerce, Special Agents Series, No. 106.
Washington. 1915.

CHAPTER XXVII

AGRICULTURAL CREDIT IN THE UNITED STATES

While agricultural credit has been a subject of intermittent
discussion in the United States for almost a generation, the
movement has had its main development within recent years.
In November, 1911, the American Bankers' Association created
a committee to study land and agricultural credit at home
and abroad. In March, 1912, American ambassadors and
ministers were instructed by the State Department to gather
information concerning rural credit institutions in Europe.
A year later the Southern Commercial Congress also
instituted a careful investigation. These acts, and reports
published gave the movement a national character and scope.

Several states, such as Massachusetts, New York, and
Missouri, have recently made legislative provision for rural
credit institutions and during the last two years very
numerous bills pertaining to rural credit have been
introduced in Congress. It seems not unlikely that
legislation providing for the establishment of a federal
system of land banks and rural credit associations,
subsidized by the Government, will be enacted in the near
future.

The functions and work of rural credit institutions in
Europe, briefly discussed in the first two selections of
this chapter, are treated more fully in connection with the
chapters on the banking systems of European countries,
notably those of Germany and France.

[197]Various European nations, with soil naturally inferior to ours,
have established agricultural credit and thereby have greatly eased the
burden of the cost of living. Hitherto we have lived on the bountiful
overflow of our rich land, and the pinch of necessity has not been felt;
but now our population has grown enormous, our standards of living have
been greatly raised, and our land is showing the effect of generations
of taking out with very little putting back. We must do better or
suffer.

By the installation of agricultural credit, farming will not only be
made more profitable, but it will in the end make country life more
attractive. The banking system of to-day is adapted to the needs of
manufacture and commerce. The processes of nature are so much slower,
however, that banking for farmers must be organised on a basis of credit
for much longer periods.

Our present system of borrowing on land is by mortgages running from
three to five years, the entire principal coming due at one time. This
is expensive, involving renewals, and dangerous from the possibility of
the mortgage falling due at a time of restricted credit so that it
cannot be renewed. On the continent of Europe this business is handled
by so-called land-mortgage banks, or rather associations.

The mortgages granted are pledged for the security of bonds which the
institution issues and sells in the general market. These bonds have no
fixed maturity, but can be retired at par or some small premium at any
time. When the borrower mortgages his land to the bank he agrees to pay
a certain fixed sum semi-annually. This is called the "annuity" and is
composed of the annual interest plus an amount, generally 1/2 per cent.,
toward the reduction of the principal of the debt and known as
"amortisation," and an additional amount, about 1/4 per cent., toward
the expenses of the bank. The borrower, therefore, at once begins to
extinguish the principal of the debt; and as each year the principal
decreases, the interest, of course, decreases also, and, the annuity
being fixed, the proportion of it applicable toward the extinction of
the mortgage increases. Thus it happens that, beginning with a payment
of 1/2 per cent. toward principal, the mortgage bearing 4 per cent. to
4-1/2 per cent., which are the general rates, the entire debt is
extinguished in between fifty and sixty years.

The mortgaging of land is known as long-term credit, and it may be
handled by joint-stock institutions or by associations of borrowers, but
in institutions furnishing the credit required by farmers for working
capital, such as the purchase of seeds, fertilizer, payment for labour,
etc., which is known as short-term credit, the aim that the borrower
should be primarily considered rather than the lender assumes
fundamental importance.

On the continent of Europe a solution of the problem of short-term
credit is found in the organisation of banks by the application of
so-called co-operative principles. The purpose is to provide
organisations in which the borrower receives consideration rather than
the lender, also to keep the money of any body of individuals for the
use of that body. Under our present system a great deal of money
belonging to farmers finds its way into Wall Street. At present the
lenders are organised; whereas the borrower stands alone.

AGRICULTURAL CREDIT CONDITIONS IN THE UNITED STATES

[198]The United States, although the leading country of the world in the
amount of its agricultural products and in the extent of its banking
business, is behind nearly every other progressive country of importance
in the development of agricultural credit, _i. e._, short-time
non-mortgage credit. Our manufacturing and commercial businesses are
financed largely by means of such credit, and the capital invested in
these industries is thereby rendered manifoldly efficient; not so with
agriculture. Most farmers apparently make little or no use of short-time
credit. There seems to be a wide acceptance in this country even among
the farmers themselves of the dictum of Louis XIV, that: "Credit
supports agriculture, as the cord supports the hanged." Is this a
correct description of the situation? If so, what is the explanation,
and what remedies if any are needed? The object of this paper is to
throw light upon the answers to these questions.

First, as to existing banking facilities for agricultural credit, and
their utilization by farmers. It is well known that the banking capital
of the country is concentrated to a great extent in our large cities--to
a greater extent than it would be if we had a well-developed system of
branch banks like Canada--and that the banks of these cities are
prevented by reason of their location from making many agricultural
loans, even if they were so inclined. Of the 7,301 national banks in the
United States September 1, 1911, 191 or 2.6 per cent. were located in
the dozen largest cities of the country.[199] The national banks of
these twelve cities, representing but 14 per cent. of the population of
the country, had 37 per cent. of the national banking capital (capital,
surplus, and undivided profits), 33 per cent. of the individual
deposits, and 40 per cent. of the loans. It should be noted, however,
that since the act of 1900, authorizing the establishment of national
banks with a capital of less than $50,000 in small towns, there has been
a continual and rapid increase in the number of national banks in small
communities. On September 1, 1911, out of the total 7,301 national banks
there were 1,966 with a capital of $25,000, and therefore presumably
located in towns of less than 3,000 population, 372 with a capital
between $25,000 and $50,000, and therefore presumably in towns of less
than 6,000 population, and 2,297 with a capital between $50,000 and
$100,000. Except for banks in towns not exceeding 6,000 population, the
law as amended in 1900 does not permit any national bank to be organized
with a capital less than $100,000.

Are the national banks which are accessible to farmers in a position
under the law to meet farmers' needs? The answer to this question must
be in the affirmative. Aside from the fact that national banks are not
permitted to make loans on real estate security,[200] there is no
restriction in the national banking act which would interfere with loans
to farmers for agricultural purposes. Personal security alone is legally
acceptable; the range of possible collateral security is practically
unlimited; and there is no limitation fixed by law as to the period of
loans. National banks therefore have a very free hand in regard to loans
to farmers.

When we inquire concerning agricultural credit in banks under state
charters we find conditions varying with the different States, but, with
a few minor qualifications, it may be said that the state banking laws
are free from restrictions that would hamper state banks and trust
companies in extending credit liberally to responsible farmers. They
are in a much better position in one respect to deal with farmers than
are national banks, that is, in the matter of accepting real estate
security. No state denies state banks this privilege, and such
restrictions as exist upon its exercise are generally not onerous.

If commercial banks are comparatively unhampered by law in making
short-time loans to farmers, it may be asked: To what extent are such
loans made? Unfortunately practically no information is available on
this question. In answer to an inquiry the Comptroller of the Currency
wrote, under date of May 27 of this year, that no information with
reference to short-time loans made to farmers by national banks had ever
been compiled by the comptroller's office. The writer has found no trace
of any investigation of this subject by state banking departments. For
about a year he has taken occasion to inquire at every opportunity of
individual bankers concerning their experience with regard to loans to
farmers in different parts of the country. The replies received are so
divergent that no conclusion can be drawn from them, except that the
practice varies widely in different sections of the country and even in
different communities in the same section, and that probably the farmers
of the North Central and Western States borrow of commercial banks more
than do those of the Eastern and Southern States. There is not
sufficient evidence, however, for this latter inference to make it much
more than a guess. In the absence of any comprehensive data, I shall
resort to the unsatisfactory but representative replies from different
parts of the country.

Neither of the two national banks in the city of Ithaca, N. Y., makes
any appreciable amount of loans to farmers. Both claim to be willing to
do so, but say there is practically no demand. In some of the
neighboring cities, however, such loans by national banks are more
common. The cashier of a national bank in a town of about 800 population
in an agricultural section of northeastern Pennsylvania writes:

Our farmers as a rule are not large borrowers and want loans
only in small amounts for short periods.

Farmers in general will not go on each other's paper no
matter how good the parties are, for they have been so often
taken in by wild-cat schemes that they are shy when their
names are required to be placed upon paper. They realize
also that they are not familiar with business methods in the
commercial world and dare not trust themselves.

There is a moderate amount of borrowing by farmers in western New
Jersey. Estimates made by bankers in Princeton as to the proportion of
farmers in that neighborhood who borrow for short periods of local banks
vary from 15 to 40 per cent.

A former president of a national bank in Indianapolis writes:

We came very little in contact with farmers. We made special
effort to secure such business by sending to a considerable
mailing list of carefully selected farmers, circulars and
personal letters ... but the business did not come. My
inference was that they dealt with the nearby small banks.

Of the situation in Lafayette, Indiana, a former vice-president of a
national bank, writes:

About 50 per cent. of our business was with farmers. They
borrow frequently from commercial banks, funds to be used
for crop planting, crop gathering, purchase of agricultural
machinery, improvements on the farm, purchase of cattle, and
the carrying of cattle or hogs to maturity. Through Indiana
these farmers' loans are very usual in the country banks,
many preferring state charters so they may make these loans
not only on personal but also on mortgage security.

Farmers are seldom able to give any but personal or mortgage
security. A large percentage of them are sufficiently
responsible to be entitled to and to receive reasonable
credit without security.

Farmers seem to endorse for each other much more readily
than do those of other classes.... The reason is, I think,
clear. Each knows pretty much everything about his
neighbor's financial status, the amount and value of his
land, his live-stock, and other visible personal property,
the amount of any mortgage and when due. So much being thus
in the open there is less of the secretive habit, so that
the extent of the invisible personal property and debts is
apt to be known.

A similar report comes from a national bank in Lincoln, Nebraska, from
which the following extracts are taken:

The farmers of this state have need of accommodations of
this kind to carry them through the crop season. As a matter
of fact, they use short-time credit to fully as great an
extent as do the business men in the city and smaller towns.
In fact, I think it is true that in the smaller towns the
bankers favor the farmers in preference to the small
business men....

There is no doubt about the average well-to-do farmer in
this state being able to furnish satisfactory security aside
from mortgaging his farm for such temporary loans within any
reasonable limitations. In some cases the banks take chattel
mortgages on cattle or other live-stock, and in some cases
where the farmer has a good equity in his farm they will not
hesitate to take his personal note.

While I do not know that there is any particular difference
between farmers and other classes in this state as to their
willingness to go security for each other, yet very little
of this is done any more. There was a time when it was not
an uncommon thing, but it has become less and less until now
there is very little signing done for others. In fact, the
farmers feel that they are able to take care of themselves
and do not ask others to sign with them, and are able to
handle themselves without such an endorsement. This is true
of all classes in this state.

I have never felt that in this locality farmers suffered in
any way from lack of credit facilities....

A former bank examiner in the state of California, himself a farmer,
writes:

The farmers of California do not to any considerable extent
make a practice of borrowing money from local banks or money
lenders for short periods....

In reviewing the various bank examiners' reports on some 500
state banks I recall very few instances of crop mortgages,
and it impresses me that in many of the cases the mortgage
was taken to obtain additional security for loans previously
granted and secured otherwise.

I think it would be safe to say that the bankers as a rule
have not favored short-time unsecured loans to farmers. They
are, however, fast awakening to the fact that as a rule
these are the safest loans a bank can make, and are making
an effort to get in closer touch with the farmer. It would
also be safe to say that the average small farmer does not
as yet realize that he _can_ obtain such credit at a bank.

Our farmers as a class are exceedingly reluctant "to go each
other's security." Two-name paper is mostly confined to
commercial transactions.

A college professor in the state of Washington informs me that
short-time loans to farmers are common in that state, but that
frequently the rate of interest charged is 2 per cent. higher than that
on commercial loans--the explanation commonly given being that a farmer
borrowing generally reduces the resulting deposit credit more rapidly
than does a merchant.

In the Southern States, particularly in the cotton, rice, and tobacco
sections, the use of crop liens for short-time loans appears to be much
greater than in other sections of the country.[201] Such meager
testimony as I have been able to secure seems to show that the amount of
short-time agricultural credit extended by banks in the South is
relatively small but rather rapidly increasing. The banks are catering
more and more to this class of business.

Other evidence might be cited, but the above gives a fair picture of the
situation as revealed by all the testimony received--a confused picture
of widely varying conditions. Public opinion is now being aroused on the
subject of agricultural credit, and pressure is liable to be brought for
hasty and perhaps radical legislation. Obviously, the first step to be
taken in the interest of a sane solution of the problem is to find out
exactly what the problem is. To this end the writer would urge strongly
the need of investigations by the Comptroller of the Currency and by the
various state banking departments of the present facilities and
practices in the matter of agricultural loans. In view of the increasing
public interest in the subject the investigations cannot be undertaken
too soon.

Although the farmers in any section of the country may not resort to the
banks for short-time credit it does not follow that they are not
receiving such credit. As a matter of fact they are often receiving it
on a considerable scale and in the most expensive way. _i. e._, in the
form of book credits with merchants. It is a common practice throughout
the country for farmers to run up book accounts with local merchants
during the spring and summer to be paid in the fall when the crops are
sold. When this is done on any considerable scale the farmer probably
pays more than bank interest under the guise of prices; and this is
particularly true when he obligates himself to sell his crops to the
creditor merchant. In the South this practice is carried to the extreme
in the familiar "store-lien" system which holds many farmers in the
cotton belt in a condition bordering on perpetual servitude. The custom
is for the farmer to buy supplies of the local general store on credit
for the year, agreeing to sell to the merchant his cotton crop in the
fall, thereby cancelling the debt. A crop lien is generally given, and
the merchant often dictates the character and the amount of the
planting. The prices paid for cotton under this system are liable to be
exceptionally low, and the prices paid by the farmer for his supplies
exceptionally high. The system has proven a curse to many sections of
the South. Witnesses before the United States Industrial Commission
estimated the interest rates imposed by this system at from 20 per cent.
upwards. Mr. George K. Holmes of the United States Department of
Agriculture testified:

The rate of interest on the liens on the cotton crop of the
South, it is safe to say, probably averages 50 per cent. a
year. All cotton men will agree that it is at least that.
The store system of the South is a sort of peonage; that is
what it amounts to with the cotton planter.[202]

Since the Industrial Commission's report was published the banking
facilities of the South have been greatly increased, and the banks are
coming into closer touch with farmers, with the result that the
store-lien system is gradually breaking down.

Another form of credit to farmers is that obtained from dealers in farm
implements and machinery which the farmers frequently buy on time,
paying interest during the credit period.

One informant, who has been a bank examiner, writes from California--and
his testimony is applicable to many other sections of the country:

The new generation of merchants is not disposed to carry the
farmer as of old and insists that overdue accounts be
covered by promissory notes which are in turn hypothecated
with their bank. In other words a clearer demarcation of
function is being gradually brought about to the best
interests of all concerned.

Such in general is the present situation in the United States in the
matter of short-time agricultural credit as evidenced by the very
indefinite and scant information available. What are the causes? Perhaps
in them will appear some suggestions for the remedy.

The chief reasons for the backwardness of the United States as compared
with Europe with regard to agricultural credit may be briefly summarized
as follows: (1) Our wonderful agricultural domain where good land could
be had almost for the asking, and where for generations land was so
cheap and labor and capital so dear that intensive cultivation was
generally unprofitable. (2) The prosperity of our farmers who have not
been forced by dire necessity to resort to credit as were the farmers of
Germany at the middle of the last century when the Raiffeisen
co-operative banks were first organized. (3) The nomadic character of a
considerable part of our agricultural population as it has moved
continually westward in taking up of new lands, and more recently as it
has been retracing its steps or moving northward. (4) The isolation of
our farmers in this country of large farms and "magnificent distances."
(5) The rapid growth of the manufacturing and commercial business of the
country--and that largely in the hands of the same class of people who
control the bulk of the banking business.[203]

Add to these circumstances the obstacles which farmers always encounter
in the matter of credit, as compared with manufacturers and merchants,
obstacles such as the uncertainty of crops and the strongly seasonal
character of the farmer's credit demands, and we have a sufficient
explanation for the backwardness of agricultural credit in this country.

To emphasize most of these causes, however, is to brand oneself as
belonging to a past generation. Our domain of free arable land is
practically gone; good farms must be bought, and for them ever
increasing prices must be paid.[204]

The era of hand cultivation is giving way to that of farm machinery
propelled by horse-power and even by steam, gasoline, or electricity,
with its resulting great increase in the efficiency of labor. Eleven
years ago the editor of _The Dakota Farmer_, in his testimony before the
United States Industrial Commission, put the matter tersely, and with
little exaggeration, as affecting his own section of the country, at
least, when he said: "When I first worked out it took five binders to
follow a machine, one man to rake off, and one to carry the bundles
together. Now the hired girl frequently drives a machine that does the
whole business."[205] Some idea of the extent of this increase may be
obtained by reference to the following figures compiled from census
reports:

VALUE OF FARM IMPLEMENTS AND MACHINERY IN THE U. S.[206]

_Year_ _Value_ _Per Cent.
000,000 Increase_

1910 $1,265 69
1900 750 52
1890 494 22
1880 407 50
1870[207] 271 10
1860 246 62

The increase in the value of farm implements and machinery per acre of
land in farms from 1900 to 1910 was from $0.89 to $1.44, or 61.8 per
cent.

An analysis of the figures for farm machinery by geographic divisions
shows a marked difference in the rates of increase, but the tendency in
all sections during the last forty years has been decidedly upwards, the
greatest growth having been witnessed in the decade ending 1910. During
that decade the lowest rate of increase in any section was that of New
England, 39 per cent., and the highest that of the Mountain States, 163
per cent.[208]

Another development which is making larger demands upon the farmer for
working capital is the increasing use of artificial fertilizers, the
expenditure for which in the United States approximately doubled from
1880 to 1900.

As the result of such tendencies and of the rapid depletion of our free
domain, farming in the United States is losing its old-time kinship to
mining and becoming more like manufacturing. More and better machinery
and more power are needed on most farms in the interest of efficiency.
This calls for short-time credit. But a supply of good machinery
requires a fair sized farm for its efficient utilization--hence the need
for larger farms and for mortgage credit to make their purchase
possible. Upon this subject there are some very illuminating data in
Warren and Livermore's _Agricultural Survey_ of four townships in
Tompkins County, N. Y., from which the following is quoted:

The value of farm machinery increases rapidly with the size
of the farm.... Any one who has ever made a list of the
necessary farm machinery will see at once how inadequately
these small farms are equipped. Yet their machinery costs
nearly twice as much per acre as that on the larger farms
that have nearly three times as much machinery. Machinery
can be used more effectively on large farms. One mower, one
hay rake, one tedder, one hay loader, one corn harvester,
one grain harvester, one grain drill, one manure spreader,
one potato digger, one potato planter, can do their work on
a 250 acre farm as readily as on a small farm. Few of the
small farms have half of these tools. If a small farm does
have nearly all the list, it cannot use them enough to pay
for the investment. The more efficient and numerous machines
become, the larger our farms should be. It is interesting to
notice how many of the tools are of very recent development.
Almost half of the value of farm machinery on a
well-equipped farm is invested in machinery that has been
perfected in the last few years.

Much the same situation exists in regard to an adequate equipment of
horses.

Three or four horses are the smallest number that can be
used efficiently with modern machinery.... The small farms
have not enough horses to make efficient teams and yet they
are over-supplied with horses compared with their area. On
these farms there are only 15 acres per horse. On the
largest farms, one horse farms three times this area, with
no resulting decrease in crop yields.... When we consider
the cost of keeping a horse we see what a great advantage
the larger farms have.

Forces like these are counteracting what is commonly thought of as the
normal tendency of agriculture to move toward more intensive cultivation
_on small farms_, with the result that the average amount of improved
farm land per farm actually increased instead of diminishing in the
United States during the last decade. This does not mean less intensive
cultivation, in fact quite the contrary; it means more intensive
cultivation, but by the efficient utilization of good machinery and of
power. It means further, as said above, a demand for mortgage credit for
the purpose of enlarging farms--and that, at rapidly increasing farm
prices.

The farming population is becoming more settled now that the free lands
are practically gone and the frontier has disappeared.[209] The
isolation of the farmer is rapidly becoming a thing of the past, with
the advent of rural free delivery, rural telephone, the automobile, and
the parcels post. The farmer no longer buys gold-bricks nor is duped by
fraudulent lightning-rod schemes except in the pages of the comic
supplements.

When seeking credit the farmer can offer better security than ever
before. His markets are larger, better organized, more certain, and more
accessible. The risk of crop failure is less, thanks to the wonderful
progress of scientific agriculture. There are few pests which cannot now
be readily controlled by the intelligent farmer, who takes time by the
forelock. The problem of moisture is growing less serious every year
with the improvements in irrigation, dry farming, and the more
scientific diversification of crops.

Conditions then point to an increasing need for agricultural credit, and
to improving circumstances for its safe development.

If the time is ripe for a greater use of bank credit in agriculture,
how is that credit to be obtained? Broadly speaking, four methods may be
mentioned, only the last two of which are deserving of much attention at
the present time. They are: (1) Establish government agricultural banks;
(2) adopt the Egyptian plan of a government guaranty to an agricultural
bank established with private capital; (3) encourage the farmers to
organize co-operative credit societies on some such plan as the
Raiffeisen or Schulze-Delitzsch banks of Germany; (4) utilize more
effectively in the interest of the farmer our present banking machinery,
and improve it where it is defective.

The suggestion of an agricultural bank owned and operated by government,
either state or federal, is not worthy of serious consideration in this
country at the present time. The history of such banks both in Europe
and America has generally been a disastrous one, although a few have
succeeded. Some exist to-day which are performing useful services to
farmers, notably in the line of mortgage credit, among which may be
mentioned those of the Australian States and New Zealand,[210] and the
recently established one in the Philippine Islands. The success of such
institutions is not such as to justify any attempt to establish them in
the United States, at least until every reasonable effort has been made
to solve the problem by means of private and co-operative effort.

The other plan, commonly known as the Egyptian plan[211] from its most
important example, seeks to eliminate the evils of a purely government
bank and to take advantage of its meritorious features. In Egypt the
agricultural bank is owned and financed by private capital; it enjoys,
however a government guaranty of principal and of 3 per cent. interest.
Its administrative expenses are kept low by an arrangement with the
Egyptian Government by which the Government tax collectors make
collection of instalments on the Bank's loans at the time of the
collection of the regular land tax, for which the Bank pays a small
commission. The Agricultural Bank of Egypt has had a phenomenal success,
rendering an invaluable service to the Egyptian fellaheen, and at the
same time yielding good profits to its owners. It was this type of bank
that the United States Government authorized established in the
Philippines by the act of March 4, 1907, but the interest guaranty of 4
per cent. has so far proved too low to attract capital into the
enterprise.[212]

A bank organized on the Egyptian plan is well adapted to do pioneer work
among ignorant farmers, where the apparent risks and heavy
administrative expenses prevent private capital from entering the field.
A government guaranty, however, hardly seems necessary in the United
States, and our people would probably look askance at any proposal for a
great agricultural bank or banks of this type with branches scattered
throughout the country. It is contrary to our banking traditions, and,
like the plan for a strictly government bank, should not be thought of
until plans for meeting the need by private initiative have been fairly
tried and found wanting.

When one considers the question of the improvement of agricultural
credit in the United States one instinctively thinks of the co-operative
credit banks of the old world, because of their phenomenal success for a
half century and more, the simplicity of their structures, the ease with
which they may be established, and their ready adaptability to the
widely varying conditions found in a great country like the United
States. The description of the wonderful success of these institutions
as told by Henry W. Wolff in his _People's Banks_ reads like a fairy
story. Although the success of co-operative banks has been great in
nearly every country of Continental Europe, nowhere else has it been so
great as in Germany, the country of their origin, and it is to Germany
one naturally turns first for suggestions. There we find four types of
co-operative credit banks, Landschaften, Ritterschaften,
Schulze-Delitzsch banks and Raiffeisen banks. The first two are
co-operative associations loaning money on land mortgages, and securing
funds largely through the issue of bonds against the collective
mortgages. Being concerned with long-time mortgage credit they do not
fall within the province of this paper. The other two types of banks
deal especially with short-time credit, the one chiefly in the towns and
cities, and the other with farmers in the rural communities. It is with
the latter that we are most concerned. Let us therefore consider briefly
the essential features of the Raiffeisen system.

These features are: (1) Organization on the strictly co-operative
principle, none but members having the right to borrow, although
non-members may make deposits. (2) Limitation of loan operations to a
very small area in which all farmers are acquainted with each other. A
bank's field of business, the founder believed, should not cover a
parish of less than 400 people nor of more than 1,500. The banks were to
be, therefore, purely neighborhood affairs. There is a sympathetic but
well-informed neighborhood opinion which prevents the squandering of
loans. (3) Unlimited liability of all members for the debts of the bank,
a necessary corollary of which is the provision that membership is
obtained only by election by those already members. (4) The working
capital of the bank is obtained chiefly from the following sources: (a)
Small savings "drawn, either from within the area covered by the bank,
in which case it comes both from members and non-members, the former
being rewarded where possible at slightly higher rates in order to
encourage membership; or from without the area, in which case it of
necessity comes from non-members."[213] (b) Loans from the provincial
bank of the district, or more importantly from the central bank of the
Empire at which the local bank keeps a current account and with which it
may rediscount its paper. Funds are also sometimes obtained from other
banks or from private individuals. (c) A purely nominal share capital
which the banks did not originally have, and which they have been forced
against their will to issue. The requirement is now usually met by the
issue of a few low-priced shares of which no member can hold more than
one and upon which no dividend is paid. (d) Two surplus funds called
reserve funds; one used exclusively to cover losses, and the other being
the principal reserve fund (_Stiftungsfund_), commonly used for
"positive improvements, such as the extension of the premises or the
establishment of a burial fund."[214] In this fund must be placed
two-thirds of the annual profits. The fund cannot be distributed among
the members, even though the bank be dissolved. In such a case it is
held in trust for a time for a new bank, should one be established, and
if no such bank is established it must be used for some work of public
utility. A recent publication of the International Institute of
Agriculture[215] analyses the total working capital of the rural banks
of Germany for the year 1909 as follows:

_Amount Percentage
in Marks
000,000_

Share capital 22.4 1.2
Reserves 51.0 2.6
Deposits on current account 189.1 9.8
Savings deposits 1,455.6 75.2
Other liabilities[216] 217.5 11.2
Total working capital 1,935.5 100.0

The striking fact brought out by these figures is that out of nearly two
billion marks placed at the disposal of farmers, less than[217] 11.2 per
cent. was furnished by outsiders, while more than 88.8 per cent., was
provided by the savings and other deposits of the farmers themselves and
of the local public. (5) A fifth feature of the Raiffeisen system is
that the bank's administrative organization is simple and democratic.
Final authority on local questions resides in the general meeting in
which every member has one vote. There is elected annually a committee
of management consisting usually of five or six directors who meet
weekly. As a check upon this executive committee there is also elected
annually a council of supervision consisting of from six to nine
members. A biennial audit is made of the accounts of each bank by an
accountant employed by the district or central union. The books of the
bank, except the individual deposit ledger, are open to the inspection
of all members. Officers of the local banks serve without compensation,
except the treasurer who has no vote in the making of loans.... (6)
Advances take two forms: the ordinary loan (of which the name is
sufficiently descriptive), and the current account which is similar to
the Scotch cash credit. The latter constitute about a third[218] of the
total and show a tendency to increase in proportion to the ordinary
loans. The period of the ordinary loan varies from six months to three
years; and in exceptional cases it may be even longer.[219] Loans are
repayable in instalments covering interest and part of the principal, or
in lump sums. Banks reserve the right to call a loan on four weeks'
notice. The average credit advanced per member is 500 marks, and the
average interest rate probably somewhere between 4 and 5 per cent.
Although mortgage and other collateral security is sometimes accepted,
the banks' chief reliance is personal security, and the great bulk of
the loans are made on two-name paper.

The Raiffeisen banks are organized into provincial federations with
provincial banks at their head, and these in turn into a national
federation with a central bank at its head. These provincial banks and
the central bank "equalize the need of credit of the individual banks,
supplying them with money when required and employing their surplus
funds."[220] A large proportion of the German co-operative banks and
other co-operative agricultural societies are federated in a single
national organization, the National Federation of Darmstadt.[221]

Such are the leading features of the greatest agricultural credit system
of the world. To the American the surprising thing about it all is that
such co-operative credit banks are practically unknown in the United
States, although there has been a remarkable development here in recent
years of other forms of co-operation among farmers.[222] This surprise
is the greater when one bears in mind that "whole counties have been
populated in the Northwest by European agriculturists who came from
neighborhoods where they were familiar with agricultural co-operative
credit, and yet not a society of co-operative credit for these
immigrants has been established from the beginning to the present
time."...[223]

What is needed now--and possibly about all that will be needed in the
future--is a campaign of education among the farmers themselves rather
than one of legislation; although the development of such societies will
doubtless be furthered in many states by legislation, such as was
recently enacted in Massachusetts (ch. 419, Acts of 1909), freeing them
from some of the hampering provisions of the general banking act of the
state. Conditions are so widely different in different sections of the
country, and among different classes in the same section, that
co-operative agricultural credit societies will need to be given a
fairly free hand in such matters as limited or unlimited liability, the
amount of share capital, receipt of deposits, etc., so that they may
adapt themselves to local needs. A reasonable amount of government
supervision on the part of the banking departments of the states seems
desirable.

Passing now to the question of the better utilization of our existing
banking machinery, we may consider it first from the standpoint of the
Government, then from that of the banks, and finally from that of the
farmers themselves.

The provisions of the national banking act _(Revised Statutes_, Sec.
5137) are too rigid in the matter of loans on real estate security.[224]
National banks are, of course, intended to be banks for business men,
and their assets should be quick assets in so far as their liabilities
are quick liabilities. But it should not be overlooked that the modern
farmer is a business man, that he needs active credit for the efficient
conduct of his current business, and that land is the only kind of
collateral many farmers can give that is acceptable to bankers. Many
worthy farmers are not willing and some are not able to secure
satisfactory endorsers to their paper. Crop liens, except in the South,
are not usually very acceptable to banks. The ability of the farmer to
give mortgage security to national banks in case of need would often
prove a great help. Furthermore, now that a majority of our national
banks have savings departments, and that savings deposits might wisely
be made withdrawable subject to advance notice, it is not unreasonable
that these banks should be permitted to invest at least a substantial
part of their savings funds in the same kinds of mortgage securities
that are open to the investment of funds of savings banks; provided, of
course, that due care be taken to prevent the juggling of accounts
between the commercial department and the savings department of the
bank.

Another form of desirable legislation in the interest of the farmer
consists in the abandonment of our unscientific bond secured bank-note
circulation for a scientific system, and in the rendering of our deposit
currency more elastic. The more the farmer resorts to bank credit as a
means of financing his current business the more will he suffer from the
seasonal inelasticity of our bank-note and deposit currency. Farming
business is pre-eminently seasonal in character; the farmers over the
greater part of the country need funds most at about the same times of
the year, _i.e._, the fall and spring. A great increase in the demand
for currency and capital, say in the fall, under an inelastic currency
and credit system like our own, means to the farmer, highest interest
rates at just the time when he needs most to borrow, greatest scarcity
of cash at just the time when his need for cash is the most urgent, and
prices depressed by a tight money market at the time of the year when he
has most to sell. It is doubtful if any class of people in the country
would benefit more from a thoroughgoing reform of our banking system
than would the farmers.

The apportionment of responsibility between farmer and banker for their
not having gotten together better is an impossible task. Although some
exceptions must be made, particularly in the Middle West, as a general
proposition neither has appreciated the opportunity which the other
offered.

The banker must be brought to realize that one of the best kinds of
paper in the world is short-time business paper bearing the names of two
responsible farmers. He should be an adviser and friend to the farmer as
much as to the city customer. He should make the farmer feel that a
productive loan to him is not of the nature of a favor reluctantly
granted--as so many farmers complain--but rather a business proposition
profitable to both, as gladly given as it is received. He should further
co-operate with the local business men in preparing financial ratings of
farmers, to fill the gap left by the inability, to be hoped temporary,
of mercantile credit agencies to rate farmers as extensively as they do
other business men of like capital.

The farmer, on the other hand, must be educated by the banker, the
press, and the agricultural school and college, to the advantages of
credit as a mean to the more efficient working of his farm. This should
be done with caution, for credit is a two-edged sword. The farmer should
be encouraged to borrow only when it is very clear that he can use
additional capital so productively that it will pay. But what
industrious farmer could not use profitably some additional capital
every year, could he obtain it at as reasonable rates as does the
merchant? The farmer must learn to keep careful accounts. He must be
made to realize that the banks are open to him as to other business men,
and that the bulk of the country's short-time commercial loans, as
likewise of the agricultural loans of Europe, are made on the very same
security he is capable of giving, _i.e._, two-name paper of honest,
industrious business men.

FARM CREDIT IN A NORTHWESTERN STATE[225]

LONG-TIME LOANS

In North Dakota the average farm mortgage runs for 4.94 years; and the
average interest rate is approximately 8 per cent. (accurately 7.88 per
cent.). This 8 per cent. does not include the expense of abstracting
titles, examining the property, and the recording of the mortgage. These
fees are invariably paid by the borrower. Nor does this interest rate of
8 per cent. take account of the bonus that is frequently exacted, in the
newer regions, from the borrower for the privilege of securing a loan;
nor does it allow for the sum the borrower loses in paying his yearly
interest in advance, which is deducted from the principal. While the
practice of exacting a bonus is not common, it is generally the custom
to deduct the entire year's interest in advance; assuming an 8 per cent.
rate, the farmer therefore pays $80 interest not on $1,000 but on $920,
which brings the rate up to 8.7 per cent.

While the average prevailing rate, according to our returns, is
approximately 8 per cent., the rate varies in different parts of the
state, depending upon the local conditions. The rates are lowest in the
eastern tier of counties, and rise gradually towards the western part of
the state, where the rate runs up to 10 and 12 per cent., which is also
the rate in the eastern part of Montana. That the 8 per cent. rate is
quite general for a large part of the state is evidenced from the fact
that 25 of the 45 counties report an average rate of 8 per cent. or
more. In only 4 counties is the rate less than 7 per cent., and in no
county does the average fall below 6 per cent.

The above figures are conservative. They are based on returns submitted
by bankers who would naturally understate rather than overstate the rate
of interest charged in their respective localities. Furthermore, we have
a check on these bank returns in the replies received from farmers. As a
rule the rates reported by bankers and farmers are nearly identical in
their respective counties. It is safe to conclude, therefore, that the
average rate on farm mortgages for the entire state is about 8 per cent.

SHORT-TIME LOANS

Short-time loans are of two kinds, bank loans and book credit advanced
by retail stores. The bank loan is made on the farmer's note, generally
unsecured, though often secured by a chattel mortgage. According to the
reports received from 125 banks, the average length of time for these
short-time loans is 8-1/2 months; and the average rate of interest is
10.75 per cent. The average rate reported by farmers residing in 22
different counties was 11.07 per cent.

An effort was made to compare rates paid by farmers with those paid by
business men on short-time loans in the same locality. The same banks
that reported an average of 10.75 per cent. to farmers averaged only
9.18 per cent. on loans made to merchants and manufacturers. Fully 95
out of the 125 reporting banks stated that the rate was higher for
agricultural short-time loans than for commercial loans; 26 reported the
rate to be the same for both classes; and only 4 reported a lower rate
for the farmer. As North Dakota, however, is not a manufacturing nor a
jobbing state, commercial paper is scarce, and consequently comparisons
of the above nature are apt to be misleading. The significant fact
remains that the farmer pays from 10 to 11 per cent. on small loans, for
short periods of time.

Store or book credit is a form of short-time loan which is perhaps more
important than bank credit. In a state where the bank charges a high
rate of interest, the farmer is more likely to buy merchandise on credit
than to borrow from the bank and pay cash. The North Dakota farmer is
rarely denied credit at a country store. To secure information on this
form of credit, questionnaires were mailed to implement and hardware
dealers, as well as to farmers. One question asked of implement dealers
was: "What percentage of farmers pay cash in buying farm machinery?" The
answer from 54 firms, located in 35 counties, was that only 13 per cent.
of the farmers pay cash, 87 per cent. buying on time. Out of 29 farmers
reporting only 6 pay cash in buying machinery and supplies. These book
accounts run anywhere from three months to two years; the average
account is carried about one year (12.37 months). The farmer
contemplates making payment immediately after his prospective crop is
marketed. In case of crop failure the retailer will carry the account
over until the next harvest season.

It is quite common for the dealer to obtain a note from the farmer--the
note generally bearing a 10 per cent. interest rate from the date of
issue. Often, however, the note does not begin to bear interest until
the farmer has failed to make payment at the expected time, that is,
immediately following the harvesting season. The 54 implement and
hardware dealers reported an average of 10.26 per cent. interest per
year on these notes.

It is more difficult to secure uniform information from dealers on the
subject of book credits, especially with reference to the interest rates
charged on such accounts. The practice varies. Usually an interest rate
is added to the credit price depending on the duration of the account.
There is no common discount rate for cash purchases, though 7 per cent.
is most common, that is, 7 per cent. of the credit price. This brings
the credit price of a $160 binder down to $150 for cash. As a matter of
fact all dealers quote two prices, the cash and the credit price, the
difference between the two depending upon the reputation of the buyer,
the shrewdness of the seller, and the degree of competition in the
particular locality.

On this point, replies from farmers do not differ materially from the
replies of the implement dealers. The difference between the cash price
and the credit price of a binder is usually given as $5 to $10, and a
wagon or plough, as $3 to $5. The general discount rate is 7 per cent.
off the credit price.

The implement dealers and the farmers are all agreed that cash payments
would be preferable if rates on bank loans were reduced. The farmer,
however, is often afraid to approach the banker for a loan. On the other
hand, the farmer does not always see that the book credit is quite as
expensive as bank credit, if not more so. The prevailing high bank
rate, however, from 10 per cent. to 12 per cent. on short-time loans,
does not encourage cash payments.

Are the foregoing rates too high as compared with rates in other
communities? The _Crop Reporter_ for April, 1913, shows interest rates
on short-time loans in every state in the Union. In 1913, the North
Dakota rate exceeded that of all other States; in 1912, it exceeded all
but Oklahoma.

Farmers as a rule think that rates are fixed arbitrarily by the bankers
and other money lenders in the community. That fundamental laws of
supply and demand have any controlling influence is apt to be
overlooked. Without attempting to justify the high rates let us state
some of the conditions which help to explain them. The demand for
capital in a growing state is always greater than can be met by the
local supply. In 1890, North Dakota farms were mortgaged for
$11,168,854; in 1910, for $47,841,587; in 1920 it will doubtless reach
$150,000,000. Outside capital is attracted into the state by high rates
of interest. Two life insurance companies, the Union Central of
Cincinnati and the Northwestern Mutual of Milwaukee, loan heavily in the
state. In 1910 the Union Central Life Insurance Company reported a total
investment of $5,489,087.33 in North Dakota real estate. Local banks use
farm mortgages in borrowing money from banks in large cities outside of
the state. Every town and village has its money-lender who acts as agent
for foreign investors in farm mortgages. Banks within the state compete
for capital by offering high rates of interest on time deposits, and pay
all the way from 4-1/2 to 7 per cent. interest on deposits. The rate on
loans must necessarily be higher under these circumstances than where
banks are paying 2-1/2 and 3 per cent. interest. The high interest rate
paid on bank deposits is evidence of the lack of local capital to
satisfy the local demand.

The inability to attract foreign capital on lower terms is due primarily
to the character of the investment. The newness of the state, the
instability of its population, the character of its agriculture, all
make for uncertainty. Hence the speculative character of the farm
mortgage as security for a loan. In the eastern counties where the land
has long been under cultivation, where the population is more stable,
and where mixed farming has in a large measure supplanted the bonanza
wheat farm, rates are correspondingly lower than in the newer portions
of the state. As the element of risk is eliminated from investments,
interest rates will come down. At least this seems to be the consensus
of opinion among bankers.

The character of the farming is frequently mentioned as a prominent
factor in the credit situation. A crop failure under a single crop
system, such as is practised in North Dakota, is likely to find the
farmer in bad straits. The payment of interest on the mortgage is
delayed or deferred. The local bank or loan company is obliged either to
carry the farmer along for a year or to foreclose. Since many farm
mortgages are held by outside investors, the annoyance is sufficient to
reflect itself in an increased rate of interest. Because of this fact
many bankers are urging mixed farming as a means of reducing rates. This
aspect of the question is well expressed in a communication from a
banker in Stark County who says:

It is our belief that the scarcity of money and the high
interest rates are largely due to poor farming. The people
having money to loan know well that our farmers here have a
very uncertain income according to their present methods of
farming, and would expect a much higher rate commensurate
with the risk taken when they can find people where money
can be placed more safely. As conditions are here now, some
people have not paid all their interest, for at least three
or sometimes four years. In the older slates, like Iowa for
example, where people farm well, interest rates are much
lower. As soon as our farmers can show that they are safe
and will take care of their obligations promptly, they can
command the lowest interest rates that may exist. We believe
it more necessary to work on better farming methods,
encouraging them, than on better interest rates, for the
lower interest rates are a natural consequence of better
farming.

Another factor is the character of the population. One prominent banker
says of North Dakota farmers: "They lack a sense of responsibility. Farm
loans require constant care, hence high rates." Another complaint is:
"Farmers are careless in not making prompt payment or renewals of
obligations." Some bankers think the high rates due to too much
borrowing; that is, too much liberality in the loaning of money.
Injudicious loaning leads to extravagance, and naturally calls for high
rates to offset the risks involved. One banker in analyzing the
situation claims that the legal restrictions placed on the loaning power
of banks is responsible for unduly high rates. In support of this view
it might be stated that while the total farm mortgages in the state in
1910 reached the $50,000,000 mark, the power to loan on real estate by
all banks, state and national, was less than $5,000,000. Banks are
forced to loan on the personal note of the farmer, secured by a
mortgage, instead of taking a direct mortgage on the property. Other
banks turn these mortgage loans over to trust companies, and collect a
commission from the farmer for placing the mortgage.

Commissions are responsible for at least from one to two per cent. of
the rate when loans are handled by real estate agents and loan
companies. In the case of loans by life insurance companies, the state
agent generally receives one per cent. and the local agent, at interior
points, receives one per cent. Two per cent. could be saved by the
farmer if the money could be borrowed directly from the investor,
without the aid of an agent.

Allowing, however, for all these local conditions--the great demand for
capital in a new and developing country, the inability to attract
sufficient outside capital because of the risky character of
investments, the irresponsible character of some elements in the
population, the character of farming methods, the commission agent, and
the legal restrictions handicapping banks--allowing for all these
conditions, and because of some of them, it is believed that the farmers
by organizing co-operative credit associations could reduce the rate of
interest on both long- and short-time loans; and, furthermore, that such
co-operative credit facilities would be a means of improving the methods
of farming, would encourage stability in population, and would make the
farmer feel that he is not being discriminated against in the borrowing
and employment of capital.

CATTLE LOAN BANKS[226]

Consumers desiring a reduction in the cost of food supplies will be
interested in a study of the operations of cattle loan companies and in
the development which these may reasonably attain as a result of the
provision in the Federal Reserve Act for the rediscounting of
agricultural paper.

The cattle loan company, commonly referred to as "cattle bank," is a
middleman between borrowing cattle-owners and lending bank-managers. Its
business methods and forms closely parallel those of real estate
mortgage loan companies except for the fact that cattle loans are of
shorter duration and secured by mortgages of the chattel variety. Cattle
loan companies, incorporated under state charters, have been operating
in such cities as Fort Worth, Denver, East St. Louis, St. Joseph,
Portland, South St. Paul, Omaha (2), and Kansas City (3), some of them
for over twelve years; and one is now being organized in Chicago. These
companies have a paid-in capital stock ranging from $50,000 to $300,000,
and are usually closely affiliated with a national or state bank, as are
trust companies in the larger cities.

These companies are informed of desired loans through country bankers,
or by receipt of direct applications, the latter usually from the larger
"cattle-growers." In some cases the company on its own initiative urges
cattlemen in whom it has particular confidence to undertake feeding
operations at a time when the beef market offers a favorable opportunity
for such production. In every case a salaried examiner of the company
inspects the plant and herd of the cattle-grower and his personal
capacity and integrity before the granting of a loan. And thereafter the
examiner, on his regular circuit, maintains a continuous inspection and
volunteers advice designed to protect the value of the security given
for the loan. When a loan application has been acted upon favorably, a
promissory note and chattel mortgage are taken. The funds of the company
then advanced to the borrowers may be utilized to buy more cattle, to
pay outstanding debts such as those for feeding expense, or, as is often
the case, to buy the very cattle which are pledged as security for the
loan. In a few cases where the cattle-grower enjoys an exceptional
credit, funds will be advanced for the full purchase price of a herd for
seasonal feeding purposes, or to develop two-year-olds into finished
four-year-old beef cattle. The loans granted are seldom less than 60 per
cent. of the known value of the cattle.

To secure a buyer for the note and mortgage is the second primary
function of the cattle loan company. If the loan is a small one, usually
$10,000, it may be sold entire, the chattel mortgage assigned and the
note indorsed to the buyer. If the loan is a larger one, of $50,000 to
$100,000, it is necessary to subdivide it in order to provide a ready
sale. The mortgage and note are assigned in parts of $5,000, $20,000, or
other denominations, to suit the convenience of the buyers of the paper.
In this case the assigned parts, since they are indorsed by the loan
company, are equivalent to a "debenture" issue secured by a pledge of
specified assets held by the company for the protection of the
note-holders. The size of mortgage loan most frequently made is $10,000,
while loans of $100,000 are exceptional.

The business of cattle loan companies approaches closely to the
functions of the commercial paper broker. The cattle loan company has an
advantage over the commercial paper broker in that the favorable
location of the company--always at the receiving cattle-market of the
district in which its loans are exclusively placed--enables it fully to
protect its interest by claiming the proceeds of sales of mortgaged
cattle. This is particularly true in the case of range cattle, which can
be readily identified by the mortgaged brands.

To cover expenses of administration the cattle loan company secures for
itself a part of the interest paid on the loan. The rate charged the
borrower is usually determined by conditions in the locality where it is
made, sometimes running as high as 10 per cent., and again, influenced
by general rates for capital, falling as low as 7 per cent. From this
gross interest charge a commission has to be given to the local banker
who makes the loan, expenses of examination and management must be met,
and an appropriation made to a contingency reserve fund to cover
occasional losses incurred from the circumstance that the companies
usually become surety, by indorsement, for the final payment of all the
loans which they have placed with lenders. These deductions determine
what may be safely paid to eastern purchasers of the paper, usually 5 or
6 per cent.

Holders of cattle paper have never suffered in times of financial panic
from failure to pay at maturity. Cattle, like grain, are a cash
commodity purchased by retailers and sold by them, largely for cash, to
satisfy a relatively constant consuming demand. This characteristic is
retained even in time of panic.

Maturities are usually six months for feeding purposes; and less often
of two and one-half years for developing two-year-olds for market. This
two and one-half year paper is occasionally converted into the six-month
variety by the sale of notes running for six months, based upon the
two-and-one-half year mortgage. These notes are taken up at maturity by
the loan company and reissued or renewed for like succeeding periods
until the original loan is repaid.

In the past this form of loan has not been so desirable as it will be in
the near future. It has been a relatively long-term investment; and
while perfectly liquid at maturity and enjoying a good rate of return,
it has not possessed a sufficiently wide market to insure salability at
those times when the demands of depositors and local customers for
accommodation press in upon the investing bank. This difficulty will be
fully corrected by the expected operations of the Federal Reserve Act.
Eastern bankers possessing these six-month notes will probably find them
readily rediscountable with the local federal reserve bank at any time
up to maturity. And a considerable amount of two-and-one-half year notes
may be held to advantage, since, if properly selected with successive
maturities, one-fifth of their total amount will be immediately
rediscountable when necessary.

By rendering this form of agricultural paper liquid before maturity the
Federal Reserve Act will have become a most important influence for
enlarging the amount of capital devoted to this branch of industry.
Already eastern bankers have scouts touring the Western States to study
this form of banking with a view to investing several millions of
dollars each. Interest rates upon these loans will unquestionably be
reduced in time through such increased competition of lenders. The loan
companies will hardly suffer, however. While charging the cattle-grower
less, they will be enjoying a larger turnover and should welcome this
new development. The four or five million dollars placed in such loans
yearly by the average loan company, as at present constituted, is but a
fraction of the loans that may be placed by them within a few years.

By reducing the interest cost charged to cattle-growers an important
service will have been performed for the consumer. Such a reduction will
increase, in the first instance, the cattle-man's profit and induce him
to increase his holdings. The benefit of increased production at lowered
expense should, in time, be passed on to the final consumer of beef.

This phase of the operations of the Federal Reserve Act will be of
distinct benefit, and possibly also the least dangerous of all forms of
legislation designed to assist American agriculture.

FOOTNOTES:

[197] Adapted from R. B. Van Cortland. _What is Agricultural Credit?
North American Review_, Vol. 199, April, 1914, pp. 585-588.

[198] E. W. Kemmerer, _Agricultural Credit in the United States, The
American Economic Review_, Vol. 2, No. 4, December, 1912, pp. 852-872.

[199] New York, Chicago, Philadelphia, St. Louis, Boston, Cleveland,
Baltimore, Pittsburgh, Detroit, San Francisco, Milwaukee, and
Cincinnati. For Buffalo, the tenth city in population, Cincinnati, the
thirteenth city, was substituted, since for Buffalo, which is not a
reserve city, satisfactory banking figures are not available.

[200] [National banks are now permitted to lend on real estate security
by the Federal Reserve Act passed in 1913.]

[201] Cf. Testimony before United States Industrial Commission
(_Report._ X, under subjects of "Credit System" and "Crop Lien System,"
_passim_.)

[202] _Report_. X, p. 161.

[203] In some states farmers themselves own considerable amounts of bank
capital. This is said to be particularly true of Iowa.

[204] The average value per acre of farm land in the United States rose
from $15.57 in 1900 to $32.40 in 1910, a rise of 108 per cent.
_Thirteenth Census, Bulletin on Farms and Farm Property_, p. 15.

[205] _Report_, X, p. 938.

[206] Exclusive of Alaska and Hawaii.

[207] Values in gold.

[208] Cf. _Twelfth Census_, V, pp. xxix and xxx. and _Thirteenth Census,
Bulletin on Farm and Farm Property by States_, pp. 13 and 15.

[209] Every census since 1870 has shown a larger percentage of the
native population living in state or territory of birth.

[210] On this subject see the writer's article on "Agricultural Credit"
in L. H. Bailey's _Cyclopedia of American Agriculture_, IV, p. 270; and
his _Report to the Treasurer of the Philippine Islands on The
Advisability of Establishing a Government Agricultural Bank in the
Philippine Islands_, pp. 9-11, 151-154.

[211] Cf. E. W. Kemmerer, _Report to the Secretary of War and to the
Philippine Commission, on The Agricultural Bank of Egypt_. (Manila, P.
I.: 1906. Also published by Bureau of Insular Affairs, Washington, D.
C.)

[212] Cf. E. W. Kemmerer, _An Agricultural Bank for the Philippines,
Yale Review_, November, 1907, pp. 262-279.

[213] C. R. Fay, _Co-operation at Home and Abroad_, p. 44. (New York;
Macmillan, 1908.)

[214] Fay, _Co-operation_, etc., p. 44.

[215] _An Outline of the European Co-operative Credit Systems_, pp. 12
and 13.

[216] Under "other liabilities" are included in addition to other items
the funds which the banks have borrowed from banks and individual
capitalists.

[217] The capital of the district banks and of the central bank came
largely from the local banks.

[218] In 1909 the figures for Germany were: Loans on current account, M
425,995,403 and Loans for fixed periods, M 1,082,446,388. The
International Institute of Agriculture, _An Outline_, etc., p. 14.

[219] _Idem_.

[220] _Ibid._, p. 17.

[221] _Idem_.

[222] "Farmers' economic co-operation in the United States has developed
enormously during the period under review [1896-1908], and it safe to
say that at the present time more than half of the 6,100,000 farms are
represented in economic co-operation; the fraction is much larger if it
is based on the total number of medium and better sorts of farmers to
which the co-operators mostly belong." The most prominent objects are:
Insurance, creameries, cheese factories, co-operative selling
organizations of numerous kinds, co-operative buying organizations,
co-operative warehouses, co-operative telephones, co-operative
irrigation, etc. _Annual Report of the Secretary of Agriculture 1908_,
pp. 183, 184.

[223] Quoted from a letter from Mr. George K. Holmes, Statistician of
the Department of Agriculture, Washington, D. C.

[224] For a statement of the more liberal privileges concerning the
making continued: of loans on mortgage security conferred on national
banks by the Federal Reserve Act see p. 750.--EDITOR.

[225] Adapted from Meyer Jacobstein, _Farm Credit in a Northwestern
State, American Economic Review_, Vol. 3, September, 1913, pp. 598-605.

[226] J. F. Ebersole. _Cattle Loan Banks, The Journal of Political
Economy_, Vol. 22. No. 6, June, 1914, pp. 577-580.

CHAPTER XXVIII

THE CONCENTRATION OF CONTROL OF MONEY AND CREDIT

HAVE WE A MONEY TRUST?

[227]If by a "money trust" is meant--

An established and well-defined identity and community of
interest between a few leaders of finance which has been
created and is held together through stock holdings,
interlocking directorates, and other forms of domination
over banks, trust companies, railroads, public-service and
industrial corporations, and which has resulted in a vast
and growing concentration of control of money and credit in
the hands of a comparatively few men--

your committee has no hesitation in asserting as the result of its
investigation that this condition, largely developed within the past
five years, exists in this country to-day.

The parties to this combination or understanding or community of
interest, by whatever name it may be called, may be conveniently
classified, for the purpose of differentiation, into four separate
groups.

First. The first, which for convenience of statement we will call the
inner group, consists of J. P. Morgan & Co., the recognised leaders, and
George F. Baker and James Stillman in their individual capacities and in
their joint administration and control of the First National Bank, the
National City Bank, the National Bank of Commerce, the Chase National
Bank, the Guaranty Trust Co., and the Bankers Trust Co., with total
known resources, in these corporations alone, in excess of
$1,300,000,000, and of a number of smaller but important financial
institutions. This takes no account of the personal fortunes of these
gentlemen.

Second. Closely allied with this inner or primary group, and indeed
related to them practically as partners in many of their larger
financial enterprises, are the powerful international banking houses of
Lee, Higginson & Co. and Kidder, Peabody & Co., with three affiliated
banks in Boston--the National Shawmut Bank, the First National Bank, and
the Old Colony Trust Co.--having at least more than half of the total
resources of all the Boston banks; also with interests and
representation in other important New England financial institutions.

Third. In New York City the international banking house of Messrs. Kuhn,
Loeb & Co., with its large foreign clientele and connections, whilst
only qualifiedly allied with the inner group, and only in isolated
transactions, yet through its close relations with the National City
Bank and the National Bank of Commerce and other financial institutions
with which it has recently allied itself has many interests in common,
conducting large joint-account transactions with them, especially in
recent years, and having what virtually amounts to an understanding not
to compete, which is defended as a principle of "banking ethics."
Together they have with a few exceptions pre-empted the banking business
of the important railways of the country.

Fourth. In Chicago this inner group associates with and makes issues of
securities in joint account or through underwriting participations
primarily with the First National Bank and the Illinois Trust & Savings
Bank, and has more or less friendly business relations with the
Continental & Commercial National Bank, which participates at times in
the underwriting of security issues by the inner group. These are the
three largest financial institutions in Chicago, with combined resources
(including the two affiliated and controlled state institutions of the
two national banks) of $561,000,000.

Radiating from these principal groups and closely affiliated with them
are smaller but important banking houses, such as Kissel Kinnicut & Co.,
White. Weld & Co., and Harvey Fisk & Sons, who receive large and
lucrative patronage from the dominating groups and are used by the
latter as jobbers or distributors of securities the issuing of which
they control, but which for reasons of their own they prefer not to have
issued or distributed under their own names. Messrs. Lee, Higginson &
Co., besides being partners with the inner group, are also frequently
utilised in this service because of their facilities as distributors of
securities.

Beyond these inner groups and subgroups are banks and bankers throughout
the country who co-operate with them in underwriting or guaranteeing the
sale of securities offered to the public and who also act as
distributors of such securities. It was impossible to learn the identity
of these corporations, owing to the unwillingness of the members of the
inner group to disclose the names of their underwriters, but sufficient
appears to justify the statement that there are at least hundreds of
them and that they extend into many of the cities throughout this and
foreign countries.

The patronage thus proceeding from the inner group and its subgroups is
of great value to these banks and bankers, who are thus tied by
self-interest to the great issuing houses and may be regarded as a part
of this vast financial organisation. Such patronage yields no
inconsiderable part of the income of these banks and bankers and without
much risk on account of the facilities of the principal groups for
placing issues of securities through their domination of great banks and
trust companies and their other domestic affiliations and their foreign
connections. The underwriting commissions on issues made by this inner
group are usually easily earned and do not ordinarily involve the
underwriters in the purchase of the underwritten securities. Their
interest in the transaction is generally adjusted, unless they choose to
purchase part of the securities, by the payment to them of a commission.
There are, however, occasions on which this is not the case. The
underwriters are then required to take the securities. Bankers and
brokers are so anxious to be permitted to participate in these
transactions under the lead of the inner group that as a rule they join
when invited to do so, regardless of their approval of the particular
business, lest by refusing they should thereafter cease to be invited.

It can hardly be expected that the banks, trust companies, and other
institutions that are thus seeking participations from this inner group
would be likely to engage in business of a character that would be
displeasing to the latter or that would interfere with their plans or
prestige. And so the protection that can be offered by the members of
this inner group constitutes the safest refuge of our great industrial
combinations and railroad systems against future competition. The
powerful grip of these gentlemen is upon the throttle that controls the
wheels of credit and upon their signal those wheels will turn or stop.

In the case of the pending New York subway financing of $170,000,000 of
bonds by Messrs. Morgan & Co. and their associates, Mr. Davison
estimated that there were from 100 to 125 such underwriters who were
apparently glad to agree that Messrs. Morgan & Co., the First National
Bank, and the National City Bank should receive 3 per cent.--equal to
$5,100,000--for forming this syndicate, thus relieving themselves from
all liability, whilst the underwriters assumed the risk of what the
bonds would realise and of being required to take their share of the
unsold portion. This transaction furnishes a fair illustration of the
basis on which this inner group is able to capitalise its financial
power.

It may be that this recently concentrated money power so far has not
been abused otherwise than in the possible exaction of excessive profits
through absence of competition. Whilst no evidence of abuse has come to
the attention of the committee from impartial sources, neither has there
been adequate proof or opportunity for proof on the subject. Here again
the data have not been available.

Sufficient has, however, been developed to demonstrate that neither
potentially competing banking institutions nor competing railroad or
industrial corporations should be subject to a common source of private
control.

Your committee is convinced that however well founded may be the
assurances of good intentions by those now holding the places of power
which have been thus created, the situation is fraught with too great
peril to our institutions to be tolerated.

THE BORROWER AND THE MONEY TRUST

[228]Some trusts are denounced because of their attitude toward their
employés. Many trusts are efficient or inefficient because of the way
their millions of labourers work. But let us be fair to Big Business.
Why not examine its one branch where labour is almost absent, where
there is no brawn and all brain?

BANKING THE MOST LOGICAL OF TRUSTS

A bank in New York City gave its employés a Christmas present equal to
half their annual salary. The bank had assets of $100,000,000. A fine
example, you say, to other great business concerns! But the bank had
only fifty employés. In the entire country there are probably not more
than 100,000 persons engaged in banking, either directly or indirectly.

The banker has, relatively speaking, no human factor to consider. And
that factor with a concern like the United States Steel Corporation or
the Pennsylvania Railroad is mammoth, almost baffling. The banker deals
not in the production or distribution of wealth itself (in both of which
much labor is needed), but solely in the paper representatives of
wealth, money, and credit. Thus he can apply far more directly than the
manufacturer or railroad manager the economies and efficiencies of Big
Business.

Banking--the business of dealing in money and credit--is the most
logical of trusts. And in practice it has justified the theory. Where
banks have become larger they have become stronger, where co-operation
and concentration have gone far, there safety and effectiveness have
reached a high pitch.... Banking is the one central business of all--it
is the business of businesses. So if it has become more efficient as the
trust idea, or at least the principle of concentration, has gained sway,
how can we have too much concentration and who is there to complain?...

If the bankers have, faithfully and well, handled the trust of
extending credit to the limit of their ability, yet when the president
of the second bank in size in the country acknowledges himself to be one
of about a dozen men in whose hands the power of extending credit is, in
the last analysis, concentrated--then it is high time, seriously and
fearlessly, to consider the subject....

Three main factors are in the main responsible for the concentration of
the control of credit and they are the growth of big banks, the growth
of big industries, and the financial laws of the country....

NO LACK OF BANKING FACILITIES

However great the concentration of money power in this country, it
cannot truthfully be said that banking facilities are not also
increasing. Figures taken from the reports of the National Monetary
Commission and other official sources show that the number of banks is
mounting up faster than either wealth or population....

WHERE THE MONEY HAS GONE

When one first realises the extent of this country's banking resources
he is properly astonished. But how evenly are these resources
distributed? It is commonly known that banking facilities in the
Southern and Western sections of the country are small indeed as
compared with the New England, Eastern, Central, and Pacific Coast
sections, where large cities abound. To illustrate, in 1909, when the
total banking power was close to twenty-one billions, more than half was
represented by forty-seven cities, and close to one-quarter was held by
the two hundred banks in New York and Chicago. In other words about 1
per cent. of the country's banks held close to one-quarter of the
country's banking power.

Now it is a well-known fact that an individual or corporation with large
resources and large business exerts an influence in his particular field
far in excess of his actual mathematical percentage of the total
resources or business. Thus the dominating position of the big banks is
even greater than mere figures indicate. But there is still another fact
which centralises and cements their power. The only banks which are
really large are in a few cities, and the larger they are, the more they
tend to the very greatest centres of population. Thus toward the end of
1911, there were 183 banking institutions with deposits of $10,000,000
or more, of which sixty-two were in New York City. There were thirty-six
institutions with deposits of $25,000,000 or more. Sixteen of these were
in New York City and four in Chicago. There were ten with deposits of
$75,000,000 or more, and of these, seven were in New York and two in
Chicago. Of the ten largest trust companies six were in New York, three
in Chicago, and one in Boston.

These great banks and trust companies are of very recent growth. Twenty
years ago the deposits of our largest bank were one-twentieth of what
they are to-day. At the first inauguration of President McKinley, which
was really not so far back as the Dark Ages, there was no bank in New
York with more than $30,000,000 of deposits. Now there are six banks
each with more than $100,000,000 of deposits. A trust company in New
York City, which had deposits of $20,000,000 five years ago, now has
deposits of $166,000,000 and its twenty-eight directors sit [1912] in
boards of other banking institutions with resources of $1,250,000,000.
When it comes to actual cash we find the position of the New York and
Chicago banks even more dominant....

CONSOLIDATION--A STEADY PROCESS

Despite the disproportionate size of New York and Chicago banks their
number is steadily decreasing. This is because the process of
consolidation proceeds just as steadily. In 1853 there were fifty-three
banks in the New York Clearing House Association, and in 1911 there were
fifty, although in the meantime the amount of business had increased
twenty times. There are now less than 130 banks in New York, or ten less
than ten years ago, although in that time cash holdings have doubled and
deposits have increased a third. In ten years no less than 103 banks
have gone out of existence, generally through absorption into larger
institutions.... In Chicago the same process of consolidation has gone
on. One Chicago trust company has absorbed six others in eight years.

New York and Chicago are by no means the only cities in which the
obvious tendency is to have fewer but larger banks. Look about at
random. Akron, Ohio, where the rubber industry has recently become of
more than local importance, has felt the necessity of banks large enough
to carry on its trade, and consolidation has resulted. In Detroit, where
the automobile trade has set in motion a great industrial development,
the Old Detroit National has absorbed the American Exchange National. In
Seattle, Nashville, Wilmington, Portland, Philadelphia, Baltimore, San
Francisco, and Louisville there have been many recent mergers and
absorptions. In Cincinnati one of the largest institutions in the Ohio
Valley has been formed by the absorption of the Merchants' National by
the First National. As for Boston the desire of her capitalists to make
New England more powerful in the business life of the country has led to
the recent absorption of the City Trust Company by the Old Colony and
the steady growth of three financial institutions, the Shawmut National
Bank, the First National Bank, and the Old Colony Trust Company, these
three far exceeding all others in size....

HOW THE LAW HAS FOSTERED AFFILIATION

... One great cause of the concentration of banking and financial power
into a few hands has been the consolidation of banking resources into a
few great units and the friendly affiliations of these units. But these
units have not grown big merely because their managers or owners willed
it so. The banking and currency laws of the country have forced money
into a few centres. The banks of New York City employ--mainly in
financial or stock market loans--about $600,000,000 which belongs to
banks in other parts of the country. Naturally this concentration of
money in a few banks "places these banks in a position to control the
issuing or granting of credit"--to use the exact words of the president
of one of them--"thereby placing the money power in the hands of a
comparatively small number of men."

But this gravitation of money to New York is because the money is idle
and is hunting a job, and not because of any process of usurpation,
manipulation, or combination. It naturally arises under and by virtue
of the reserve requirements of our National Banking Act.... The bulk of
idle country bank cash which finds employment in New York comes here
because of the existing reserve system, and there are several great
banks in both New York and Chicago which have few customers other than
the thousands of country banks whose "correspondents" they are.

THE CORPORATION AND THE BANK

Thus banking and financial power is concentrated in a few hands not only
by the growth of great banks and by the laws of the country, but also by
the legitimate business practices which have grown up under these laws.
But the massing of this power in a few vast, centralised units has been
a development of the last ten or fifteen years only. That is, it has
been coincident with the development of trusts and combinations. Big
Business and Big Banking have gone hand in hand. Each has made the other
possible. By law a bank cannot loan more than one-tenth of its capital
and surplus to any one customer. But the customers have grown into
behemoths. How then could the banks fail to grow?

Before trusts existed and before small railroads were united into large
systems the few banking houses of magnitude which existed in Wall Street
had engaged in merchant banking, for the industries and railroads had
not been large enough to attract their attention. These small industries
and railroads were controlled by their owners, and their capital
requirements were supplied largely in the localities in which they were
situated. But as railroads and industries were consolidated it was found
necessary to apply to the larger New York banking firms to supply the
funds. These bankers had European connections as well as close
affiliations with the big national banks and life insurance companies,
and were able not only to furnish the needed capital but also undertook
to market the securities of the newly formed combinations.

Thus a few banking houses, of which J. P. Morgan & Co. is the chief
example, became in a way responsible for these new creations and
naturally assumed charge not only of their finances, but to some extent
of their other affairs. Thus the headquarters of the trusts and
railroads gradually moved to New York. In the treasuries of these
companies were vast sums of money to be banked, and it was inevitable
that most of it should be placed in New York banks. The average daily
balance of the United States Steel Corporation is about $75,000,000 and
the American Tobacco Company has perhaps $20,000,000. There is also the
Standard Oil Company, whose balance is perhaps as large.

These few financial groups, J. P. Morgan & Co., Kuhn, Loeb & Co., and
the capitalists identified with the National City Bank and the First
National Bank, along with a few others, are primarily in the business of
selling securities and loaning money upon them. In fact they may be
described as the great security issuing houses. Such influence as their
members or directors may exert over railroad and other corporations is
largely due to their ability to dispose of securities and to give these
securities the stamp of soundness and conservatism. Here it may be added
that men like J. P. Morgan would not be directors in so many
corporations if their advice and assistance were not eagerly sought.

In the small village a small group of men own the bank, the coal yard,
the ice-plant, the trolley line, the gas plant, and the little
factories. Every day of the year these men, in their different
capacities, have to trade with themselves in the purchase of supplies,
etc., for their different companies, one from another. No one thinks of
accusing them of double dealing, and yet the situation differs not a
whit from the vast system of interlocking bank and corporate directors
in New York except in degree and in fact, which, however, is vital, that
the New York system affects the whole commonwealth whereas the business
convolutions of Deacon Jones of Jones' Corners do not.

Now it must not be supposed that bankers such as Mr. Morgan and his
partners are usually large owners in the companies they influence or
even control. Often they do not own 15 per cent. of the stock of the
banks they dominate. Often they become directors with but a few shares
of qualifying stock. Still more often their influence is exerted merely
as financial advisers. Often they nominate the president of a railroad
or manufacturing company as Morgan & Co. nominated the president of the
Atlas Portland Cement Company. Often the bankers take no part in the
direction of companies until these companies have shown incapacity or
have had for any reason, business or governmental, to be reorganised,
either in form or management. Recent cases which come under one or the
other of these heads are the Wabash Railroad, the United States Motors
Co., the Westinghouse Electric & Manufacturing Company, the
International Paper Company, the American Tobacco Company and the
American Sugar Refining Company.

HARMONY THE WATCHWORD

There is little evidence to show any actual agreement or even
arrangement among the great financial groups. Through interlocking
directors and the wide following of smaller firms which each of the big
groups has, the whole big banking situation in New York is closely knit
together. There is a carefully fostered community of interest even among
hostile groups, each group having a director or two, like a financial
ambassador, in the other banks.[229] In the past there has been keen
rivalry. Historically the Morgan and First National Bank groups have
long been close, and two members of the Morgan firm were taken from the
First National Bank. At one time these two groups bitterly fought the
other two powerful groups--the Kuhn, Loeb-National City Bank interests.
But in recent years harmony has prevailed....

It must be remembered that the four banking groups are now managed for
the most part by young men. These young men are more accustomed to the
ways of conciliation than were the late E. H. Harriman, and John D.
Rockefeller and J. P. Morgan. The younger men trouble themselves little
with the former conflicts of Morgan, Hill, Rockefeller, Schiff,
Stillman, Harriman, and Ryan. They have forgotten even the accusations
and charges which the life insurance scandals made public. Their aim is
more impersonal--it is to "develop business," and the surest way to do
that is by working harmoniously together.

MONEY POWER NOT DISTINCTLY AMERICAN

Striking as the concentration of banking, money, and financial power
seems, it is no greater here than abroad, perhaps not so great. In
London there are banks with fifty millions of capital, or twice as much
as our one largest bank, and deposits of nearly four hundred millions of
dollars, or twice as much as our largest bank. Even Canada, with a
population less than one-tenth of ours, has a bank as great as our
greatest. Relatively its big banks are bigger than ours. Concentration
in Canada has gone much farther than here. Six banks in the Dominion
hold half its entire banking resources. The autocratic power wielded by
the score of great Canadian banks would start a revolution in this
country. Germany and France long ago went through the process of bank
consolidation.

WHY, THEN, DO WE HEAR FEW COMPLAINTS FROM ABROAD?

Here is a problem to be faced with intellectual honesty. Money power may
be a bad thing, but let us not be so dishonest as to declare it a new
thing. The New York Clearing House Association may wield power too
autocratic, but let it not be overlooked that a similar organisation in
London, with only one-third as many members, has long exercised as great
power without raising any hue and cry of a Money Trust. Also consider
Germany. If you have the time and courage to undertake such a task, go
through the ponderous volume issued by the National Monetary Commission
telling of the actual results of the great bank system in that country.
It is a weary task reading the long-winded testimony of Herr Professor
Doctor Governor this and that, but it is worth the labour.

We are told that great banks are more amenable to public opinion than
smaller scattered institutions, that the Government is more ably
assisted in its financial operations, that fewer reckless loans are
made. Quicker prognostication of crises, whether on the Bourse or in
commerce and industry, quicker adoption of preventive measures thereby
lessening the effects of crises, are other services rendered by
concentrated banking in Germany....

In 1907, when there was far less both of co-operation and concentration
among the banks of this country than there is to-day, each bank standing
weakly isolated and alone, frantically grasped all the cash it could
muster. When the panic storm broke banks struggled to call in loans and
line their vaults with cash. Business was crippled; industry was
squeezed dry of its lifeblood. Last year when Germany was threatened
with both war and panic, trouble was averted by the German "Money
Trust," which loaned more than $200,000,000. It takes no expert
knowledge of finance or banking to perceive that a few great, strong
banks, or many smaller ones (provided they are welded closely together)
can meet a storm more calmly than scattered, unconnected institutions.

WHERE IS THE VITAL DIFFERENCE?

If concentration is a good thing, how can there be too much of it? Here
is the answer. Concentrated power without responsibility may be the
worst possible thing. The other great financial nations have money
trusts ... too, but each is capped by a vast central bank, more or less
a government institution, and from the necessity of the case operated
not only with a view to the general welfare but more or less openly and
publicly.... The American "Money Trust" is strictly private, responsible
to no one. It may act philanthropically if it chooses, but it is
governed by nothing but choice. The money kings can, if they wish, exact
any price.

R. H. Thomas, former president of the New York Stock Exchange, told the
Pujo committee how Wall Street had finally to turn to one man, J. P.
Morgan, in the panic of 1907, to save it from complete disaster. He did
not know where the relief came from, in what form, nor with what
conditions. It just came. Since at that time the entire country was
dependent upon Wall Street because its surplus money was there, there is
no escaping the fact that the whole financial situation of the country
was at the mercy of one man. A 200 per cent. rate for loans would be
inconceivable in one of the European financial centres because the
central banks of Europe are the guarantors of the stability of the
money market. The central banks of Europe depend upon no man, selfish or
altruistic. They are the public financial regulators of the whole
nation.

Has the Money Power been used to crush and squeeze?... Suppose that it
has not been so used. Nevertheless, its control is in the hands of a few
men. Even if their action be honest and intended for the public
interest, they are necessarily most interested in the great undertakings
in which we have seen them to be engaged. By reason of these limitations
they must check and limit, if they do not destroy, genuine economic
freedom and competition.... A handful of men, responsible to no one but
themselves and God, have become masters of the lifeblood of commerce and
industry. That this power has been more rapidly concentrated into their
hands than the people have supposed is the unavoidable conclusion of
this article.

From private persons, acting in private, and dominated in the main by
private motives there cannot be expected the wisest and broadest
direction of the flow of money--the lifeblood of business. These men
have not asked for this power. They know it is too great for them. On
the whole they have behaved with singular restraint. But only a fool
would suppose that the best system for financing the small farmer in
Florida or the small tin can manufacturer in Oregon is to turn over the
entire money power of the nation to J. P. Morgan and a few other private
persons. How under such a system could the great trusts fail to thrive
at the expense of the small man?

THE BANKS AND RAILWAY FINANCE

[230]Close relationships of railways with banks or other credit
institutions have grown up naturally through the need for new capital
constantly imposed upon an expanding railway system. Some railways have
been fortunate enough to possess a relatively stable body of
stockholders whose confidence in the management is so complete that new
funds can be raised by direct appeal of the management to the
stockholders without the intervention of outside financial interests.
But these cases have thus far been rare in American railway finance.
When the policy calls for the raising of funds by the issuance of bonds
rather than stock, the appeal is to a wider and to an anonymous public
rather than to a corporation's own stockholders. Frequently the appeal
must be to a class of investors situated in another section of the
country or even in a foreign country. Most railways have not the
technical organization nor the established market necessary to handle
their issues easily, and usually it is found that in spite of the often
exorbitantly high commissions which the bankers exact for their
services, the net result is more satisfactory than that secured through
the railway's own efforts. To the extent that this is the case, the
bankers are performing a service of genuine economic value, and it must
be concluded that under present conditions such service cannot readily
be dispensed with.

Assuming this service as a necessity, the next step is for the banker to
seek representation upon the railway board. His house has made itself
responsible for a large issue of securities. It appeals to the investing
public, not technically guaranteeing the issue, but practically doing so
because of solicitude that its reputation for the handling of high-grade
securities shall not be impaired. It seeks therefore to protect its own
standing, and at the same time to make the securities more attractive to
its customers, by demanding a place on the board of directors from which
it can follow in detail the employment of the funds secured through its
assistance. Large investors like life insurance companies, savings
banks, fire insurance companies, guaranty companies, trust companies,
demand as a prerequisite to purchase of securities that the underwriting
house shall be represented on the board. The railway's credit--its
ability to sell its issues--is dependent frequently upon the presence on
its directorate of this representative. However, the banker is not in
the position solely of a spectator or a detective. His expert advice is
sought and usually followed. Often he is in a position where he can
stipulate conditions under which alone he will undertake to provide the
funds required, and such stipulations are frequently of immense
influence in furthering efficient railway management. A recent example
is found in the furnishing of money to the Chesapeake and Ohio Railway
Company by Kuhn, Loeb & Co. under a stipulation that the road must put
back into its property each year a certain amount of its earnings.
Instances might be multiplied in which railway corporations have been
saved from disaster and set upon their feet through the aid of those who
have furnished the funds, and who have stipulated in connection
therewith that in order to insure their knowledge of all transactions,
and to give them a position from which they might bring their influence
to bear, they should be granted representation on the railway board.

Of course it must be admitted that the power of the banker may be
misused to his own private advantage. The power is there--the power to
refuse funds--the power that comes from command of enormous sources of
capital, the prestige gained by years of successful experience. Men who
have attained such a position have the personal qualities that give them
naturally a commanding place in any council of business men. When such
men dominate the policy of a railway and the results are disastrous, it
is exceedingly difficult fairly to fix the responsibility and assess the
blame. The line between good faith and good judgment or between personal
ambition that amounts to breach of trust, and a misplaced optimism
concerning the outcome of a specific policy, is a very difficult line to
draw. Although praise and blame cannot be assigned with any precision
between Mr. Morgan and Mr. Mellen in the unfortunate New Haven
situation, it is the prevailing opinion of the New England public that
it has not been benefited greatly by the presence on the New Haven board
of the distinguished banker member. Generally speaking, however, the
powerful banking interests have thrown their influence in the direction
of railway efficiency and the public advantage. If our judgment as to
the desirability of the relationship of railways and credit institutions
is to be determined solely by results, we must conclude that the balance
swings heavily in favor of the continuance of the present policy.

However, opposition to the close association of financial houses and
railways has not sprung from any such favorable relationships as we
have here described. It grows rather out of the concentration and
monopolization of credit. A powerful banking house which has identified
its interests with that of one railway system is in position, because of
its direct influence on the railway and its close affiliation with all
other sources of credit, seriously to hamper if not altogether to
prevent the securing of credit by a rival interest. This power over
credit is not confined to one city or to one section of the country, but
it reaches every section and even extends beyond national boundaries
into the foreign sources of investment funds. Local or small enterprises
requiring only moderate underwriting are frequently financed
independently, but it is an acknowledged fact testified to by the large
bankers themselves that with rare exceptions issues of securities in
large amounts, except when taken up by the stockholders, must receive at
least the tacit approval of the big financial group. Participation by
the smaller banking houses in future underwritings depends upon loyalty
to the syndicate in whatever enterprises are now being offered. The
little fellows are inclined to respect a suggestion not to assist an
enterprise of a character likely to interfere with undertakings already
financed by the large interests. This informal but none the less
effective network of alliances tends to destroy the competitive market
for capital, and to restrict the railways to one source of credit. There
does not appear to be any serious competition among the large bankers,
but rather an understanding in the nature of a division of the field. A
railway obtains the services of a single banking house which acts as its
fiscal agent, underwrites its securities, receives its deposits, and has
a representative on the railway's board of directors. When the railway
becomes involved in financial difficulties, the same banking house
organizes protective committees, devises reorganization schemes, and
creates voting trusts. As Mr. Brandeis has put it, it adds to its duty
as midwife also that of undertaker.

Is this relationship potentially dangerous for the railways and the
public? The late Mr. Morgan, in his illuminating testimony in the money
trust investigation, took the position that the situation might be
dangerous in the hands of the wrong men, but he clearly implied that
there had been no bad results thus far and there were not likely to be
in the future with a continuance of the present leadership. His argument
reminds one of the young lady who "when she was good was very, very
good, and when she was bad she was horrid." Yet this view is that of
most of the financial leaders who appeared before the Pujo committee....

Mr. Davison and Mr. Schiff both opposed the policy of concentration
through interlocking at the point where the representative of the two
interests might wield a dominating influence, but they found it
difficult to fix that point.

Mr. Baker, who took the position that safety lies in the personnel of
the men, that in good hands interlocking could not do any harm, but in
bad hands would be very bad, concluded nevertheless that the movement of
concentration had gone about far enough. And Mr. George M. Reynolds, of
Chicago, thus frankly expressed himself: "I am inclined to think that
the concentration, having gone to the extent it has, does constitute a
menace." And again, "I think a more wide distribution of the power of
credit ... would really be better in the long run." When asked the
direct question, "Do you approve of the identity of directors or
interlocking directorates in potentially competing institutions?" he
replied, "Personally I do not believe that is the best policy."

It should be kept in mind that there is no evidence on record that this
power has been used oppressively otherwise than in the rate of
commission charged. Many of the bankers insist that the monopolization
of credit is a physical impossibility.... There is, nevertheless, a
concentration of credit in comparatively few hands.

If the conclusions thus far established are sound, it becomes clear that
the real evil resulting from the interlocking of railways and credit
houses, if any evil exists, arises primarily out of the relation of
credit institutions to each other, rather than out of their relation to
the railways through representation on railway boards. Were this
interlocking of railways and banks to be wholly prohibited without any
alteration in the organization of the credit market, I am unable to see
how the situation would be changed materially. The tendency on the part
of the bankers would still be to follow the law of "banking ethics" and
divide the field; a railway would still employ a single banking house as
its fiscal agent, and this banking house would still exercise a powerful
influence in determining the policy of the railway. At the same time the
railway would be deprived of the presence on its board of a financial
expert whose experience might be drawn upon in the detail of management
day by day.

As Mr. Reynolds has admitted, the menace is in the concentration of
credit. Such power may not thus far have been misused. But as the Pujo
committee has said, "whenever the incentive is at hand, the machinery is
ready." Those who have the public welfare at heart have no right to
assume that such power will never be used to the personal interest of
the bankers themselves and to the injury of the public. While I have no
great enthusiasm for the popular pastime of rushing to Washington for a
statute whenever the economic machinery fails to run smoothly, I am in
sympathy with those who are studying the problem of the restoration of
an open competitive market for capital.

However, this is a problem of extraordinary difficulty, and I do not
myself see the way at present to its solution. I am aware that Congress
has enacted legislation with the purpose of destroying this
concentration of credit, and that many look upon the Clayton Act, so far
as it touches our problem, as a distinct step in advance. Personally I
am sceptical as to its efficacy in its present form. The opportunities
for evasion are too numerous. However, it can be laid down as a general
rule that all statutory enactment which really endures is a product of
successive increments of legislation--the result of experimental tests
and the knowledge that is gained by experience. It is no argument
against the interlocking provisions of the Clayton Act that they do not
solve the problem and that they can be evaded readily. Such an attitude
of timidity and pessimism assumed twenty-five years ago would never have
given us our present air-tight Interstate Commerce Act. It may well be,
however, that no relief can be found short of the radical step of
employing government credit in aid of public-service industries. So
vital is the necessity of the service to the people that the time may
come when government loans to transportation corporations will appear to
be a logical and natural step. But this is a digression.

Once this free market for capital is assured, the question again arises,
Shall the railway board of directors contain banker members? Obviously
the only purpose that the railway could then have in admitting bankers
to its directorate would be the opportunity to utilize their experience
in the direct management of the property. Quite as obviously the
principal motive of the banker in accepting membership on a railway
board would be to represent the underwriters and to act as fiscal agent.
But with the capital market competitive, I can find no serious objection
to such relationship. Even under present conditions the banker in the
majority of cases respects his trust, refuses to vote on questions
involving his personal interest, and performs loyally his service to the
railway; but his mere presence on the board as the embodiment of the
railway's only source of credit may be sufficient to control the
situation in his behoof. However, with a free credit market, the
dominating position of the banker largely disappears and he becomes what
he ought to be, an expert adviser on financial matters. It may be asked
why, if the banker is now to confine his activities to what Mr. Loree
has called the "necessarily intimate relation between the banker and the
seeker for accommodation," this cannot be accomplished in the same
manner as in unincorporated businesses without putting the banker on the
directorate. In reply attention may be called to the fact that even in
the case of unincorporated businesses, the credit departments of the
large banks are virtually in the position of directors, so intimate and
comprehensive is their influence and advice. But more than this the
business of a railroad is so complex and extensive, its activities are
so multifarious, that an intimacy with its affairs sufficient to make
the banker's counsel of value would be impossible except by actual
presence on the directorate.

Under these changed conditions of credit, I can see greater opportunity
for the utilization of the service of expert bankers in railway
management. Directorships which have been monopolized in the hands of a
few banker specialists in railway securities should then be more widely
distributed. It is quite impossible to believe that expert banking
talent available for this service is as rare as the present situation
would suggest, in which the abilities of a relatively few men are made
to do duty in dozens of corporations. This absurd situation springs not
from a scarcity of talent but from the narrow market for credit. A
liberation of that market would bring latent ability from its
hiding-places, and by the infusion of new blood would stimulate the
management of our railway enterprises. It would open this field of
activity to men "who have been obliged to serve when their abilities
entitled them to direct."

FOOTNOTES:

[227] Adapted from the _Report of the Committee Appointed to Investigate
the Concentration of Control of Money and Credit_, 62d Congress, 3d
Session, pp. 130-33.

[228] Adapted from Albert W. Atwood, _The Borrower and the Money Trust,
Review of Reviews_, Vol. 46, August. 1912, pp. 207-218.

[229] [Interlocking directorates among the more important banks were
prohibited by the Clayton Act, passed in 1914. See p. 624.]

[230] Frank Haigh Dixon, _The Economic Significance of Interlocking
Directorates in Railway Finance, The Journal of Political Economy_, Vol.
23, No. 2, February, 1915, pp. 938-946.

CHAPTER XXIX

CRISES

THE NATURE OF AN ECONOMIC CRISIS

[231]A definition of an economic "crisis" is, like most other
definitions, very difficult to construct. By way of introduction we
shall quote a few chosen somewhat at random. Adolph Wagner, the German
economist, expresses his idea by saying: "Crises imply ... the
overwhelming and simultaneous occurrence of inability on the part of
independent _entrepreneurs_ to pay their debts." This is similar to the
statement of John Stuart Mill: "There is said to be a commercial crisis
when a great number of merchants and traders at once either have, or
apprehend that they shall have, a difficulty in meeting their
engagements." Professor E. D. Jones says: "A crisis is the sudden
application of a critical conservatism to business transactions, leading
to such a demand for liquidation as to cause a widespread inability
among business men to meet their obligations." Senator Theodore E.
Burton states: "The word crisis, if employed with entire accuracy,
describes a period of acute disturbance in the business world, the
prevailing features of which are the breakdown of credit and prices and
the destruction of confidence. It has especially to do with the
relations of debtor and creditor."

None of these definitions gives so clear an idea as does a brief
description. Probably no one has ever pictured the crisis and the
associated events more effectively than did Frederick Engels in his
little volume, _Socialism: Utopian and Scientific_:

As a matter of fact, since 1825, when the first general
crisis broke out, the whole industrial and commercial world,
production and exchange among all civilized peoples and
their more or less barbaric hangers-on, are thrown out of
joint about once every ten years. Commerce is at a
standstill, the markets are glutted, products accumulate, as
multitudinous as they are unsaleable, hard cash disappears,
credit vanishes, factories are closed, the mass of the
workers are in want of the means of subsistence; bankruptcy
follows upon bankruptcy, execution upon execution. The
stagnation lasts for years; productive forces and products
are wasted and destroyed wholesale, until the accumulated
mass of commodities finally filter off, more or less
depreciated in value, until production and exchange
gradually begin to move again. Little by little the pace
quickens. It becomes a trot. The industrial trot breaks into
a canter, the canter in turn grows into the headlong gallop
of a perfect steeplechase of industry, commercial credit,
and speculation, which finally, after breakneck leaps, ends
where it began--in the ditch of a crisis. And so over and
over again.

Perhaps even this vivid word picture will be less impressive to some
than a few facts as to the serious effects of the crisis and the
depression that follows it. Professor Wesley C. Mitchell in his recent
volume entitled _Business Cycles_ has recorded the significant features
of the crisis of 1907 in England and the United States and the following
points have been taken from his account. By the middle of the summer
evidences of difficulty had begun to appear in England. British railway
stocks had fallen off in price; the shipbuilding yards had few new
contracts; costs of production had become so great that many
manufacturers were refusing to take new business at the ruling
quotations; the building trades were dull; the ratio of net to gross
railway receipts declined; commodity prices began to drop; bank
clearings fell off; imports gained less rapidly; and the percentage of
trade union members unemployed rose from 2.8 per cent. at the end of
April to 3.6 per cent. by the close of August. These difficulties came
to a climax in the latter half of the year, being intensified by the
crash in the United States. The bank rate of the Bank of England rose
from 4-1/2 to 7 per cent., where it remained for nearly two months.
During this period the market rate averaged from 5-1/2 to 6-1/2 per
cent. Imports and exports showed smaller and smaller increases over the
preceding year and in the early months of 1908 began to decline;
clearings fell off sharply and trade union unemployment increased to
nearly 10 per cent. during the latter months of 1908.

In the United States, where the crisis degenerated into a panic,
conditions were much worse. In advance of the actual outbreak of the
panic there was for months evidence of a tension in the investment
market. Copper especially fell in price and was followed by copper
stocks. This precipitated difficulty among a group of banks that were
more or less closely identified with the copper interests. Runs were
started and a number of banks were forced to suspend payments. A
scramble for cash followed, spreading from New York throughout the
United States and accompanied by very serious consequences. Among the
worst of the effects were a premium on currency which rose at one time
as high as 4 per cent.; the necessity of introducing numerous
substitutes for cash; a demoralization of the domestic and foreign
exchange markets that caused heavy losses both to bankers and to
business men, while the amount and the prices of securities dealt in on
the stock exchanges seriously declined. During November and December
currency was at a premium of from 1/8 to 4 per cent. Call loan rates
were erratic, going as high as 125 per cent. in the latter part of
October and fluctuating between 5 and 25 per cent. as late as during the
latter half of December. During November there was a decline in the
amount of time loans and the quoted rates ranged from 6 to 7 per cent.
in October, 12 to 16 per cent. in November, and 8 to 12 per cent. in
December. Worse still was the stoppage of business by those enterprises
that could not pay the high rates and could make no special arrangements
to secure lower ones. Business failures in the United States which had
been as low as 161 in the last week of 1906, were 300 for the week
ending December 19, 1907, and 435 for the week ending January 9, 1908.
In the second quarter of 1907 there were 2,471 and for the first quarter
of 1908 there were 4,909.

These derangements of business would seem to be of interest primarily to
the bankers and brokers or to the large borrowers--to the capitalist
class. The counterpart of the picture is to be found in the effect of
the crisis upon the man of small means and upon the poor. Inability to
borrow may mean considerable inconvenience or even financial ruin for
the man of large affairs but it does not usually mean actual suffering.
Nevertheless his failure to secure funds and the necessity of selling
his securities or commodities at a low price may force him to close his
factory, to delay extensions, or at least to curtail operations. He
receives fewer orders for goods and as a result buys smaller amounts of
raw materials and lessens his own output.

This means reductions of wages and discharge of workmen. Some writers
have urged that the workingman receives a fixed wage and does not assume
industrial risks, which are borne by the capitalist or entrepreneur.
Such a statement is fallacious. The employee participates in the risks
of modern industry and suffers from a business derangement far more
severely than his employer. The capitalist secures less profits but with
his accumulated savings ordinarily endures no real privation, while
large numbers of the workers with little or no savings face actual
hunger or starvation. Demands upon charitable organizations increase,
bread lines grow longer, and suffering becomes widespread and intense
until the crisis and the ensuing depression are over....

THE CRISIS OF 1907 IN THE LIGHT OF HISTORY

[232]... From one point of view ... every economic crisis is a financial
crisis. For since values are expressed in terms of money, and since the
modern business superstructure is erected on the basis of credit, every
economic revulsion expresses itself through the medium of a change in
prices; and since the bank is the center of credit operations, every
crisis inevitably involves a revolution in the conditions of credit.
From this point of view, all crises may be declared to be financial
crises.

From another standpoint, however, a distinction may be drawn between
financial crises proper and commercial or industrial crises in the
larger sense. There may be a financial panic or crisis due primarily to
temporary and sudden oscillations in the condition of the money market
or in the price of securities. Such oscillations, sharp and sudden
though they be, may have but little relation, whether of effect or of
cause, to the general commercial and industrial interests. Of this
character, for instance, were the original Black Friday in England, in
1745, its namesake, the famous Black Friday in 1869 in New York, as well
as many spasmodic fluctuations due either to political rumors like that
which followed the Venezuelan Message of 1895, or to temporary
speculative manipulations, like the Northern Pacific "squeeze" of 1901.
Of a distinctly different nature are those wider disturbances which are
traceable to more general economic causes and which, even though they
culminate in acute financial trouble, are followed by an industrial and
commercial depression of more or less magnitude.

Into which category is to be put the crisis of 1907; and if in the
latter, what were its causes?

At the outset it must be remembered that crises are essentially modern
phenomena. We have had financial transactions, and that, too, on a large
scale, for many centuries and in many civilizations. But crises, in
contradistinction to temporary panics, have existed in England only
since the middle of the eighteenth, and in other countries only since
the beginning of the nineteenth, century. The first crisis in England,
barring the financial flurry connected with the South Sea Scheme in
1720, was that of 1763, followed by the minor disturbances of 1772 and
1783, and the more widespread convulsions of 1793, 1810, and 1825. The
first crisis in the United States was that of 1817; and it was not until
1837 that we find the first international crisis, spreading from the
United States to England and then to France. In Germany the period of
important crises was ushered in even later.

Crises, in other words, are products of modern economic life. Modern
economic life, however, has as its basal characteristic industrial
capitalism, with the factory system and the newer methods of production
for a wide market. This transition to modern industrial capitalism began
in England in the latter half of the eighteenth century, was initiated
in America in the first two decades of the nineteenth century, and took
place on the continent at a later date, last of all in Germany. The
explanation of crises must therefore be sought in some feature of our
modern capitalistic life.

The current explanations may be divided into two categories. Of these
the first includes what might be termed the superficial theories. Thus
it is commonly stated that the outbreak of a crisis is due to lack of
confidence--as if the lack of confidence was not in itself the very
thing which needs to be explained. Of still slighter value is the
attempt to associate a crisis with some particular governmental policy,
or with some action of a country's executive. Such puerile
interpretations have commonly been confined to countries like the United
States, where the political passions of a democracy have had the fullest
sway. Thus the crisis of 1893 was ascribed by the Republicans to the
impending Democratic tariff of 1894; and the crisis of 1907 has by some
been termed the "Roosevelt panic," utterly oblivious of the fact that
from the time of President Jackson, who was held responsible for the
troubles of 1837, every successive crisis has had its presidential
scapegoat, and has been followed by a political revulsion. The crisis of
1857 helped to weaken the Democrats; the crisis of 1873 resulted in a
popular majority for Tilden; the crisis of 1884 put Cleveland into the
presidential chair; and the crisis of 1893, with the ensuing depression,
brought the Republicans back to power.

Opposed to these popular, but wholly unfounded, interpretations is the
second class of explanations, which seek to burrow beneath the surface
and to discover the more occult and fundamental causes of the
periodicity of crises. Here we find an interesting and progressive
series of attempts to grapple with the difficulties of the problem. For
a long time economists and business men advanced the theory of
overproduction, forgetful of the fact that there really cannot be any
such phenomenon as too much actual production of wealth.

With the disappearance of this doctrine there came into prominence its
variant, which put the emphasis on relative, rather than absolute, or
universal overproduction, that is, the overproduction of some things and
the underproduction of others. This theory also failed to command
general assent, for the reason that no one could show in what respects
there was any underproduction of wealth, or any lack of particular
products during the years preceding a crisis. Others again, have sought
the causal fact in underconsumption, alleging that the larger
consumption of wealth will in itself take up all the slack of
production, and thus obviate a crisis. This explanation also is
inadequate, because it overlooks the fact that the real falling off in
consumption comes after the crisis has developed and not before; in
fact, the period of prosperity which precedes a crisis is generally
marked by a prodigious increase in consumption.

The socialists, again, seek to explain crises by the existence of
private property in the means of production, and contend that if we were
to cease the exploitation of the laborer by the modern capitalistic
method, crises would disappear. While, however, agreeing in this general
conclusion, they differ in their detailed analyses. Thus Rodbertus
maintains that the secret of crises is to be found in the fact that the
progress of industry causes a continually greater output of product,
while the exclusion of the laboring classes from any participation in
this increased productivity involves a relative diminution in demand,
and thus ultimately a fall in price, culminating in a crisis. Marx, on
the other hand, puts the emphasis on the fact that the necessary fall in
the rate of profits (which, according to him, is a result of the surplus
value, or exploitation theory) is incompatible with the greatly
increased productivity of fixed capital inherent in the present system,
and that the clashing of these two incongruous tendencies of modern
industrial life brings about a relative overproduction of capital, and
gives rise to periodical explosions. This view, finally, is sharply
criticised by the latest and ablest of the socialist theorists,
Tugan-Baranowsky, who in turn maintains that crises are due primarily to
the fact that under the modern system it is impossible to invest the
fresh accumulations of capital proportionally in all branches of
industry, and that it is this relative disproportion of accumulated
capital to the particular demand that causes the anarchy of the market
and the recurrent convulsions of industry.

While the socialist scholars have undoubtedly made valuable
contributions to the discussion of the problem, they, like the earlier
economists, have erred in laying stress on the question of technical
production rather than, as is done by the more recent economic thinkers,
on that of business enterprise and capitalization. This is manifestly
not the place to elaborate a general theory of crises. If we attempt,
however, to give the bare outline of the modern explanation. It would be
approximately as follows:

The problem of crises or industrial depressions is one of relative
capitalization. Under the present system of enterprise, production is
carried on in mass for a prospective market, rather than as formerly in
small quantities to fill a definite order. Even if it be contended that
certain factories nowadays are busy with producing to order, it is none
the less true that numerous plants are continually being erected in the
expectation that orders will be received in the future. The good times,
or periods of rising prices, may be due to many causes--either in
general to an augmented gold output, or in particular to the increase in
the demand for some special product, whether in the iron industry
through a new navy program, or in the clothing industry through the
outbreak of a war, or in any other industry through a change of fashion
or what not. Prices first rise in the particular enterprise, production
augments, the movement spreads to other lines of business, and the new
enterprises are financed by loans from the banks or trust companies, or
by the sale of securities on a capitalization proportionate to the
anticipated earnings. In times of buoyancy we are continually
capitalizing anticipated earnings and future hopes, and we do this
through the utilization of credit on a large scale. We build railways,
put millions into steel plants, "boom" land sites, and form combinations
of all kinds, employing the credit facilities granted by the banks, or
throwing the securities on the stock market. We "water" the stock or, if
that be forbidden by law, we drive the market quotations to a high
point, because we think that this is warranted by prospective earnings.
Sometimes we say that we capitalize the good will or, in the case of
quasi-public enterprises, the franchise; but in all cases we capitalize
the future because we believe that we shall earn an income which will
justify this capitalization.

The peculiarity, however, of an up-grade movement which rests on modern
credit facilities is that we wear magnifying glasses or look at the
future in too roseate a light. It is a natural tendency of human nature
to capitalize one's hopes and expectations too liberally. If this is
done on a continually larger scale, the capitalization becomes so great
that actual earnings do not come up to our anticipations or the fear of
a discrepancy between actual and estimated earnings begins to obsess us.
It becomes necessary to reduce the capitalization to its true
dimensions, _i. e._, to a sum proportioned to actual earnings. This
process of readjustment of overcapitalized values obviously involves
loss; but readjustment there must be. If the realization of its
necessity is sudden, we have a crisis or panic.

In the height of the period of exaltation or prosperity, something
happens to disturb confidence. A chance occurrence, a mere rumor, may
suffice. Some bank considers its credit too heavily engaged, or suspects
the adequacy of the collateral. Just at the flood of the tide, when new
demands are constantly being made, it finds itself unable or unwilling
to respond. Its refusal starts or intensifies the feeling of insecurity,
and with the inability of some important concern to meet its
obligations, a failure occurs and the crisis is precipitated. If, on the
other hand, the situation is well handled, and if the readjustment of
the overcapitalized values to actual earning capacity can be brought
about more gradually, we have, in lieu of a crisis, a liquidation and a
period of depression which lasts until the up-grade movement again sets
in.

Crises, therefore, are not necessarily the result of increased technical
production. The important point is not production, but capitalization.
There may be overcapitalization, without overproduction. Overproduction
of particular things may indeed accompany overcapitalization, but the
stress must be laid, not on the relation between production and
consumption, as the old writers assumed, but on the discrepancy between
the investment and its returns.

While the general features of a crisis are thus everywhere the same, the
details differ in each case. Sometimes it is the banks that fail first,
sometimes the general business enterprises. Sometimes it is the railway
securities that first feel the strain, at other times "the industrials,"
and at still other times the raw materials. Sometimes the bolt comes out
of the clear sky with prices at a maximum, sometimes it is only the last
stage of a period of liquidation with progressively lower prices. But
however unpredictable and seemingly inscrutable the actual course of
events, the fundamental explanation is always the necessary readjustment
of capitalization to actual earning capacity.

That this is true of all our crises can be seen from a hasty review. The
crisis of 1817 was the result of the first utilization of modern
capitalist methods in America. The period of the War of 1812 was marked
by three facts: first, the industrial revolution in New England and the
introduction of the factory system in the textile industry; second, the
great development of internal improvements through canal and turnpike
companies; third, the sudden multiplication of banks to finance the new
enterprises. The consequence was the so-called "Golden Age," which
lasted for several years, until checked by the immense imports from
England after the war, and destroyed by the collapse of the
overcapitalized undertakings. It was well into the twenties before the
country recovered from the industrial depression, and then came the
second up-grade movement, which culminated in 1837. This was primarily a
land and transportation, rather than a purely industrial, phenomenon.
The canals and turnpikes in the East were now being replaced by
railways, and the spread of slavery caused a rush of cotton planters,
not only to the black belt, but to the pine barrens and hill country of
the South. It was primarily land values that were being overcapitalized,
and the process went on to such an extent that the annual land revenues
of the Government now exceeded the total governmental receipts from all
sources of a few years before. Finally, to finance this land movement
there were called into being hundreds of the "coon-box" banks, that
found a champion in President Jackson in his war against the Bank of the
United States. As the period of exaltation had been unexampled, so the
collapse was proportionally great. The crisis of 1837, followed as it
was by those of 1839 and 1841, was still more serious than that of 1817.

It was again well-nigh a decade before the readjustment of values had
been completed. The following decade was in turn marked by five striking
facts: first, the gold discoveries of California and Australia, which
soon initiated a general rise of prices; second, the consummation of the
revolution in the media of transportation by land and water, and the
settlement of the entire Mississippi Valley, the most fertile portion of
the continent; third, the abolition of the corn laws in England and the
opening up of a market for our incipient surplus of wheat; fourth, the
era of industrial invention which resulted in the application of
capitalistic methods to new classes of enterprise besides the old
textile industries; and fifth, the development of free banking with the
"wild-cat" institutions to provide the credit facilities for this
prodigious overcapitalization. The crisis of 1857, which was the
inevitable result, was perhaps still more acute than its predecessors.
The continuance of its depressing influence on industry, however, was
checked by the economic effects of the Civil War, which gave an
artificial stimulus to many forms of enterprise.

In the period immediately succeeding the war, great changes again
occurred. The transcontinental roads were completed and the Eastern
trunk lines consolidated; the great wheat fields of the country were
opened up under the new homestead laws, and the period of large exports
began; the Bessemer process revolutionized the iron industry, and the
factory system was now applied to boots, sewing-machines, and
agricultural implements; the great copper and silver deposits were
developed, and the petroleum output grew apace; while the greenbacks and
the greenback movement fomented the process of inflation. The
discrepancy between the capitalization and the actual earning capacity
of the country's business enterprises again became so overwhelming that
the necessary readjustment took the form of the convulsion of 1873--a
convulsion the depressing effects of which were felt with almost
increasing severity for six years.

The crises of 1884 and 1893 were both less intensive and more
short-lived than their predecessors, for reasons which it is now not
difficult to explain. The resumption of specie payment in 1879 was
rendered possible, and was followed by a series of abundant crops which
revivified enterprise, and which were aided by the use of agricultural
machinery on a large scale. The energy and the capital of the nation,
however, were devoted in increasing measure to the transportation
industry. This resulted in a perfect orgy of new railroad construction,
the entire mileage of the country increasing in five years by 50 per
cent. As the overcapitalization was primarily a railway
overcapitalization, the resulting reaction of 1884 was essentially a
railway crisis, leading to but indirect and temporary disturbances in
industry at large. Within a year or two recovery was general, and the
prosperous years from 1886 onward were reflected in the existence of a
huge surplus of governmental revenues. The live-stock and meat-packing
business attained its high-water mark; the textile industries made great
progress in the finer grades, and the ready-made clothing industry
assumed vast dimensions; the iron and steel industry was revolutionized
anew by the invention of the open-hearth process and the utilization of
cheap ore from the Lake Superior region; the South was being quickly
developed by the Northern capital that poured into the cotton mills and
the coal and iron mines; electricity was applied to industry on an
increasing scale, and the country took rapid strides in its evolution
from an agricultural to an industrial community.

The movement of overcapitalization, however, was somewhat checked by two
important facts: the downward tilt of world prices in general, which had
been falling since 1873 and which were fast reaching their lowest point;
and the relative shrinkage, not only in the amount of the wheat crop,
but also in the value of both the wheat and the cotton crops. The
resulting reaction of 1893, which was itself partly due to the ill-timed
experiments with silver legislation, was as a consequence neither so
profound nor so long-continued, since the discrepancy between
anticipated and actual values turned out not to be so excessive.

When we come particularly to the crisis of 1907, we find that the
general causes were very much the same. The last decade has been
characterized by the most unexampled prosperity in our history. The most
striking initial cause is the prodigious increase in the gold supply.
Whereas the annual average value of the output of gold was under one
hundred millions in the first half of the eighties, and only a hundred
and twelve millions in the second half, it has grown with such enormous
strides that during the past two years it has reached an annual value of
about four hundred millions. The result has been a constant rise of
prices from the minimum level of 1896. The rapid accumulation of gold,
much of which went into the bank reserves, enabled the financial
institutions to expand their credit facilities many fold, and as a
consequence enterprise flourished in every direction. During the last
decade the record crops of cereals and cotton, the extension of dry
farming, the effects of irrigation on fruit culture, the development of
truck farms, and the unparalleled increase of immigration led to a
remarkable enhancement of land values throughout the length and breadth
of the land; the output of coal doubled, that of petroleum more than
doubled, and that of pig iron, as well as of steel, actually trebled;
the huge combinations of capital, now spreading to every form of
enterprise, effected prodigious economies and revolutionized business
methods; and the transition from the agricultural to the industrial
phase of economic development proceeded with unlooked-for celerity.
Values were pushed up on all sides and the hopes of a prosperous
community were capitalized with a recklessness born of unbounded faith.
The pace was too rapid; the reaction was bound to ensue. In the late
autumn of 1907 the revulsion was precipitated, with all the familiar
accompaniments of an acute panic such as the collapse of several
financial institutions, the sudden curtailment of loans, leading to the
failures of some prominent business concerns, the hoarding of money, the
appearance of a premium on currency, going to over 3 per cent., and the
frantic efforts of the financiers to relieve the situation by the
importation of gold, the issue of clearing-house certificates and the
interference of Government through the dubious expedients of the placing
of a new bond issue and the emission of Treasury loan certificates.

The crisis of 1907, however, is on the whole not comparable either to
that of 1857 or to that of 1873, for reasons which have thus far perhaps
not been adequately discussed. These reasons may be classed under five
heads.

In the first place, the very magnitude of the country's resources has
been a favorable factor. The unparalleled prosperity of the past decade
has made possible the accumulation of a vast reserve in the case, not
only of the great corporations, but also of the average business man.
This reserve has acted as a buffer to the shock of reaction, and has
softened the impact through a speedy restoration of confidence in the
excellence of the country's assets and in the real solvency of business.

Secondly, the crops, while not those of a bumper year, have been large
and valuable. It is significant that almost each of our great crises in
the past has been preceded either by the failure of the harvest at home
or by the existence of such a bountiful output abroad as greatly to
reduce prices. It must be remembered that, notwithstanding all recent
developments, this country is still primarily agricultural, and that
upon the varying extent of our great staple crops depends in large
measure the effective demand which sets and keeps in motion the wheels
of business activity. By a fortunate coincidence, the crisis was
attended by a phenomenon which in ordinary times would have spelled
prosperity, and which in this extraordinary conjuncture helped to bring
back normal conditions.

In the third place, the overcapitalization of values was somewhat less
conspicuous than hitherto in our greatest industry--that of
transportation. Some of our former crises have, as we know, been brought
on primarily by the speculative building of railroads. But whereas in
the early eighties the annual increase of construction reached ten and
eleven thousand miles, during the past five years, with a railway system
three times as large, the annual increment of new construction was only
four or five thousand miles. The consequence has been that with the
rapid upbuilding of the country the railways have grown up to their
capitalization, until it is now reasonably certain that there has been
for some little time scarcely any actual overcapitalization. A striking
proof of the absence of any real discrepancy between normal values and
the capitalization of actual earning capacity is afforded by the
congestion of traffic of a year or two ago; and even with only normal
business activity it is computed that, in order to prevent this
congestion in future and to maintain the railways at a reasonable
standard of efficiency, there will be required an annual investment of
over a billion dollars.

Fourthly, the crisis of 1907 was preceded by a period of gradual
liquidation. General prices of commodities, with a few notable
exceptions like that of copper, were indeed high until well-nigh the
outbreak of the panic. But the prices of securities had for some time
undergone a marked shrinkage. Some, quite mistakenly, attribute this
shrinkage to lack of confidence engendered by the governmental policy
toward industry; others, with equal readiness and no less extravagance,
ascribe it to the distress caused by the exposure of the methods of
"high finance" in positions of trusteeship. In reality, however, the
depreciation in securities was caused chiefly by the rise in the rate of
interest. In fact the one phenomenon is really the other; for where
earnings remain unchanged, the capitalization of the earnings depends on
the rate of interest. If it be objected that the price of stocks fell
because of the apprehended decrease of future earnings, due to lack of
confidence, the retort is obvious that this would not suffice to explain
the equal or still greater fall in the capital value of bonds, private
or public, with a fixed rate of interest. The depreciation was not
national, but international, in character; and it applied not only to
our railway and industrial securities, but to the English "Consols" as
well.

The rise in the interest rate, which explains the fall in the capital
value of securities, was due to several causes. First and foremost is
the increase in the gold output. For, as is now well established by
economic theory and reinforced by the observations of practical men,
while any increase in the supply of loanable funds on the call-money
market temporarily reduces the "money rate," an increase in the general
supply of standard money in the community, on the contrary, raises not
only the price level of all commodities, but the price for the use of
capital, which we call the general rate of interest. The increase of
money as the standard of value inevitably tends to increase the general
rate of interest. Again, since the rate of interest is always adjusted
to the earnings of the fund of capital at the margin of its employment,
the rate of interest has risen because there has been relatively less
capital available for employment. The fund of free capital has been
rapidly diminishing during the past few years. Hundreds of millions were
destroyed in the Boer and Japanese wars; hundreds of millions more
disappeared through the destruction of San Francisco and Valparaiso; and
countless millions in addition have been utilized to finance the more or
less dubious schemes which have sprung up in all countries during the
years of prosperity. Even though there was no great overcapitalization
of railroads and even though many of the industrial enterprises were
really legitimate, the discounting of the future was not quite ample,
and the capital was invested more rapidly than the immediate returns
would warrant. The replacement fund, in other words, was neither quite
large enough nor quite active enough; and with the gradual exhaustion of
the available free capital, interest rates necessarily rose and security
values as a consequence fell.

The period of liquidation was thus a fortunate event. By checking the
movement of exaltation and preventing the level of prices from being so
extreme, it kept the reaction from being so great. Where the crest of
the wave is lower, the shock of its break is less. Had the ascent of
prices and values gone on unhindered, the convulsion of 1907 would have
been far more severe. From this point of view, even those who mistakenly
persist in ascribing the lack of confidence to the President ought in
reality to be grateful to him; for to the extent that he may be said to
have superinduced the liquidation of the spring and summer, he assuredly
contributed to mitigate the shock of the inevitable reaction in the
autumn.

The fifth and final cause of the lesser magnitude of the crisis is the
development of trusts. Until we attain the right perspective, it is
always difficult to get a correct view of the far-reaching changes which
are taking place under our very eyes. Especially true is this of such a
veritable revolution as is typified by the modern concentration and
integration of industry into the vast combinations known as trusts.
There are indeed many disquieting and untoward symptoms in the
development of which this is not the place to speak. But as against the
undoubted perils of what we are all now coming to recognize as an
inevitable process, we sometimes forget to put at least one
countervailing advantage which is of especial importance in this
connection. The modern trust, as typified in its most developed form by
the United States Steel Corporation, is apt to exert an undeniably
steadying influence on prices. Precisely because of the immense
interests at stake, and the danger of a reaction, the trust with its
consummately able management tends toward conservatism. As compared with
the action of a horde of small competitors under similar conditions, it
is apt during a period of prosperity to refrain from marking up prices
to the top notch, and is likely to make a more adequate provision for
the contingencies of the market. With this greater moderation is apt to
be associated a more accurate prevision, which succeeds in a more
correct adjustment of present investment to future needs. The drift of
business enterprise in its newer form is thus toward a relative checking
of the discrepancy between estimated and actual earnings, or, in other
words, toward a retardation in the process of overcapitalization. The
history of trusts is still too recent, and in not all of them are we yet
able to discern the working out of what ultimately will come to be
recognized as the real laws of their evolution. To those, however, who
comprehend what this revolution in business enterprise really implies,
it can scarcely be doubted that the fruit of this steadying influence
and of the better adaptation of the present to the future is already
perceptible. Notwithstanding the quite unexampled prosperity of the last
decade, the tempo of overcapitalization has been relatively less rapid
and the process of readjustment throughout the world of enterprise has
therefore been less extreme. Industry has slackened rather than
collapsed, and the disturbance itself has been comparatively
short-lived, with the prospects of an early rebound. The influence of
trusts in moderating crises and in minimizing depressions will doubtless
become more apparent with each ensuing decade in the history of modern
industry.

While the general causes which are responsible for the crisis of 1907
have been recounted above, there still remains one point of fundamental
importance. If we compare our economic history with that of Europe, we
observe that acute financial crises have there almost passed away.
England has had no severe convulsion since 1866, and in France and
Germany also the disturbances are more and more assuming the form of
periodic industrial depressions rather than of acute financial crises.
The responsibility for the continuance in this country of a phenomenon
which is in large measure vanishing elsewhere rests beyond all
peradventure of doubt on the inadequacy of our currency system.

CURRENT THEORIES OF CRISES

TWO POINTS OF AGREEMENT

[233]Wide divergences of opinion continue to exist among competent
writers upon crises; but in recent years substantial agreement has been
reached upon two points of fundamental importance.

Crises are no longer treated as sudden catastrophes which interrupt the
"normal" course of business, as episodes which can be understood without
investigation of the intervening years. On the contrary, the crisis is
regarded as but the most dramatic and the briefest of the three phases
of a business cycle--prosperity, crisis, and depression.[234] Modern
discussions endeavor to show why a crisis is followed by depression,
and depression by prosperity, quite as much as to show why prosperity is
followed by a crisis. In a word, the theory of crises has grown into the
theory of business cycles.[235]

This wider grasp of the problem has discredited the view that crises are
due to abnormal conditions which tempt industry and trade to forsake
their beaten paths and temporarily befog the judgment of business men
and investors, or to misguided legislation, unsound business practices,
imperfect banking organization, and the like.[236] As business cycles
have continued to run their round decade after decade in all nations of
highly developed business organization, the idea that each crisis may be
accounted for by some special cause has become less tenable. On the
contrary, the explanations in favor to-day ascribe the recurrence of
crises after periods of prosperity to some inherent characteristic of
economic organization or activity. The complex processes which make up
business life are analyzed to discover why they inevitably work out a
change from good times to bad and from bad times to good. The influence
of special conditions is admitted, of course, but rather as a factor
which complicates the process than as the leading cause of crises.

BEVERIDGE'S "COMPETITION THEORY"

Among these theories which seek to account not for crises but for the
cyclical fluctuations of economic activity, the "competition theory"
tentatively advanced by Beveridge is one of the simplest.

In most instances, he begins, production is carried on by several or
many establishments, each acting independently, and each seeking to do
as large a share of the business as possible. Whenever the demand for
their wares increases, each competitor tries to engross a larger portion
of the market. "Inevitably, therefore, all the producers together tend
to overshoot the demand and to glut the market for a time. This is a
result not of wild speculation nor of miscalculation of the total
demand; it must be a normal incident wherever competition has a place at
all." Such activity among producers constitutes the period of
prosperity. But sooner or later the glutting of the market becomes
apparent, and then the crisis comes, because the goods cannot all be
sold at a profit. Prices fall, production is checked, and a period of
depression ensues. Gradually, however, the slackened rate of production
allows the accumulated stocks to be cleared, perhaps below cost price,
perhaps by waiting until demand grows up to supply. When this excess of
demand over supply has once again become patent, business recovers.
Depression yields to prosperity, competitors again vie with each other
to increase their shares in the output, after a few years the market is
glutted again, and a new crisis comes, to be followed once more by
depression. Thus business cycles are due in the last resort to "the
simple and well nigh universal fact of industrial competition."[237]

MAY'S THEORY OF THE DISCREPANCY BETWEEN WAGES AND PRODUCTIVITY

Like Beveridge, May conceives crises to result immediately from the
glutting of markets for industrial products. But May offers a quite
different analysis of the cause of gluts. The continually growing
productivity of industry makes necessary a corresponding growth of the
market, if disaster is to be avoided. But to enable producers to sell
their growing output promptly prices must be reduced and wages must be
raised in proportion as the supply of goods increases. For it is only by
combining an increase in the money income of the mass of the population
with a decrease in the cost of commodities that a country's home markets
can be kept expanding with the progress of industrial methods. Periods
of prosperity attended by rising prices necessarily violate this
condition of business hygiene and inevitably end by glutting markets.
Then come crises, which restore the body politic to health by forcing
down prices to the point where consumers can purchase the supplies which
are offered. The germ of the trouble, then, is the tendency of prices to
rise during periods of increasing productivity. Accordingly, May urges
as remedy a legal limitation of the rate of profits, in order that
producers may be forced to reduce prices as they increase output.[238]

HOBSON'S THEORY OF OVER-SAVING

A third explanation of how markets come to be glutted periodically is
offered by Hobson's theory of over-saving. Hobson holds that at any
given time "there is an exact proportion of the current income which, in
accordance with existing arts of production and existing foresight, is
required to set up new capital so as to make provision for the maximum
consumption throughout the near future." Now, if in a period of
prosperity the rate of consumption should rise _pari passu_ with the
rate of production, there is no inherent reason why the prosperity might
not continue indefinitely. But in modern societies, a considerable
portion of the wealth produced belongs to a small class. In active times
their incomes rise more rapidly than their consumption and the surplus
income is perforce saved. There results for the community as a whole a
slight deficiency of spending and a corresponding excess of saving. The
wealthy class seeks to invest its new savings in productive
enterprises--thereby increasing the supply of goods and also increasing
the incomes from which further savings will be made. This process runs
cumulatively during the years of prosperity until finally the markets
become congested with goods which cannot be sold at a profit. Then
prices fall, liquidation ensues, capital is written down, and the
incomes of the wealthy class are so reduced that savings fall below the
proper proportion to spending. During this period of depression the glut
of goods weighing upon the market is gradually worked off, and the
prospect of profitable investment slowly returns. Saving rises again to
the right proportion to spending and good times prevail for a season.
But after a while the chronic impulse towards over-saving becomes fully
operative once more, and soon or late begets another congestion of the
markets and this congestion begets another depression. Proximately,
then, the cause of alternating prosperity and depression is the
tendency toward over-saving; ultimately it is the existence of the
surplus incomes which lead to over-saving.[239]

HULL'S THEORY OF THE CHANGING COSTS OF CONSTRUCTION

An American business man, George H. Hull, has recently drawn from his
experience of practical affairs conclusions which resemble those drawn
by [a German] Professor Spiethoff, from his theoretical analysis of
economic records. High prices of construction, runs his thesis, is the
hitherto "unknown cause of the mysterious depressions" from which the
industrial nations suffer.

In demonstrating the thesis, Hull contends that agriculture, commerce,
and finance fluctuate within relatively narrow limits. Agriculture
provides the necessities of life, commerce distributes them, and finance
adjusts the bills. The volume of all this business is fairly constant,
because the demand for necessities is incapable of sudden expansion or
contraction. Industry, on the contrary, may expand or contract
indefinitely--especially that part of industry devoted to construction
work. For the sources of "booms" and depressions, therefore, we must
look to the enterprises which build and equip houses, stores, factories,
railways, docks, and the like.

Of the huge total of construction, which Hull believes to make over
three-quarters of all industrial operations, at least two-thirds, even
in the busiest of years, consists of repairs, replacements, and such
extensions as are required by the growth of population. This portion of
construction is necessary and must be executed every year. But the
remaining portion is "optional construction," and is undertaken or not
according as investors see a liberal or a meagre profit in providing new
equipment.

Now, when the costs of construction fall low enough to arouse "the
bargain-counter instinct," many of "the far-seeing ones who hold the
purse-strings of the country" let heavy contracts, and their example is
followed by the less shrewd. The addition of the resulting new business
to the regular volume of "necessity construction" plus the provision of
ordinary consumers' goods creates a "boom." But, after a year or two,
contractors discover that their order books call for more work than they
can get labor and materials to finish on contract time. When this
oversold condition of the contracting trades is realized, the prices of
labor and of raw materials rise rapidly. The estimated cost of
construction on new contracts then becomes excessive. Shrewd investors
therefore begin to defer the execution of their plans for extending
permanent equipment, and the letting of fresh contracts declines apace.
As they gradually complete work on their old contracts, all the
enterprises making iron, steel, lumber, cement, brick, stone, etc., then
face a serious shrinkage of business. Just as the execution of the large
contracts for "optional construction," let in the low-priced period,
brought on prosperity, so the smallness of such contracts, let in the
high-price period, now brings on depression. Then the prices of
construction fall until they arouse "the bargain-counter instinct" of
investors once more, and the cycle begins afresh.

While Hull grants that panics are often caused by strictly financial
disorders, he holds that all industrial depressions are caused by high
prices of construction, and foreshadowed by high prices of iron.
Consequently he believes that depressions could be prevented from
occurring if the Government would collect and publish monthly "all
pertinent information in relation to the existing volume of construction
under contract for future months, and all pertinent information in
relation to the capacity of the country to produce construction
materials to meet the demand thus indicated."[240]

SOMBART'S THEORY OF THE UNEVEN EXPANSION IN THE PRODUCTION OF ORGANIC
AND INORGANIC GOODS

Sombart, like many of the recent German writers, finds ill-proportioned
production the chief cause of crises; but he thinks it inaccurate to say
that the overproduction is in industrial equipment. For during the
German "boom" which collapsed in 1900-01, overproduction was quite as
marked in industries making equipment for electric lighting systems,
telephone plants, street railways, dwellings, bicycles, etc., as in
industries making machines. The real lack of proportion he sees in the
unlike degree of expansion in industries using organic and inorganic
materials. The inorganic industries, typified by steel, can expand to an
enormous extent within a brief period without being seriously hampered
by scarcity of raw materials. The organic industries, typified by
cotton-spinning, on the contrary, are always in precarious dependence
upon the year's harvests. In the organic industries, one may say, the
condition of business is determined by the harvests; in the inorganic
industries the condition of business determines the production of raw
materials. The modern crisis, then, following upon a period of
prosperity, is substantially the result of the different rhythm of
production in the organic and inorganic realms. The organic industries
dependent upon harvests cannot keep pace with the inorganic when the
latter are being rapidly extended by heavy investments of capital.[241]

CARVER'S THEORY OF THE DISSIMILAR PRICE FLUCTUATIONS OF PRODUCERS' AND
CONSUMERS' GOODS

Carver has suggested a way of accounting for business cycles by applying
the laws of value which govern producers' goods. He points out that a
comparatively small change in a factory's selling prices will cause a
much greater change in its profits, if volume of output and expenses
remain the same. Since the value of the factory as a going concern is
the capitalized value of its prospective profits, a large increase of
profits will cause a large increase of the factory's value, provided the
high profits are expected to continue long. Hence the law that "the
value of producers' goods tends to fluctuate more violently than the
value of consumers' goods." It follows that:

"A slight rise in the price of consumers' goods will so
increase the value of the producers' goods which enter into
their production as to lead to larger investments in
producers' goods. The resulting larger market for producers'
goods again stimulates the production of such goods, and
withdraws productive energy from the creation of consumers'
goods. This for the time tends to raise the price of
consumers' goods still higher, and this again to stimulate
still further the creation of producers' goods. There is no
check to this tendency until the new stock of producers'
goods begin to pour upon the market an increased flow of
consumers' goods. This tends to produce a fall in their
value, which in turn produces a still greater fall in the
value of producers' goods, and so the process goes."

Thus, once more, prosperity breeds crisis and depression; but this time
the reason is found in the dissimilar fluctuations which the laws of
value establish for the goods which people use and the equipment with
which they are made.[242]

FISHER'S THEORY OF THE LAGGING ADJUSTMENT OF INTEREST

Another interesting suggestion comes from Irving Fisher. By statistics
he has shown that when for any reason prices begin to rise, interest
rates advance, but not fast enough to offset the decline in the
purchasing power of the principal caused by the rise of prices. During
such periods, accordingly, borrowers on the whole get the better of
lenders and make high profits. Since the borrowers consist largely of
active business men, precisely the class of greatest foresight, they
grasp the situation more quickly than lenders. As a result of their
desire to profit by their opportunity, loans are rapidly extended. This
extension is effected largely by the lending of bank credits, that is,
by the increasing of deposit currency. The greater volume of the
currency combines with more rapid circulation of money and checks to
increase prices again, and so to start the whole process anew on a
higher level. "There is thus set up a vicious circle, which will
continue just as long as the rate of interest fails to make a proper
adjustment to put on the brakes and prevent over-borrowing."

"But the rise in interest, though belated, is progressive, and, as soon
as it overtakes the rate of rise in prices, the whole situation is
changed." Borrowers can no longer hope to make great profits, and the
demand for loans ceases to expand. Further, the higher rate of interest
reduces the price of many of the securities used as collateral for
loans. Business men "who have counted on renewing their loans at the
former rates and for the former amounts are unable to do so. It follows
that some of them are destined to fail." There follow suspicions
regarding the solvency of the banks, runs for cash, forced curtailment
of loans, and exceedingly high rates of interest--in short, the
phenomena of crisis.

The contraction of loans is accompanied by a reduction of deposit
currency and a slower circulation both of money and of checks. Hence
prices decline. Again the rate of interest follows; but just as it was
slow to rise so now it is slow to fall. Then the business men who borrow
find that the sluggish adjustment of interest reduces their profits.
Therefore loans, and the deposits based on loans, contract again. But
the shrinking volume of deposit currency causes a further fall of
prices, and once more interest lags behind and renews the process. Thus
the phase of depressions runs cumulatively until at last the progressive
reduction of interest has overtaken the fall of prices. At this point
business men find their profits rising to the normal level. Borrowing
becomes freer, the volume of deposit currency swells, prices start
upward, and the cycle begins afresh.[243]

* * * * *

Beveridge ascribes crises to industrial competition, May to the
disproportion between the increase in wages and in productivity, Hobson
to over-saving,... Hull to high costs of construction, Lescure to
declining prospects of profits,... [Seligman] to a discrepancy between
anticipated profits and current capitalization, Sombart to the unlike
rhythm of production in the organic and inorganic realms, Carver to the
dissimilar price fluctuations of producers' and consumers' goods, Fisher
to the slowness with which interest rates are adjusted to changes in the
price level.

One seeking to understand the recurrent ebb and flow of economic
activity characteristic of the present day finds these numerous
explanations both suggestive and perplexing. All are plausible, but
which is valid? None necessarily excludes all the others, but which is
the most important? Each may account for certain phenomena; does any one
account for all the phenomena? Or can these rival explanations be
combined in such a fashion as to make a consistent theory which is
wholly adequate?

MITCHELL'S THEORY OF BUSINESS CYCLES

[244]Only by putting any theory to the practical test of accounting for
actual business experience can its value be determined. The case for the
present theory, therefore, and also the case against it, is to be found
not in the easy summary which follows, but in the difficult chapters
which precede,[245] or better still in an independent effort to use it
in interpreting the ceaseless ebb and flow of economic activity.

1. THE CUMULATION OF PROSPERITY

With whatever phase of the business cycle analysis begins, it must take
for granted the conditions brought about by the preceding phase,
postponing explanation of these assumptions until it has worked around
the cycle and come again to its starting point.

A revival of activity, then, starts with this legacy from depression: a
level of prices low in comparison with the prices of prosperity, drastic
reductions in the costs of doing business, narrow margins of profit,
liberal bank reserves, a conservative policy in capitalizing business
enterprises and in granting credits, moderate stocks of goods, and
cautious buying.

For reasons which will appear in the sequel, such conditions are
accompanied by an expansion in the physical volume of trade. Though slow
at first, this expansion is cumulative. Now it is only a question of
time when an increase in the amount of business transacted which grows
more rapid as it proceeds will turn dullness into activity. Left to
itself, this transformation is effected by slow degrees; but it is often
hastened by some propitious event arising from other than domestic
business sources, such as exceptionally profitable harvests, heavy
purchases of supplies by Government, or a marked increase in the export
demand for the products of home industry.

Even when a revival of activity is confined at first within a narrow
range of industries or within some single section of the country, it
soon spreads to other parts of the business field. For the active
enterprises must buy more materials, wares, and current supplies from
other enterprises, the latter from still others, and so on without
assignable limits. Meanwhile all enterprises which become busier employ
more labor, use more borrowed money, and make higher profits. There
results an increase in family incomes and an expansion of consumers'
demand, which likewise spreads out in ever widening circles. Shopkeepers
pass on larger orders for consumers' goods to wholesale merchants,
manufacturers, importers, and producers of raw materials. All these
enterprises require more supplies of various kinds for handling their
growing trade, and increase the sums which they pay out to employés,
lenders, and proprietors--thus stimulating afresh the demand for both
producers' and consumers' goods. Soon or late this expansion of orders
reaches back to the enterprises from which the impetus to greater
activity was first received, and then this whole complicated series of
reactions begins afresh at a higher pitch of intensity. All this while,
the revival of activity is instilling a feeling of optimism among
business men, and this feeling both justifies itself and heightens the
forces which engendered it by making every one readier to buy with
freedom.

While the price level is often sagging slowly when a revival begins, the
cumulative expansion in the physical volume of trade presently stops the
fall and starts a rise. For, when enterprises have in sight as much
business as they can handle with their existing facilities of standard
efficiency, they stand out for higher prices on additional orders. This
policy prevails even in the most keenly competitive trades, because
additional orders can be executed only by breaking in new hands,
starting old machinery, buying new equipment, or making some other
change which involves increased expense. The expectation of its coming
hastens the advance. Buyers are anxious to secure or to contract for
large supplies while the low level of quotations continues, and the
first definite signs of an upward trend of quotations brings out a
sudden rush of orders.

Like the increase in the physical volume of business, the rise of prices
spreads rapidly; for every advance of quotations puts pressure upon some
one to recoup himself by making a compensatory advance in the prices of
what he has to sell. The resulting changes in prices are far from even,
not only as between different commodities, but also as between different
parts of the system of prices. Retail prices lag behind wholesale, the
prices of staple consumers' behind the prices of staple producers'
goods, and the prices of finished products behind the prices of their
raw materials. Among raw materials, the prices of mineral products
reflect the changed business conditions more regularly than do the
prices of raw animal, farm, or forest products. Wages rise often more
promptly, but always in less degree than wholesale prices; discount
rates rise sometimes more slowly than commodities and sometimes more
rapidly; interest rates on long loans always more sluggishly in the
early stages of revival, while the prices of stocks--particularly of
common stocks--both precede and exceed commodity prices on the rise. The
causes of these differences in the promptness and the energy with which
various classes of prices respond to the stimulus of business activity
are found partly in differences of organization between the markets for
commodities, labor, loans, and securities; partly in the technical
circumstances affecting the relative demand for and supply of these
several classes of goods; and partly in the adjusting of selling prices
to changes in the aggregate of buying prices which a business enterprise
pays, rather than to changes in the prices of the particular goods
bought for resale.

In the great majority of enterprises, larger profits result from these
divergent price fluctuations coupled with the greater physical volume of
sales. For, while the prices of raw materials and of wares bought for
resale usually, and the prices of bank loans often, rise faster than
selling prices, the prices of labor lag far behind, and the prices which
make up supplementary costs, _i. e._, interest, rent, depreciation,
insurance, salaries for general officials and the like, are mainly
stereotyped for a time by old agreements regarding salaries, leases, and
bonds.

This increase of profits, combined with the prevalence of business
optimism, leads to a marked expansion of investments. Of course the
heavy orders for machinery, the large contracts for new construction,
etc., which result, swell still further the physical volume of business,
and render yet stronger the forces which are driving prices upward.

Indeed, the salient characteristic of this phase of the business cycle
is the cumulative working of the various processes which are converting
a revival of trade into intense prosperity. Not only does every increase
in the physical volume of trade cause other increases, every convert to
optimism makes new converts, and every advance of prices furnishes an
incentive for fresh advances; but the growth of trade also helps to
spread optimism and to raise prices, while optimism and rising prices
both support each other and stimulate the growth of trade. Finally, as
has just been said, the changes going forward in these three factors
swell profits and encourage investments, while high profits and heavy
investments react by augmenting trade, justifying optimism, and raising
prices.

2. HOW PROSPERITY BREEDS A CRISIS

While the processes just sketched work cumulatively for a time to
enhance prosperity, they also cause a slow accumulation of stresses
within the balanced system of business--stresses which ultimately
undermine the conditions upon which prosperity rests.

Among these stresses is the gradual increase in the costs of doing
business. The decline in supplementary costs per unit of output ceases
when enterprises have once secured all the business they can handle
with their standard equipment, and a slow increase of these costs begins
when the expiration of old contracts makes necessary renewals at the
high rates of interest, rent, and salaries which prevail in prosperity.
Meanwhile prime costs, wages and raw materials, rise at a relatively
rapid rate. Equipment which is antiquated and plants which are ill
located or otherwise work at some disadvantage are brought again into
operation. The price of labor rises, not only because standard rates of
wages go up, but also because of the prevalence of higher pay for
overtime. More serious still is the fact that the efficiency of labor
declines, because overtime brings weariness, because of the employment
of "undesirables," and because crews cannot be driven at top speed when
jobs are more numerous than men to fill them. The prices of raw
materials continue to rise faster on the average than the selling prices
of products. Finally, the numerous small wastes, incident to the conduct
of business enterprises, creep up when managers are hurried by a press
of orders demanding prompt delivery.

A second stress is the accumulating tension of the investment and money
markets. The supply of funds available at the old rates of interest for
the purchase of bonds, for lending on mortgages, and the like, fails to
keep pace with the rapidly swelling demand. It becomes difficult to
negotiate new issues of securities except on onerous terms, and men of
affairs complain of the "scarcity of capital." Nor does the supply of
bank loans grow fast enough to keep up with the demand. For the supply
is limited by the reserves which bankers hold against their expanding
demand liabilities. Full employment and active retail trade cause such a
large amount of money to remain suspended in active circulation that the
cash left in the banks increases rather slowly, even when the gold
output is rising most rapidly. On the other hand, the demand for bank
loans grows not only with the physical volume of trade, but also with
the rise of prices, and with the desire of men of affairs to use their
own funds for controlling as many business ventures as possible.
Moreover, this demand is relatively inelastic, since many borrowers
think they can pay high rates of discount for a few months and still
make profits on their turnover, and since the corporations which are
unwilling to sell long-time bonds at the hard terms which have come to
prevail try to raise part of the funds they require by discounting one-
or two-year notes.

Tension in the bond and money markets is unfavorable to the continuance
of prosperity, not only because high rates of interest reduce the
prospective margins of profit, but also because they check the expansion
in the volume of trade out of which prosperity developed. Many projected
ventures are relinquished or postponed, either because borrowers
conclude that the interest would absorb too much of their profits, or
because lenders refuse to extend their commitments farther.

There is one important group of enterprises which suffers an especially
severe check from this cause in conjunction with high prices--the group
which depends primarily upon the demand for industrial equipment. In the
earlier stages of prosperity, this group usually enjoys a season of
exceptionally intense activity. But when the market for bonds becomes
stringent, and--what is often more important--when the cost of
construction has become high, business enterprises and individual
capitalists alike defer the execution of many plans for extending old
and erecting new plants. As a result, contracts for this kind of work
become less numerous as the climax of prosperity approaches. Then the
steel mills, foundries, machine factories, copper smelters, quarries,
lumber mills, cement plants, construction companies, general
contractors, and the like find their orders for future delivery falling
off. While for the present they may be working at high pressure to
complete old contracts within the stipulated time, they face a serious
restriction of trade in the near future.

The imposing fabric of prosperity is built with a liberal factor of
safety: but the larger grows the structure the more severe become these
internal stresses. The only effective means of preventing disaster while
continuing to build is to raise selling prices time after time high
enough to offset the encroachments of costs upon profits, to cancel the
advancing rates of interest, and to keep investors willing to contract
for fresh industrial equipment.

But it is impossible to keep selling prices rising for an indefinite
time. In default of other checks, the inadequacy of cash reserves would
ultimately compel the banks to refuse a further expansion of loans upon
any terms. But before this stage has been reached, the rise of prices is
stopped by the consequences of its own inevitable inequalities. These
inequalities become more glaring the higher the general level is forced;
after a time they threaten serious reduction of profits to certain
business enterprises, and the troubles of these victims dissolve that
confidence in the security of credits with which the whole towering
structure of prosperity has been cemented.

What, then, are the lines of business in which selling prices cannot be
raised sufficiently to prevent a reduction of profits? There are certain
lines in which selling prices are stereotyped by law, by public
commissions, by contracts of long term, by custom, or by business
policy, and in which no advance, or but meagre advances can be made.
There are other lines in which prices are always subject to the
incalculable chances of the harvests, and in which the market value of
all accumulated stocks of materials and finished goods wavers with the
crop reports. There are always some lines in which the recent
construction of new equipment has increased the capacity for production
faster than the demand for their wares has expanded under the repressing
influence of the high prices which must be charged to prevent a
reduction of profits. The unwillingness of investors to let fresh
contracts threatens loss not only to contracting firms of all sorts, but
also to all the enterprises from whom they buy materials and supplies.
The high rates of interest not only check the current demand for wares
of various kinds, but also clog the effort to maintain prices by keeping
large stocks of goods off the market until they can be sold to better
advantage. Finally, the very success of other enterprises in raising
selling prices fast enough to defend their profits aggravates the
difficulties of the men who are in trouble. For to the latter every
further rise of prices for products which they buy means a further
strain upon their already stretched resources.

As prosperity approaches its height, then, a sharp contrast develops
between the business prospects of different enterprises. Many, probably
the majority, are making more money than at any previous stage of the
business cycle. But an important minority, at least, face the prospect
of declining profits. The more intense prosperity becomes, the larger
grows this threatened group. It is only a question of time when these
conditions, bred by prosperity, will force some radical readjustment.

Now such a decline of profits threatens worse consequences than the
failure to realize expected dividends. For it arouses doubt concerning
the security of outstanding credits. Business credit is based primarily
upon the capitalized value of present and prospective profits, and the
volume of credits outstanding at the zenith of prosperity is adjusted to
the great expectations which prevail when the volume of trade is
enormous, when prices are high, and when men of affairs are optimistic.
The rise of interest rates has already narrowed the margins of security
behind credits by reducing the capitalized value of given profits. When
profits themselves begin to waver the case becomes worse. Cautious
creditors fear lest the shrinkage in the market rating of the business
enterprises which owe them money will leave no adequate security for
repayment. Hence they begin to refuse renewals of old loans to the
enterprises which cannot stave off a decline of profits, and to press
for a settlement of outstanding accounts.

Thus prosperity ultimately brings on conditions which start a
liquidation of the huge credits which it has piled up. And in the course
of this liquidation prosperity merges into crisis.

3. CRISES AND PANICS

Once begun, the process of liquidation extends rapidly, partly because
most enterprises which are called upon to settle their maturing
obligations in turn put similar pressure upon their own debtors, and
partly because, despite all efforts to keep secret what is going
forward, news presently leaks out and other creditors take alarm.

While this financial readjustment is under way, the problem of making
profits on current transactions is subordinated to the more vital
problem of maintaining solvency. Business managers concentrate their
energies upon providing for their outstanding liabilities and upon
nursing their financial resources, instead of upon pushing their sales.
In consequence, the volume of new orders falls off rapidly. That is, the
factors which were already dimming the prospects of profits in certain
lines of business are reinforced and extended. Even when the
overwhelming majority of enterprises meet the demand for payment with
success, the tenor of business developments therefore undergoes a
change. Expansion gives place to contraction, though without a violent
wrench. Discount rates rise higher than usual, securities and
commodities fall in price, and as old orders are completed working
forces are reduced; but there is no epidemic of bankruptcies, no run
upon banks, and no spasmodic interruption of the ordinary business
processes.

At the opposite extreme from crises of this mild order stand the crises
which degenerate into panics. When the process of liquidation reaches a
weak link in the chain of interlocking credits and the bankruptcy of
some conspicuous enterprise spreads unreasoning alarm among the business
public, then the banks are suddenly forced to meet a double strain--a
sharp increase in the demand for loans, and a sharp increase in the
demand for repayment of deposits. If the banks prove able to honor both
demands without flinching, the alarm quickly subsides. But if, as has
happened twice in America since 1890, many solvent business men are
refused accommodation at any price, and if depositors are refused
payment in full, the alarm turns into panic. A restriction of payments
by the banks gives rise to a premium upon currency, to hoarding of cash,
and to the use of various unlawful substitutes for money. A refusal by
the banks to expand their loans, still more a policy of contraction,
sends interest rates up to three or four times their usual figures, and
causes forced suspensions and bankruptcies. There follow appeals to the
Government for extraordinary aid, frantic efforts to import gold, the
issue of clearing-house loan certificates, and an increase of bank-note
circulation as rapid as the existing system permits. Collections fall
into arrears, domestic-exchange rates are dislocated, workmen are
discharged because employers cannot get money for pay-rolls or fear lest
they cannot get pay for goods when delivered, stocks fall to extremely
low levels, even the best bonds decline somewhat in price, commodity
markets are disorganized by sacrifice sales, and the volume of business
is violently contracted.

That crises still degenerate on occasion into panics in America, but not
in England, France, or Germany, arises primarily from differences in
banking organization and practice. In each of the three European
countries, the banking system as a whole is so organized by the
prevalence of branch banking and the existence of a central bank that
reserves which bear a small proportion to the aggregate demand
liabilities of all the offices can be applied when and where they are
most needed. The central bank not only carries a reserve which is far in
excess of immediate requirements in ordinary times, but also uses this
reserve boldly in times of stress, presenting in both these respects a
marked contrast to the policy of American banks. As a result, European
business men need not fear either a refusal to lend or a restriction of
payments by the banks on which they depend. And panic has small chance
to develop where the depositor can get his money at need and the solvent
business man can borrow. [Written before the establishment of the
Federal Reserve system.]

4. DEPRESSION

The close of a panic is usually followed by the reopening of numerous
enterprises which had been shut during the weeks of severest pressure.
But this prompt revival of activity is partial and short-lived. It is
based chiefly upon the finishing of orders received but not completely
executed in the preceding period of prosperity, or upon the effort to
work up and market large stocks of materials already on hand or
contracted for. It comes to an end as this work is gradually finished,
because new orders are not forthcoming in sufficient volume to keep the
mills and factories busy.

There follows a period during which depression spreads over the whole
field of business and grows more severe. Consumers' demand declines in
consequence of wholesale discharges of wage-earners, the gradual
exhaustion of past savings, and the reduction of other classes of family
incomes. With consumers' demand falls the business demand for raw
materials, current supplies, and equipment used in making consumers'
goods. Still more severe is the shrinkage of investors' demand for
construction work of all kinds, since few individuals or enterprises
care to sink money in new business ventures so long as trade remains
depressed and the price level is declining. The contraction in the
physical volume of business which results from these several shrinkages
in demand is cumulative, since every reduction of employment causes a
reduction of consumers' demand, and every decline in consumers' demand
depresses current business demand and discourages investment, thereby
causing further discharges of employés and reducing consumers' demand
once more.

With the contraction in the physical volume of trade goes a fall of
prices. For, when current orders are insufficient to employ the existing
equipment for production, competition for what business is to be had
becomes keener. This decline spreads through the regular commercial
channels which connect one enterprise with another, and is cumulative,
since every reduction in price facilitates, if it does not force,
reductions in other prices, and the latter reductions react in their
turn to cause fresh reductions at the starting point.

As the rise of prices which accompanied revival, so the fall which
accompanies depression is characterized by certain regularly recurring
differences in degree. Wholesale prices fall faster than retail, the
prices of producers' goods faster than those of consumers' goods, and
the prices of raw materials faster than those of manufactured products.
The prices of raw mineral products follow a more regular course than
those of raw forest, farm, or animal products. As compared with general
index numbers of commodity prices at wholesale, index numbers of wages
and interest on long-time loans decline in less degree, while index
numbers of discount rates and of stocks decline in greater degree. The
only important group of prices to rise in the face of depression is
that of high-grade bonds.

Of course the contraction in the physical volume of trade and the fall
of prices reduce the margin of present and prospective profits, spread
discouragement among business men, and check enterprise. But they also
set in motion certain processes of readjustment by which depression is
gradually overcome.

The prime costs of doing business are reduced by the rapid fall in the
prices of raw materials and of bank loans, by the marked increase in the
efficiency of labor which comes when employment is scarce and men are
anxious to hold their jobs, and by close economy on the part of
managers. Supplementary costs also are reduced by reorganizing
enterprises which have actually become or which threaten to become
insolvent, by the sale of other enterprises at low figures, by reduction
of rentals and refunding of loans, by charging off bad debts and writing
down depreciated properties, and by admitting that a recapitalization of
business enterprises--corresponding to the lower prices of stocks--has
been effected on the basis of lower profits.

While these reductions in costs are still being made, the demand for
goods ceases to shrink and then begins slowly to expand--a change which
usually comes in the second or third year of depression. Accumulated
stocks left over from prosperity are gradually exhausted, and current
consumption requires current production. Clothing, furniture, machinery
and other moderately durable articles which have been used as long as
possible are finally discarded and replaced. Population continues to
increase at a fairly uniform rate: the new mouths must be fed and the
new backs clothed. New tastes appear among consumers and new methods
among producers, giving rise to demand for novel products. Most
important of all, the investment demand for industrial equipment
revives; for though saving may slacken it does not cease, with the
cessation of foreclosure sales and corporate reorganizations the
opportunities to buy into old enterprises at bargain prices become
fewer, capitalists become less timid as the crisis recedes into the
past, the low rates of interest on long-term bonds encourage borrowing,
the accumulated technical improvements of several years may be utilized,
and contracts can be let on most favorable conditions as to cost and
prompt execution.

Once these various forces have set the physical volume of trade to
expanding again, the increase proves cumulative, though for a time the
pace of growth is kept slow by the continued sagging of prices. But
while the latter maintains the pressure upon business men and prevents
the increased volume of orders from producing a rapid rise of profits,
still business prospects become gradually brighter. Old debts have been
paid, accumulated stocks of commodities have been absorbed, weak
enterprises have been reorganized, the banks are strong-all the clouds
upon the financial horizon have disappeared. Everything is ready for a
revival of activity, which will begin whenever some fortunate
circumstance gives a sudden fillip to demand, or, in the absence of such
an event, when the slow growth of the volume of business has filled
order books and paved the way for a new rise of prices. Such is the
stage of the business cycle with which the analysis began, and, having
accounted for its own beginning, the analysis ends.

MOORE'S "RAINFALL" THEORY

[246]To Professor Moore the fundamental problem of economic dynamics is
to formulate the law governing the "ebb and flow of economic life" which
is "the most general and characteristic phenomenon of a changing
society." The motto of the department of agriculture of the United
States--"Agriculture is the foundation of manufacture and commerce"--is
significant and that the farmer is at the mercy of the weather is
proverbial. There may be such a close connection between the weather,
the crops, and crises that we shall be able to find in weather changes
the cause of crises.

An examination of all the numerous factors involved in the problem would
be a stupendous task and Professor Moore limits himself to a
consideration of a selected few. "The variation in the quantity of the
rainfall is one of the weather changes known to have a marked effect
upon the yield of the crops." Hence the inquiry is directed to an
examination of the "appropriate data with reference to three things: (1)
the periodicity of rainfall; (2) the effect of rainfall on the crops;
(3) the relation of the yield of the crops to economic cycles." The
study is a statistical one conducted with the greatest of care to avoid
error and the conclusions are deserving of the most careful
consideration. All generalizations are made carefully and used
cautiously with a full realization that a limited area--the upper
Mississippi Valley--has been used and a period of only seventy-two years
surveyed. Of the numerous climatic factors only rainfall has been
examined.

Remembering that these limitations are fully realized we may state the
conclusions in Professor Moore's own words: "The fundamental, persistent
cause of the cycles in the yield of the crops is the cyclical movement
in the weather conditions represented by the rhythmically changing
amount of rainfall; the cyclical movement in the yield of the crops is
the fundamental, persistent cause of economic cycles." This should be
supplemented with a statement of the law that has been sought and which
may be formulated thus:

The weather conditions represented by the rainfall in the
central part of the United States, and probably in other
continental areas, pass through cycles of approximately
thirty-three years and eight years in duration, causing like
cycles in the yield per acre of the crops; these cycles of
crops constitute the natural, material current which drags
upon its surface the lagging, rhythmically changing values
and prices with which the economist is more immediately
concerned....

In conclusion we may merely observe that many theories are obviously
presented to defend some of the other views of their advocates. The
connection of the socialist theory with the socialistic idea of value is
an obvious one. It may also be true that interest in some particular
phase of study may cause the investigator to overlook the importance of
other elements in the problem. Thus to Professor Moore climatic
conditions seem of great importance, while Professor Mitchell relegates
them to a very minor position. As time passes it will doubtless be
possible to estimate the significance of each factor with more accuracy.
When this is done a more satisfactory theory can be formulated and
methods of prevention and alleviation employed to better advantage.

STRINGENT MONEY AND FINANCIAL PANICS[247]

Is there any tendency for financial panics to occur more frequently in
the seasons of the year when the money market is normally stringent? It
has been found that the two periods of the year in which the money
market is most likely to be strained are the periods of the spring trade
revival (about March and April) and that of the crop-moving demand in
the fall; and that the two periods of the easiest money market are the
"readjustment period," extending from about the middle of January to
about the first of March, and the period of the summer depression,
extending through the summer months. Of the eight panics which have
occurred since 1873, four occurred in the fall or early winter (_i. e._,
those of 1873, 1890, 1899, and 1907); and one (_i. e._, that of 1903)
extended from March until well along in November. Out of a total of
twenty-one minor panics or "panicky periods" occurring between 1876 and
1908, inclusive, nine occurred during the fall and early winter, eight
during the spring, one began in May and extended into June, three
occurred during the summer months, and one occurred in February. The
evidence accordingly points to a tendency for the panics to occur during
the seasons normally characterized by a stringent money market.

HOW BANKS SHOULD HANDLE PANICS

[248]Whatever persons--one bank or many banks--in any country hold the
banking reserve of that country, ought at the very beginning of an
unfavourable foreign exchange at once to raise the rate of interest, so
as to prevent their reserve from being diminished farther, and so as to
replenish it by imports of bullion....

A domestic drain is very different. Such a drain arises from a
disturbance of credit within the country, and the difficulty of dealing
with it is the greater, because it is often caused, or at least often
enhanced, by a foreign drain. Times without number the public have been
alarmed mainly because they saw that the banking reserve was already
low, and that it was daily getting lower. The two maladies--an external
drain and an internal--often attack the money market at once. What then
ought to be done?

In opposition to what might be at first sight supposed, the best way for
the bank or banks who have the custody of the bank reserve to deal with
a drain arising from internal discredit, is to lend freely. The first
instinct of every one is the contrary. There being a large demand on a
fund which you want to preserve, the most obvious way to preserve it is
to hoard it--to get in as much as you can, and to let nothing go out
which you can help. But every banker knows that this is not the way to
diminish discredit. This discredit means, "an opinion that you have not
got any money," and to dissipate that opinion, you must, if possible,
show that you have money: you must employ it for the public benefit in
order that the public may know that you have it. The time for economy
and for accumulation is before. A good banker will have accumulated in
ordinary times the reserve he is to make use of in extraordinary times.

Ordinarily discredit does not at first settle on any particular bank,
still less does it at first concentrate itself on the bank or banks
holding the principal cash reserve. These banks are almost sure to be
those in best credit, or they would not be in that position, and, having
the reserve, they are likely to look stronger and seem stronger than any
others. At first, incipient panic amounts to a kind of vague
conversation: Is A B as good as he used to be? Has not C D lost money?
and a thousand such questions. A hundred people are talked about, and a
thousand think--"Am I talked about, or am I not?" "Is my credit as good
as it used to be, or is it less?" And every day, as a panic grows, this
floating suspicion becomes both more intense and more diffused; it
attacks more persons, and attacks them all more virulently than at
first. All men of experience, therefore, try to "strengthen themselves,"
as it is called, in the early stage of a panic; they borrow money while
they can; they come to their banker and offer bills for discount, which
commonly they would not have offered for days or weeks to come. And if
the merchant be a regular customer, a banker does not like to refuse,
because if he does he will be said, or may be said, to be in want of
money, and so may attract the panic to himself. Not only merchants but
all persons under pecuniary liabilities--present or imminent--feel this
wish to "strengthen themselves," and in proportion to those
liabilities....

A panic, in a word, is a species of neuralgia, and according to the
rules of science you must not starve it. The holders of the cash reserve
must be ready not only to keep it for their own liabilities, but to
advance it most freely for the liabilities of others. They must lend to
merchants, to minor bankers, to "this man and that man," whenever the
security is good. In wild periods of alarm, one failure makes many, and
the best way to prevent the derivative failures is to arrest the primary
failure which causes them. The way in which the panic of 1825 was
stopped by advancing money has been described in so broad and graphic a
way that the passage has become classical. "We lent it," said Mr.
Harmon, on behalf of the Bank of England, "by every possible means and
in modes we had never adopted before; we took in stock on security, we
purchased Exchequer bills, we made advances on Exchequer bills, we not
only discounted outright, but we made advances on the deposit of bills
of exchange to an immense amount, in short, by every possible means
consistent with the safety of the bank, and we were not on some
occasions over-nice. Seeing the dreadful state in which the public were,
we rendered every assistance in our power." After a day or two of this
treatment, the entire panic subsided, and the "City" was quite calm.

The problem of managing a panic must not be thought of as mainly a
"banking" problem. It is primarily a mercantile one. All merchants are
under liabilities; they have bills to meet soon,... are dependent on
borrowing money, and large merchants are dependent on borrowing much
money. At the slightest symptom of panic many merchants want to borrow
more than usual; they think they will supply themselves with the means
of meeting their bills while those means are still forthcoming. If the
bankers gratify the merchants, they must lend largely just when they
like it least; if they do not gratify them, there is a panic.

On the surface there seems a great inconsistency in all this. First, you
establish in some bank or banks a certain reserve; you make of it or
them a kind of ultimate treasury, where the last shilling of the country
is deposited and kept. And then you go on to say that this final
treasury is also to be the last lending-house; that out of it unbounded,
or at any rate immense, advances are to be made when no one else lends.
This seems like saying--first, that the reserve should be kept, and then
that it should not be kept. But there is no puzzle in the matter. The
ultimate banking reserve of a country (by whomsoever kept) is not kept
out of show, but for certain essential purposes, and one of those
purposes is the meeting of a demand for cash caused by an alarm within
the country. It is not unreasonable that our ultimate treasure in
particular cases should be lent; on the contrary, we keep that treasure
for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An
"alarm" is an opinion that the money of certain persons will not pay
their creditors when those creditors want to be paid. If possible, that
alarm is best met by enabling those persons to pay their creditors to
the very moment. For this purpose only a little money is wanted. If that
alarm is not so met, it aggravates into a panic, which is an opinion
that most people, or very many people, will not pay their creditors; and
this too can only be met by enabling all those persons to pay what they
owe, which takes a great deal of money. No one has enough money, or
anything like enough, but the holders of the bank reserve....

... Before 1844, an issue of notes [of the Bank of England], as in
1825, to quell a panic entirely internal did not diminish the bullion
reserve. The notes went out, but they did not return. They were issued
as loans to the public, but the public wanted no more; they never
presented them for payment; they never asked that sovereigns should be
given for them. But the acceptance of a great liability during an
augmenting alarm, though not as bad as an equal advance of cash, [_i.
e._, specie] is the thing next worst. At any moment the cash may be
demanded. Supposing the panic to grow, it will be demanded, and the
reserve will be lessened accordingly....

"On extraordinary occasions," says Ricardo, "a general panic may seize
the country, when every one becomes desirous of possessing himself of
the precious metals as the most convenient mode of realizing or
concealing his property--against such panic banks have no security on
any system." The bank or banks which hold the reserve may last a little
longer than the others; but if apprehension pass a certain bound, they
must perish too. The use of credit is, that it enables debtors to use a
certain part of the money their creditors have lent them. If all those
creditors demand all that money at once, they cannot have it, for that
which their debtors have used, is for the time employed, and not to be
obtained. With the advantages of credit we must take the disadvantages,
too; but to lessen them as much as we can; we must keep a great store of
ready money always available, and advance out of it very freely in
periods of panic, and in times of incipient alarm.

FOOTNOTES:

[231] E. M. Patterson, _The Theories Advanced in Explanation of Economic
Crises. Annals of American Academy of Political and Social Science_,
Vol. 59, May, 1915, pp. 133-6.

[232] Address by Edwin R. A. Seligman, _The Crisis of 1907 in the Light
of History_, in _The Currency Problem and the Present Financial
Situation_, A Series of Addresses Delivered at Columbia University,
1907-1908, ix-xxv. The Columbia University Press, 1908.

[233] Wesley Clair Mitchell, _Business Cycles_, _pp._ 5-19. The
University of California Press. Berkeley, 1913.

[234] The not infrequent statement that prosperity sometimes merges into
depression without the intervention of a crisis means simply that the
writers understand by crisis a violent disturbance of business
conditions. It is in closer accord with every-day usage to call such
occurrences "panics," and to apply the term "crisis" to the transition
from prosperity to depression even when accomplished quietly. On closer
inspection, a business cycle is often found to be complicated by minor
changes, such as the interruption of depression by a premature
resumption of activity, the occurrence of a pause or even a slight
crisis in the midst of prosperity, and the like. But for the present it
is wise to confine attention to the broadest features of the cycle.

[235] Compare W. Sombart, _Versuch, einer Systematik der
Wirtschaftskrisen_, Archiv für Sozialwissenschaft, 1904, pp. 1-21.

[236] The first type of theories mentioned in the preceding section.

[237] W. H. Beveridge, _Unemployment_, ed. 3 (London, 1912), chapter iv.

[238] R.E. May, _Das Grundgesetz der Wirtschaftskrisen_ (Berlin, 1902).

[239] I have followed Mr. Hobson's latest exposition, _The Industrial
System_ (London, 1909), chapters iii and xviii.

[240] George H. Hull, _Industrial Depressions_ (New York, 1911), p. 218.

[241] W. Sombart, _Die Störungen im deutschen Wirtschaftsleben_,
Schriften des Vereins für Socialpolitik, vol. 113, pp. 130-133.

[242] T. N. Carver, "A Suggestion for a Theory of Industrial
Depressions," _Quarterly Journal of Economics_, May, 1903, pp. 497-500.

[243] Irving Fisher, _The Purchasing Power of Money_ (New York, 1911),
chapter iv, and chapter xi, §§ 15, 16, 17. Compare the same writer's
summary statement of his theory in _Moody's Magazine_, February, 1909,
pp. 110-114, and H. G. Brown's paper "Typical Commercial Crises _versus_
A Money Panic," _Yale Review_, August, 1910.

[244] Adapted from Wesley Clair Mitchell, _Business Cycles_, pp.
571-579. The University of California Press. 1913.

[245] The extract here reproduced is from the concluding chapter of the
work indicated.--EDITOR.

[246] E. M. Patterson, _The Theories Advanced in Explanation of Economic
Crises_. _Annals of American Academy of Political and Social Science_,
Vol. 59, May, 1915, pp. 140, 141, 147.

[247] E. W. Kemmerer, _Seasonal Variations in the Relative Demand for
Currency and Capital in the United States_, p. 232. Publications of the
National Monetary Commission, Senate Document No. 588, 61st Congress, 2d
Session.

[248] Walter Bagehot, _Lombard Street_, pp. 46-56. Charles Scribner's
Sons. New York. 1892. (First Edition, 1873.)

CHAPTER XXX

THE WEAKNESSES OF OUR BANKING SYSTEM PRIOR TO THE ESTABLISHMENT OF THE
FEDERAL RESERVE SYSTEM

CONFLICTING OPINIONS

[249]For fifty years the United States has lived rather happily under
the National Bank Act, born in the strife of the Civil War and developed
in the period of the nation's greatest expansion and growth. This act
has, by its record, earned for itself a place as a great piece of
constructive legislation; and the recognition of this fact is
responsible for the preservation of our national banking system almost
intact under the Federal Reserve Act. The National Bank Act removed the
ills of wild-cat banking, which so afflicted the country prior to the
Civil War; gave us an absolutely safe form of money which, although not
legal tender, is taken without question by everyone; and has made
possible an enormous expansion in the banking resources and facilities
of the country. In spite of the denunciation and abuse which have been
heaped upon it, the act has been reasonably satisfactory in operation.
Anyone who reviews the figures of the material growth and prosperity of
the nation and the rise of its financial power will be forced to the
conclusion that no act that was fundamentally unsound could have been an
integral part of the achievement of such a notable record.

Designed for the purpose of encouraging a system of independent banks,
the act has been responsible, directly and indirectly, for the creation
of some twenty-five thousand banking institutions in this country,
practically all of which are independent of each other. Instead of a
small banking class and an equally small group of banks, all under the
domination of one or a very few interests, we have developed a system of
banking which has sprung from the people, and which is closer to the
people than that of any other country.

[250]We have grown and prospered in spite of an imperfect, repressing,
and perilous banking and currency system. We have grown as a vine
sometimes forces its way through a crevice in a wall, our very growth
inviting disaster and death, our wonderful vitality hastening
catastrophe.... Over fifty years of growth under the old banking act has
been forced by the generosity of the soil of a new land, by the
unconquerable energy and resiliency of a virile and courageous people;
yet it has been interrupted by periods of business depression and
stagnation; our progress punctuated by panics, discreditable,
appalling--to many ruinous.... The immediate results ... have been
crashing of banks and commercial houses, the wholesale stoppage of
industries, the wiping away or cruel draining of the results of honest
thrift, denial to willing and hungry labor of the opportunity to earn
bread and shelter.

[251]A physician would probably say that what primarily ails our
currency system and causes panics and desperate stringencies is
something akin to _arteriosclerosis_. The veins and arteries of credit,
which in order to function properly ought to be elastic and contractile
like rubber, are hard and brittle as glass. When subjected to unusual
strain they can yield but little and are very liable to rupture, and
when once stretched they are apt to remain over-enlarged....

The temporary act of May 30, 1908, which relaxed the rigor of the law in
moments of critical emergency [as to note issues] by permitting
additions to the currency to be based upon other security by payment of
a heavy and increasing tax, was no real solution of the situation. It
contained no provision to render the currency responsive to ordinary
fluctuations in currency demand, and resort to its provisions in times
of great stress might easily precipitate a panic if one did not already
exist. It was only enacted for six years, and was only regarded by its
sponsors as a temporary palliative pending the preparation of a
permanent cure. _One universally recognized essential ... of a proper
banking and currency plan is provision for a more flexible and
responsive note issue_.

INFLEXIBILITY OF LEDGER BALANCES

When we turn to credit in the form of ledger balances or "deposits" and
enquire as to the causes of their inflexibility, the explanation also
rests in quite familiar facts. There are two peculiar features of our
banking system which are practically without counterpart in other
important countries, and which render ledger balances or deposit credits
in this country less flexible and responsive than such balances or
credits are elsewhere. The _first_ is the rigidity of our reserve laws,
and the _second_ is the lack of any bankers' bank or similar
institution, with ample resources and lending power, from which the
banks can replenish their own reserves when necessary.

RIGID RESERVE REQUIREMENTS

Outside of the United States I know of only one other country in which
the law requires a cash reserve to be held against deposits. That
country is Holland, and the law applies to only one institution, the
Bank of the Netherlands, and that institution does not hold enough
deposits to make it worth mentioning in this connection (less than
$3,000,000). Our national banking law, however, and the banking laws of
most of the states are unreasonably and unsoundly rigorous in this
regard. Not only must stated proportions of all deposits be held by the
banks in reserve, but these reserves, according to the law, can never
under any circumstances be used. It is very much as if the Government,
having established naval and military reserve forces in times of peace,
were to insist that these forces should not be used in time of war, in
order to maintain them intact as reserves. Whenever the cash held by a
bank has fallen to the required minimum, the bank cannot legally
continue to extend accommodation. It cannot issue more notes unless it
has additional government bonds to deposit for their security, and it
cannot enlarge its ledger balances unless it has additional reserves. No
matter what may be the stress of an emergency, or whether it is due to
war, catastrophe, or unreasoning fear, there are no legal means for
relaxing this requirement. And so, in moments of great sensitiveness and
anxiety, legal spokes are apt to be suddenly thrust into the wheels of
credit, and the whole machinery of business brought crunching to a
standstill. _A second essential then of any adequate currency plan is
some provision which will render the reserve requirements pliable and
the reserves of possible use._

NEED OF BANKERS' BANK

Our banks also have less flexibility in their power to lend ledger
balances than the banks of practically all other countries for another
reason, because of the lack of any permanent institution or institutions
which can perform for them services similar to those which they perform
for their customers. An individual bank makes the money of each and all
of its customers flexible in amount, by rendering it of mutual service,
and available to those who most need it, when they most need it, and, in
order that the money of individual banks may be similarly flexible in
amount, of mutual service to each other and available to those
institutions which most need it, when they most need it, they require in
their turn some agency which will do for them severally and jointly what
they do for the general public....

It does not matter what such an agency may be called. It may be a
discount bureau, or a rediscount bureau, a national clearing house, or a
national or regional reserve association. Out of deference to those
great financial experts who write the banking clauses of political
platforms and whose bans and edicts are blessed with sacerdotal
infallibility, when such an institution is proposed for this country,
it must not be called a central bank. Such an institution is perhaps
most plainly designated if it is called a "bankers' bank," but by
whatever name it is referred to, the need of such an institution is the
fact of primary importance in the American banking situation.

Just as an individual bank economizes and mobilizes and makes flexible
in amount the funds of individual members of a community, so a bankers'
bank mobilizes and economizes and makes flexible in amount the money of
the banks. It collects money from institutions and localities when and
where they do not need it, and lends it to others when and where they
do. In like manner the active deposits of the various banks, as they are
not all wanted simultaneously, furnish the bankers' banks with a large
surplus reserve of lending power, which in turn is an invaluable source
of flexibility to the individual banks. By its means they can, if need
be, rediscount their commercial paper, exchange their unmatured assets
for actual cash, and secure its still better known credit in place of
their own. By its means their reserves can be replenished and their
lending power made responsive to the needs of their communities. A
bankers' bank makes it possible for the money of the individual banks to
do many times the work it would do if left in the separate institutions,
and to do it far more effectively. It is the only ultimate safeguard,
the only scientific deposit guarantee, the only sound basis of
flexibility in any banking system. As some philosopher once said of
God--if such an institution did not already exist, people would
certainly have to invent one, and, as we have no such institution
permanently and legally established in America to-day, _the prime
essential of any sufficient banking plan is the equipment of our system
in some way or other with the facilities of a bankers' bank_.

THE PARCELLATION OF RESERVES

[252]If the absolute certainty of ability to pay all depositors in
money on demand be taken as the _summum bonum_ of banking, an idea which
quite generally prevails among the unthinking, it is interesting to
reckon the cost. A bank has no fairy wand with a wave of which it can
transmute into gold the amounts due it, whether represented by
borrowers' notes or balances due from other banks. Such repayments have
an element of uncertainty which pervades all human affairs. All
uncertainty could be eliminated only by having in money on hand an
amount equal to the total of liabilities to depositors. A deposit with a
bank would then be simply a warehousing transaction.

If a readjustment to such a condition were accomplished, and if we
consider only the ultimate result, and not the cataclysm of the process,
it would clearly prove such an extinguishing restriction of commerce as
would cost fabulously more than the value of the advantage gained. It
would be like preferring the constitution of a jelly-fish to that of a
human being in order to avoid the hazard of fracturing a bone.

Only by having banks which employ in loans a part of depositors' capital
lodged with them, can the best interests of the whole people be served,
even if this entails something less than an absolute certainty of power
to liquidate deposits on demand. That banking system must then be best
which combines equally the largest measure of each of two elements: the
use in commerce of funds deposited, and the certainty of paying
depositors in money on demand.

Turning now to the vast system of banks throughout the country, if the
separate reserves of all the banks were gathered into one mass,
available to meet the demands of depositors for payment in money,
whether made in Maine or Texas, New York or California, the banks of the
whole system would be able to operate with the highest degree of safety
by having a total sum of money equal to only a small percentage of the
aggregate amount owing to depositors, and consequently would be able to
lend for use in the commerce of the country the greater proportion of
the funds deposited. The total of deposits and withdrawals made
throughout the country would very nearly offset one another. Very little
of the reserve money would actually be used. A special requirement of
one section would represent only a small percentage of the total massed
reserves. The country has such vast area, and the requirements in
different parts so vary in season that a deficiency of money in some
sections would find a measurably offsetting surplus in others.

While theoretically an institution so constituted would be strongest and
most efficient, none such exists, and no one would advocate such a
system. Omniscience and omnipotence would be required for its wise
administration.

But the conclusion seems clear that only in proportion to the massing of
reserves can efficiency in lending for commerce be combined with
strength to pay depositors. The greater the proportion of the entire
reserves gathered into one mass, the greater the efficiency and strength
rendered possible. This principle is fundamental.

The fundamental defect of our banking system, then, is the parcellation
of the entire reserves among the separate self-independent banks,
necessitating either a wastefully large proportion of reserve for
assured ability to pay, with correspondingly inefficient service to
commerce, or efficient service with the hazard of unexpected exhaustion
of reserves and consequent inability to make good the contracts to pay
depositors in money on demand.

[253]If after a prolonged drought a thunderstorm threatens, what would
be the consequence if the wise mayor of a town should attempt to meet
the danger of fire by distributing the available water, giving each
house owner one pailful? When the lightning strikes, the unfortunate
householder will in vain fight the fire with his one pailful of water,
while the other citizens will all frantically hold on to their own
little supply, their only defence in the face of danger. The fire will
spread and resistance will be impossible. If, however, instead of
uselessly dividing the water, it had remained concentrated in one
reservoir with an effective system of pipes to direct it where it was
wanted for short, energetic, and efficient use, the town would have been
safe.

We have parallel conditions in our currency system, but, ridiculous as
these may appear, our true condition is even more preposterous. For not
only is the water uselessly distributed into 21,000 pails, but we are
permitted to use the water only in small portions at a time, in
proportion as the house burns down. If the structure consists of four
floors, we must keep one-fourth of the contents of our pail for each
floor. We must not try to extinguish the fire by freely using the water
in the beginning. That would not be fair to the other floors. Let the
fire spread and give each part of the house, as it burns, its equal and
inefficient proportion of water. _Pereat mundus, fiat justitia!_

REDEPOSITED OR OVERLAPPING RESERVES

[254]If we are to understand the radical change which will be worked by
the Federal Reserve Act in the reserve situation in this country it is
necessary to examine at some length the system heretofore prevailing.
Under the National Bank Act these banks were divided into three groups
or classes, referred to as the country banks, the reserve city banks and
the central reserve city banks.

There are three central reserve cities: New York, Chicago, and St.
Louis. Every national bank in these cities is a central reserve city
bank. The reserve cities are forty-seven in number and include the
larger cities of the country. Every bank not situated in any one of the
three central reserve cities or the forty-seven reserve cities is a
country bank. This last term includes all the national banks of the
smaller cities in the country, of the manufacturing towns and
communities of New England and the Middle States and thousands of
national institutions doing business in the agricultural sections.

~The Country Banks.~--The country banks, by the terms of the National Bank
Act, are required to keep a cash reserve at all times equal to 15 per
cent. of their deposits. Under the old law the country bank must keep
only 40 per cent. of this required reserve in its own vaults, while it
is allowed to deposit 60 per cent. of the required reserve on call in
such national banks in any of the reserve cities or central reserve
cities as may be approved as "reserve agents" for it by the Comptroller
of the Currency....

~The Reserve and Central Reserve Cities.~--The second class of national
banks, known as reserve city banks, includes all national banks located
in forty-seven cities of the country, which from time to time have been
designated as reserve cities. Every national bank in them is required to
keep a reserve at all times equal to at least 25 per cent. of its
deposits. It must be borne in mind that the deposits of a reserve city
bank include not only what the banker refers to as individual
deposits--the deposits of individuals, firms, partnerships, and
corporations--but also deposits which have been made with the reserve
city bank by country banks, for which it is the reserve agent.

A reserve city bank is permitted by the National Bank Act to keep
one-half of its required reserve on deposit, subject to withdrawal on
demand, in a national bank or banks in a central reserve city, approved
by the Comptroller of the Currency, as its reserve agent....

Every national bank within the central reserve cities must keep a
reserve equal in amount to at least 25 per cent. of its deposits,
including not only individual deposits but deposits by bankers for whom
it acts as reserve agent or correspondent.

~The Reasons for the System.~--This rather complicated system of reserves
was authorized by Congress because it was necessary to allow the banks
of the country districts or smaller cities to keep reserves in other
banks in the larger centres of trade in order to facilitate the
commercial exchanges of the country; and also because it was necessary
to have some means by which banks of the larger cities could finance
payments for their customers in the great centres of the country,
especially in New York, Chicago, and St. Louis....

~Its Weaknesses.~--Our system of deposited reserves has failed miserably
in times of stress, although it has worked reasonably well in ordinary
times. It is contended that it has, to a large degree, built up the
great centres, and more especially New York City, at the expense of
country districts. It has been responsible for the seasonal withdrawal
of money which was at one time a most serious embarrassment to business,
especially in New York, Chicago, and other large cities in the fall
months, but which has practically disappeared in New York City since the
panic of 1907.... It was not until the system of deposited reserves
brought about the panic of 1907 that the country at large became
convinced that this feature of the national banking system was vicious,
dangerous, and likely to produce trouble at any time. With this
conviction began the movement which finally ended in the enactment of
the Federal Reserve Act.

~Much of Our Reserve Fictitious.~--As a matter of fact, the actual
available reserves of the three classes of national banks in the country
are much less than is indicated by the percentage specified in the act
quoted above.... This condition is referred to frequently as the
pyramiding of reserves, which means, in substance, that the national
banks of this country, omitting from consideration the state banks where
the same conditions exist in an even more aggravated form, are doing
business largely upon a paper reserve, which experience has shown is
utterly useless in times of panic. The seven thousand five hundred and
nine national banks held cash and paper reserves on October 21, 1913, as
follows:

_Cash in vaults._ _Due from banks._

Country banks $294,000,000 $534,000,000
Reserve city banks. 251,000,000 258,000,000
Central reserve city banks 381,000,000
------------ ------------
$926,000,000 $792,000,000

As a matter of fact the national banks of the country held $926,000,000
in cash as against total deposits subject to reserve requirements of
$7,172,000,000, or about 12.8 per cent. of the liabilities subject to
the requirements.

~Dangers of the System.~--So conclusive are the lessons to be learned from
the experience of the last half century with the system of redeposited
reserves, that there is a practical unanimity among bankers and
financial experts that the reserves of our banks, with the exception of
the money actually held in the vaults, are, in the words of William
Ingle, vice-president of the Merchants and Mechanics National Bank of
Baltimore, "A great deal of a delusion and a snare." In every panic, the
country banks and the reserve city banks have found that it has been
impossible for them to secure the return of the portion of these
reserves which has been redeposited in New York, Chicago, and St. Louis.
At a time of great stress, when the banks have been subjected to a
drain, they have been suddenly bereft of the support which, in theory,
should have been forthcoming from their reserve agents, and have been
forced to depend upon the 6 per cent. or 12-1/2 per cent. reserve, which
was contained in their own vaults. What is even worse, the outbreak of a
panic in New York City, where every panic of the last half century has
started, was the signal for the suspension of cash payments by every
bank in the country, within a few hours.... Thus a local panic, in many
cases occurring when business conditions were exceedingly prosperous and
healthy, has completely disorganized the exchanges of the country and
brought business to a standstill.

THE PERVERSE ELASTICITY OF NATIONAL BANK NOTES

[255]... It is not quite correct to call our national bank notes
inelastic. They are decidedly elastic. The trouble is that their
elasticity is of a wrong sort; they expand when there is need of
contraction, and contract when the need is for more currency. By calling
the notes inelastic we mean that their volume does not correspond
automatically to the need for currency. This is true, and is one of the
most serious defects of the bond-secured notes....

The demand for currency depends upon the volume of business to be
transacted, and is continually in a state of fluctuation. Various causes
have only to be mentioned to explain the unequal demand at different
times. We have thus the payments of salaries, bills, etc., coming
usually, on the first of each month. Then there are the quarterly
payments of dividends, interest, etc., falling generally on the first of
January and at intervals of three months thereafter during the year.
Above all, we have in this country a regularly recurring seasonal change
in the volume of business, due to the harvesting and moving of the crops
every fall and early winter. Besides these normal fluctuations in the
demand for currency there are of course such abnormal circumstances as
business emergencies, panics, depressions, etc., which at irregular
intervals call for expansion or contraction of the currency. To meet all
these varied demands an elastic currency is a necessity.

The most serious evils of inelasticity in this country are seen in
connection with the annual handling of the crops. It may be safely said
that for this purpose the United States needs every fall at least one
hundred and fifty million dollars of extra currency. Since our monetary
system contains no really elastic element, this extra business of the
fall has to be done with little or no increase of the country's
currency. The crops must be handled by means of a shifting of currency
from one part of the country to another. In the spring and early summer
the agricultural districts are apt to have more money than they need.
Accordingly, the country banks are in the habit of depositing part of
their reserves in banks situated in the reserve cities. A large part of
these sums eventually finds its way into the money markets of New York
and other Eastern cities, where a low rate of interest is paid to
outside banks for such deposits. Now comes the harvest season, and a
demand goes up from the country banks for the return of their deposits.
Every fall the clearing-house banks of New York City alone give up about
fifty millions of "lawful money" to meet this demand.[256] Of course
this means a tight money market. In the spring and summer the funds
obtained from the country banks were loaned out or used as reserves for
deposits. Money was in excess, interest rates were low, and speculation
was encouraged. Now loans must be called in and deposits reduced. This
sudden contraction is a hard blow to all business interests. It is
especially hard on the speculators, and their desperate demands cause
the enormous rates on call loans which are witnessed every fall on the
New York money market....

It has ... been suggested that the inelasticity of the national bank
notes does not mean that their volume never changes. As a matter of
fact, the circulation has been marked by enormous fluctuations, and
these fluctuations, having no relation to the demands of business, have
simply aggravated the evils of inelasticity which have been described.
Thus, between June 1, 1880, and June 1, 1891, the total volume of bank
notes outstanding declined from $345,000,000 to $169,000,000, a decrease
of $176,000,000, or 51 per cent. This retirement of half the circulation
came during a decade marked by large growth in population and wealth,
and by remarkable industrial expansion and business activity. The reason
for this decline lies in the fact that the Government was using part of
its large surplus revenue to pay off the debt. In eleven years the
Treasury paid $1,105,000,000, reducing the debt by more than half,
something without parallel in the history of public finance. The
retirement of half the debt caused a scarcity of United States bonds,
and their prices went soaring. Four per cents of 1907 rose from 103-113
in 1880 to 125-130 in 1888. The inevitable result was the decline of
circulation. The opposite course of events has been seen in recent
years....

[The subjoined diagram (suggested by a similar one for
1902-1906, accompanying the article a part of which is here
reproduced) illustrates the comparative seasonal elasticity
of the notes of our national banks and the circulation of
the chartered banks of Canada for the period 1910-1914. The
marked expansion of national bank notes in 1914 was due to
the crisis brought on by the outbreak of the European war.
The Aldrich-Vreeland notes which were issued in that
emergency were retired in a few months and the volume of
national bank notes assumed normal proportions.

For the Canadian statistics involved the editor is indebted
to Mr. G. W. Morley, Secretary of the Canadian Bankers'
Association.]

[Illustration]

NATIONAL BANK NOTES UNSOUND AND UNSAFE

[257]... Any correct system of credit currency must be based on a
foundation of gold. Bank credit is issued in the two forms of deposits
and notes. The former are based on a reserve of gold, the latter are
not. We have here a fundamental weakness of our bank-note system. Under
proper banking methods, deposits cannot expand without a proportional
increase of the gold reserves of the banks. This furnishes the natural
and necessary check to inflation. Our bank notes, however, have no such
connecting link with the business and the monetary stock of the world.
The basis of the American bank-note currency is the government debt, a
very inferior kind of foundation. Such a system carries with it the
possibility of paper money inflation of a peculiarly dangerous kind,
because its real meaning is apt to be concealed. For example, between
January 1, 1900, and January 1, 1908, the volume of national bank notes
outstanding increased from $246,000,000 to $690,000,000, an expansion of
$444,000,000. In other words, the circulation nearly trebled in eight
years. The cause of this great increase was not the need of more
currency but the changes in the National Bank Act made in 1900, changes
which made the establishment of national banks easier and the issue of
notes more profitable.... The future is likely to witness further
expansion, unless some change is made in our system.... It is
undoubtedly the present intention to give ... to future [bond] issues
[the privilege of being used as security for notes]. Indeed, unless this
privilege is given, there will be no market for the 2 per cent. bonds.
We may expect, therefore, to see each issue made the basis of a further
increase in the volume of bank notes.

All this means inflation, and inflation by means of a circulating medium
having no connection with the gold stock of the world. To make room for
the additional currency, gold must be forced to leave the country, and
our whole monetary system, by no means too strong to-day, will be
weakened at its foundation. This is the fundamental difference between
expansion of credit by means of deposits and expansion by means of
national bank notes. The one is based on gold; the other is based on the
government debt. When deposits expand, the reserves of the banks must
increase proportionately and, if carried far enough, the result must be
to bring in gold rather than to force it out. In like manner, deposits
cannot for any considerable time be in excess of business needs. But
bank notes may be increased indefinitely, if the Government only borrows
enough, and the result will be the expulsion of gold whenever the
currency becomes redundant. That this is an actually present danger is
sufficiently demonstrated by the recent action of the Secretary of the
Treasury, who has seen fit to add to the national debt at a time when
the Treasury had a surplus of over 250 millions, for the sole purpose of
increasing the circulation of the national banks. Our currency system
can never be sound until the bank circulation is entirely divorced from
the government debt.

The danger of inflating our monetary system with bank notes having no
gold reserve back of them is all the more serious from the fact that the
notes of the national banks are used as reserves by state banks, private
banks, trust companies, etc. They are part of the "cash reserves" on
which these banks base their deposits. Thus we have a system of credit
based on credit, and any weakness in the national bank note is carried
over and multiplied in the deposits of other banks.

The complete _reductio ad absurdum_ of this multiple credit system came
when at a recent convention of the American Bankers' Association it was
seriously proposed that it be made lawful for national banks to count
their notes as "lawful money" in their own reserves. There is good
reason to believe that this is actually practised to some extent by
national banks to-day, though the practice is, of course, illegal.

The safety of the national bank notes is seldom questioned. Whenever the
evils of our currency system are pointed out and plans for asset
currency or other reforms are proposed, the reformer is apt to be met by
the reply that, at any rate, our bank notes are perfectly safe, and we
had better put up with their other shortcomings rather than launch out
on new schemes which may possibly sacrifice that safety which we now
enjoy. The foregoing discussion should already have cast some suspicion
on this complacent attitude. It will be further weakened by a closer
analysis of the basis of the national bank circulation.

National banks may issue their notes up to the amount of their paid-up
capital, and up to 100 per cent. of the par value of United States bonds
deposited with the Treasury, but never in excess of the market value of
the bonds. The notes are engraved by the Government and issued to the
banks. When signed by the proper officers of the bank, they become the
bank's promise to pay upon demand and may be issued for circulation. The
United States Treasury is also required by law to redeem on demand all
notes of national banks presented to it. For this purpose each bank must
keep with the Treasury a reserve fund equal to 5 per cent. of its
circulation. The duty of the Treasury to pay notes on demand, however,
is not limited to the amount of this reserve, but applies to all notes
properly presented. In case of the failure of a national bank, the
Treasury is required by law to immediately redeem all its notes. The
Treasury is secured against loss by the bonds deposited, by the 5 per
cent. cash reserve, by its prior lien on the assets of the banks, and by
the personal liability of the stockholders for an amount equal to their
stock investments.

It is thus seen that the popular idea that the holder of a national bank
note is secured against loss by the government bonds deposited in
Washington is not strictly correct. What protects the holder of a note
is the absolute responsibility of the Treasury to redeem all notes on
demand. The bonds are to secure the Treasury, not the individual
noteholder, against loss. The noteholder is secured so long as the
Treasury is able to meet its legal obligations.

Let us examine the character of our government bonds as security to
enable the Treasury to meet its obligations. To understand the
situation, it should be remembered that the leading purpose in the
establishment of the national banking system was not the creation of a
scientific currency system. The National Bank Act was a war measure
enacted largely for the purpose of improving the market for government
bonds during the Civil War. It was for this purpose that the circulation
of state banks was forced out of existence by a 10 per cent. tax and the
right of issue restricted to national banks on condition of the deposit
of government bonds as security. In the accomplishment of this purpose
the act has been eminently successful. United States bonds have been
given a new utility over and above their utility as an investment. From
the very beginning, this has given them an added value and enabled the
Government to borrow at lower rates of interest than it would otherwise
have had to pay. The act of March 14, 1900, made provision for the
ultimate refunding of all the United States debt into 2 per cent. bonds,
and gave an added inducement to the use of these bonds as note security
by lowering the annual tax on circulation from 1 per cent. to one-half
of 1 per cent., provided the notes were secured by the new 2 per cent.
bonds. All bonds issued since 1900 have borne 2 per cent. interest. Yet
the market value of these bonds has always stood above par....
Obviously, this value is not based on earnings. British consols paying
2-1/2 per cent. are to-day quoted in the neighborhood of 85, which makes
them yield about 3 per cent. on the investment. The French and German 3
per cent. loans are both considerably below par. United States bonds
have been given an artificial value through their use as security for
bank circulation. The national banks to-day hold for this purpose about
two-thirds of the total funded debt of the United States. Remove this
privilege from the national debt, and we should see the 2 per cent.
bonds (which compose two-thirds of the interest-bearing debt of the
United States) fall to perhaps seventy cents on the dollar, very likely
even lower.

Here we have a remarkable situation. Our national bank notes are safe
because they are secured by government bonds, and our government bonds
are valuable because they are security for national bank notes. This
looks very much like lifting oneself by one's bootstraps.

If we are to cling to the bond-secured note system, this matter of the
artificial value of government bonds will become an important practical
problem whenever it becomes necessary for the United States to make any
addition to its debt. Either the rate of interest will have to be raised
to 3 per cent. or higher, or, if that alternative is rejected, means
will have to be found to induce the banks to use the greater part of the
new loans as security for additional note issues.[258] In practical
effect, this is only a thinly disguised resort to the time-honored but
now thoroughly discredited practice of compelling the people to use the
government debt as a circulating medium.

The bearing of this matter on the safety of the national bank note is
simple. The burden of the ultimate redemption of the bank notes has been
placed on the shoulders of the Treasury, to add to its other burdens of
maintaining the value of the greenbacks and of the silver dollars. If
loss of confidence in the bank notes should ever lead people to demand
their wholesale redemption, the Treasury would have to meet the demand
in gold. But the moment it tried to sell the bonds, it would find there
was no market for them except at a discount of perhaps 30 or 40 per
cent. It is true that the Treasury would still be able to recoup itself
for this loss in the value of the bonds by exercising its prior lien on
the assets of the banks. But this leads us to the important conclusion
that the final security for our bond-secured notes rests on the assets
of the banks after all. A more striking argument for asset currency
could hardly be discovered.

It must be remembered, however, that the foreclosure by the Government
of its claim on the assets of the national banks would cut into the
wealth on which deposits are based and so have a most disastrous effect
on the deposit system. The pressure upon the Government to refrain from
such a crushing blow to credit would be overwhelming. It is almost
inconceivable that in time of panic or a national crisis the Government
would resort to such a procedure. Almost any alternative would be
preferred. It would not be too difficult a matter for the Government to
persuade itself that the wiser and safer course would be to suspend
specie payments, perhaps even declaring the bank notes a legal tender. A
more plausible case could be made out in favor of such action than was
found sufficient to justify the issue of the greenbacks of the Civil
War. Yet such action would mean the breakdown of our financial system.

This is, of course, looking into the future and anticipating a state of
disaster which may never come. But a system which bids fair to break
down in time of disaster should be remodelled before disaster comes. And
we should not rest too confidently in the notion that disaster can never
reach us. It is only thirteen years ago [1895] that the burden of
supporting its paper and silver currency brought the United States
within twenty-four hours of suspension....

SPECULATION INVOLVED IN THE ISSUE OF NOTES

[259]When a banker takes out currency he engages in two distinct
transactions and enters upon two different hazards. In one transaction
he assumes the risk and holds the expectation of greater profit for
taking out circulation. Since buying bonds and taking out circulation
most of the time shows some theoretical profit over loaning direct,
presumably if there were no other consideration, most of the time our
bankers would keep outstanding all the notes they could. In the other
transaction, however, the banker engages in a speculation in government
securities. As a matter of fact, if the price of government bonds
advances, the profit from taking out circulation declines; but our
banker is pretty likely to view with equanimity the declining
circulation profit when he considers the profit he is making in his
speculation in bonds. On the other hand, as the price of government
bonds declines, circulation grows more profitable. The banker is likely
to view this with sour satisfaction when he looks on his loss in his
bond speculation. Profit or loss in the bond speculation is likely to
outbalance loss or profit in the circulation transaction.[260]

Let us examine the situation more closely. Just what is the profit or
loss from taking out circulation? In the first place the bank gets the
regular current money rates on the loans it makes through issuing notes.
Also it gets the interest on the government bonds it buys. This, of
course, means the real interest, or income on the investment, called
basis, taking into consideration coupon interest, price paid, and date
of maturity. Excepting for the tax of 1/2 per cent. on the circulation
taken out (1 per cent. if taken out on the 3's or 4's) and for the
expenses attendant on taking out circulation, which the government
actuaries compute to average $63 on the $100,000, this interest on the
government bonds looks like clear "velvet." It would be, too, if the
banker did not have to pay more for the bonds than the amount of
circulation he can take out against them. To figure his net profit he
must deduct from the gain items just stated what he would have made if
he had loaned his funds direct instead of investing in bonds.

Expressed as an algebraic equation the situation becomes much clearer.
Let

x = current money rate;
y = basis rate at which government bonds are bought;
z = price of government bonds;
b = circulation received ($100,000 used as basis of calculation);
c = taxes, redemption, and other circulation expenses.

(As already stated, government actuaries have calculated that
circulation expenses average to cost the banks $63 on the $100,000 of
circulation taken out. Taxes depend on whether the 2's, in which case
the tax is 1/2 per cent., or the 3's or 4's, in which case the tax is 1
per cent., are bought. Taxes, then, amount to either b(.01) or b(.005).
We can take b as a constant in our calculations and base all our
computations on taking out $100,000 of circulation.)

The equation of profit or loss on taking out circulation then reads:

yz + bx - xz - c = profit or loss.

But circulation taken out (b) can never be greater than the amount of
money paid for the bonds (z).

If government bonds should be at par or at a discount, the nominal
profit would always be just the basis interest on the bonds, less the
tax and the cost of taking out circulation, or a constant advantage in
the case of the 2's of 1.437 per cent. For the purpose of this
discussion we will consider only the 2's of 1930.

In the regular case, then, the money paid for the bonds (z) is greater
than the amount of circulation received (b). With that statement in mind
we can draw certain very definite conclusions about our circulation
direct from the equation we have formed; z is greater than b.

Repeating the equation in order to have it directly before us:

yz + bx - xz - c = profit or loss.

Then as the current interest rate (x) increases, if all the other
quantities remain constant, the negative influence in the equation grows
greater, or profit from circulation decreases. We can, then, make
definitely:

STATEMENT I

_If all other circumstances remain the same, circulation grows less
profitable as the current money rate advances._

As business increases and the demand for both credit and money
increases, as reflected in the rising interest rates, taking out
circulation _cæteris paribus_, with the inexorability of a mathematical
law, becomes _less_ profitable.

Further, there is an intimate relationship between y and z. If the price
of bonds (z) declines, the basis rate (y) must advance. As a matter of
fact as z declines yz grows greater. If, then, x remains constant and z
declines the influence of the negative quantities of the equation is
growing less. Then follows:

STATEMENT II

_As the price of bonds declines, if the current interest rate remains
constant, the profit from taking out circulation increases._

That gives the absolute mathematical basis for such general statements
as that "the price of bonds is too high to make circulation profitable."

These two facts set out in Statement I and Statement II place the banker
who has taken out circulation between the devil and the deep, blue sea.
If the price of bonds remains the same and the current interest rate
rises, his circulation grows steadily less profitable. A decline in the
price of bonds affords the only offset to an increasing interest rate.
But if the price of bonds declines enough to offset the advance in the
current interest rate, the banks must mark off enough profits to cover
the loss on the capital value of the bonds.

Speculating in securities properly forms no part of a bank's business.
It is an anomalous situation that in order to fulfil a proper function
of note issue a bank should have to undertake such an improper
speculation.

THE LACK OF ADJUSTMENT BETWEEN BANK NOTES AND DEPOSITS

[261]Under our present currency system the volume of money in
circulation is perfectly flexible. It constantly expands and contracts
in automatic adjustment to the requirements of trade and the convenience
of the people. An increase in the volume of cash transactions brings
promptly an increase in the volume of currency in circulation through
the current withdrawals of money exceeding the current deposits of
money. A lessening in the volume of cash transactions promptly drives
unneeded currency out of circulation through the deposits of money
exceeding the withdrawals. No other system could provide a currency
which would adjust its volume in circulation more exactly to the needs
of trade and the preferences of the people. There is a ceaseless flow of
the money in circulation into bank reserves, and of money in bank
reserves into circulation--ceaseless except in an occasional crisis when
the natural flow of money from bank reserves into circulation is
arbitrarily stopped by banks refusing, for self-protection, to continue
paying out to the point of exhausting reserves.

While the volume of money in circulation is thus perfectly and
automatically adjusted to trade requirements, it is to be noted that
this flexibility arises from the flow back and forth, between the mass
of money in circulation and the mass in bank reserves. In this lies the
main economic defect of our present currency system. An expansion in the
volume of money in circulation entails a corresponding contraction in
the volume of bank reserves, and necessarily a corresponding contraction
in loans. A period of expanding business would naturally be attended by
both an increased volume of loans and an increased volume of cash
transactions, such as increased pay-rolls, increased retail sales.
Increased cash transactions cause a larger volume of money to flow into
circulation. But this flow is out of bank reserves, thus contracting
them and necessitating a contraction of loans depending upon them, at
the very time when loans would naturally expand. Obviously, if business
becomes very active, the effect upon bank reserves is so adverse, and
the contraction of loans depending upon reserves so important, that
embarrassment is widespread and panic ensues.

The main defect, then, of our present currency system is that the volume
of currency in circulation has its adjustment in the flow from bank
reserves into money in circulation and from money in circulation into
bank reserves, causing a contraction of bank reserves and the loans
depending on them as business expands.

A remedy would be the use of bank notes through which the volume of
currency in circulation would have its adjustment in the flow from bank
deposits into bank notes in circulation, and from bank notes in
circulation into bank deposits, thus protecting from disturbance both
bank reserves and the loans based on them.

THE COMMERCIAL PAPER SITUATION IN THE UNITED STATES

[262]... At the present time the commercial paper situation in the
United States is peculiar. "Commercial paper" in the old and strict
sense is little used in this country. "Trade paper," as it is now
called, arises in less than 3 per cent. of the credit transactions in
the United States.[263] In some lines of trade, especially where a local
wholesaler does a large business with small tradesmen, the wholesaler
will extend credit by taking the retailers' notes; but in obtaining
credit for himself the wholesaler will not surrender control of the
bundle of retailers' notes, preferring instead to give simply his own
note on a general understanding with his banker that the personal note
rests on, and is fully covered by, the retailers' notes.[264] The
wholesaler hesitates to surrender to the banker the notes that he
receives because he fears that his competitors might get some inkling of
his trade connections, etc. In general, "trade paper" is used to settle
accounts only when the credit terms are still long, that is, four months
or more.[265]

What generally passes as "commercial paper" in the United States is
single-name paper. As in the case of the wholesaler referred to above,
the borrower of bank credit in these days offers for discount simply his
own promissory note. Some of this paper, particularly corporation notes,
carries indorsements, but these are largely "accommodation"
indorsements, which may buttress the security of the paper but which
indicate nothing as to its purpose.

The wide use of single-name paper in this country is largely explained
by the fact that the prevailing terms of payment in business
transactions are net in 30 or 60 days, with a discount for payment in
cash within variously from 10 days to one month. The cash discount
allowed is usually so large that a purchaser can ill afford not to take
advantage of it. Two per cent. discount for cash within 10 days, for
example, with "60 days net" is equivalent to a return of 12 per cent.
per annum on one's capital. In actual practice the allowance is often
even more liberal. Hence where competition is at all keen the business
man is practically forced to adopt the system of cash payments,
depending upon his bank to advance to him, on his own notes, the
necessary funds. Moreover, so broadly has the custom of taking cash
discounts spread that a failure to take advantage of them is generally
regarded as an indication of weakness, and tends to undermine general
confidence in the business man's credit standing. Hence the necessity
for maintaining his credit rating, as well as competition, virtually
forces the business man into making anticipatory cash payments and thus,
more or less as a consequence, into the general practice of discounting
his personal paper.[266]

Furthermore, as business operations have grown to a larger and larger
scale, especially in the case of large corporate enterprises, the credit
needs of business have in many cases expanded beyond the capacity of the
local banks to supply them. The necessity arose, therefore, to go
elsewhere for accommodation. This was met in some cases by the opening
of bank accounts in other centers, but obvious difficulties and
restrictions attend this method of procedure. More elastic possibilities
and fewer difficulties grew out of the employment of middlemen to market
the paper over the country as a whole on the best available terms. Hence
the note-broker is to-day an important factor in the discount market. As
a result of the note-broker's activities there has come to be
established an extensive open market for commercial (single-name) paper
in this country, and the rates at which such paper is discounted are
regularly reported in the daily newspapers.

This development of a commercial-paper market reflects, of course, a
considerable development of the demand of the banks for this form of
investment.[267] "Country banks" especially have in the last few years
heavily increased their purchases in the open market, because the
necessity of writing off heavy losses due to the shrinkage of bond
values has tended to make them more timid about investing in securities,
and because they have also learned by experience that paper purchased
through a broker does not have to be renewed, as does most of the purely
local paper.[268]

This development has, of course, tended to put an increasingly heavy
responsibility on the note-broker and has brought about, at least to
some extent, a readjustment of his business methods. At first
note-brokers simply solicited paper from merchants and charged a
brokerage fee. Latterly, the custom has grown up for the broker to buy
up the paper outright.[269] This forces the broker "to stand between the
maker and the bank," and to the extent that any given piece of paper may
be left on his hands, even though he does not indorse the paper that he
sells, it compels him to be very circumspect about the paper that he
purchases. Moreover, some banks now purchase paper with an option of
return within a specified period, making it a point carefully to
inquire about the maker of the paper before the option expires. In the
last few years banks as well as brokers have established carefully
organized credit departments, the purpose of which is, through careful
inquiry into the character and standing of sellers of paper, to enable
both brokers and bankers to select paper with sounder discrimination.

This characteristically American discount system differs greatly from
that which prevails in Europe. Abroad, single-name paper is very little
used.[270] The European banker demands more than one signature, not only
as a guaranty of security, but also as an assurance of the validity of
the transaction out of which the paper offered for discount grew. When
the prospective borrower, for some sufficient reason, does not wish to
divulge the names of his clients, as would be necessary if he drew bills
on them, he may arrange with his bank for an overdraft (known as a cash
advance),[271] or by paying a small commission he may get the bank to
"accept" a bill drawn directly on it. With a bank's acceptance a bill,
even though drawn by the humblest shopkeeper, becomes a prime investment
and may be sold openly on the market at the lowest terms that
prevail.[272] On the Continent bank acceptances thus open the market
widely to all who can arrange for them, while the open market for
single-name paper in this country is restricted to large firms of
established reputations.

In view of the prevailing practice in Europe it is interesting to
inquire why in America there should have been this peculiar development
in the discount field. It has been pointed out that before the Civil War
trade paper, as it is now called, was pretty generally used, but the
exigencies growing out of the war completely changed the situation. The
excessive issue of the greenbacks and the uncertain value of credit
instruments covering any appreciable period of time led sellers to
endeavor to bring business to a cash basis. Credits were shortened to 30
or even to 10 days, and strong emphasis was placed on immediate
payment. With cash discounts alluringly liberal, merchants could ill
afford to forego them, and cash payments tended to become more and more
common. Big houses offered single-name paper to raise the needed funds,
and little by little the older system of settling by the promissory note
of the debtor was supplanted by the system of selling on open account,
with the choice given to the debtor of a liberal discount for cash or
the payment of the due amount "net" at the expiration of a relatively
short credit period.

The transition was hastened by the development of the practice of
selling goods by sample instead of by personal selection from an
accumulated stock. Under the old practice the buyer bought under the
rule of _caveat emptor_, but when purchasing by sample he had a right to
demand that the delivered goods attain the standard of the sample, and
there grew up in consequence the doctrine of "implied warranties." These
warranties have in some lines been pushed very far,[273] but in any case
the buyer would hesitate to pay for goods until he had had a chance to
inspect them, and hence he would as a rule demand that they be consigned
to him on open account. The seller, however, cannot afford to wait for
payment until his accounts become due. Too much of his capital would be
tied up. He is forced, therefore, to go to his banker and, on the basis
of his accounts receivable, to offer his own note and thus to obtain
release of the capital otherwise temporarily beyond reach....
Single-name paper virtually monopolizes the field....

NO SYSTEM OF BANK ACCEPTANCES AND THE ABSENCE OF AN OPEN DISCOUNT MARKET

[274]The weakness of our banking system as compared with the systems of
Europe may very certainly be attributed in part to the omission of the
bank act to permit bank acceptances. It is a weakness, furthermore,
which involves the country in serious economic loss. Without a national
discount market, the great majority of our merchants and manufacturers
are compelled to confine their borrowings to American capital, either
through the discounting of their paper with their local banks or through
its sale to note brokers. All but the strongest and largest are
practically excluded from the benefits of foreign competition for their
paper. Aside from the great concerns with international ramifications,
which are able to arrange their own credits abroad, our merchants and
manufacturers are not benefited by low foreign discount rates, except in
so far as note brokers, who make it a practice to borrow in Europe with
commercial paper as collateral, are better able to finance their
purchases. What is more, they receive relatively little advantage from
an accumulation of funds in New York banks. Low call loan rates have an
indirect rather than a direct effect on the rate which the mercantile
community has to pay for money. Low call rates, in other words, are an
indication more especially of stagnation in the stock market than of a
lack of demand for accommodation from merchants and manufacturers. Such
rates do not act as a stimulus to trade in general any more than high
call rates act as an immediate check to over-expansion.

It is not only in our domestic trade that the country suffers through
the want of a discount market. Without bank acceptances we are at a
distinct disadvantage in connection with our foreign trade. Our
importers, unable to open credits with their banks, as is done abroad,
are not in a position to finance their purchases upon as favorable a
basis as the importers in other countries, as English cotton spinners,
for example. The English spinner about to purchase cotton in America
arranges for his bank to accept sixty or ninety days' sight bills drawn
on it by the American shipper. The latter draws his bills on the English
bank and attaches the documents covering the shipment, such as the bills
of lading, insurance certificates, invoices, etc. He then sells them to
a New York bank, thereby receiving immediate payment for his cotton. The
New York bank forwards the bills to its London correspondent, which
presents them for acceptance to the bank upon which they are drawn. Upon
the acceptance of the bills the documents are delivered to the
accepting bank, which then turns them over to the spinner upon whatever
arrangement has previously been made. The accepted bills are discounted
by the New York bank in London and the proceeds placed to its credit
there. The New York bank can afford to pay a high rate for such bills,
as they are drawn on prime bankers, rendering certain their ultimate
payment. The purchase of the bills does not, moreover, necessitate any
outlay of money, as against the credit to be received through the
discount of the bills the New York bank can immediately sell its checks
on London.

Without such banking facilities--that is, the ability to arrange with
his bank to accept time bills drawn on it by a foreign shipper, the
American importer is compelled to finance his purchases in either one of
two ways. He may pay for the goods at once by remitting funds direct to
the shipper. This, however, ordinarily necessitates the negotiation by
the importer of a loan on his promissory note. If he is not in a
position to secure such an advance he must shift the burden of providing
funds to finance the shipment, from the time it is forwarded until it is
to be paid for, upon the foreign shipper, who is then in a position to
exact terms more favorable to himself through an adjustment of prices.
The practice in connection with this method of making payment for
foreign purchases is for the shipper to draw his draft on the American
importer and turn it over to his banker to forward for collection. Such
drafts, drawn as they are on individual importers and not on banks whose
standing is well known abroad, must be sent for collection since there
is no general market for them. Practically the only way in which a
foreign shipper can realize immediately on bills of this character is to
dispose of them to his own banker or get him to make an advance on them.

Either of these two methods of financing our imports is expensive even
when the time between the shipment and the receipt of the goods is
short. When the time is much longer, as in the case of imports from
South America and the Far East, the cost is almost prohibitive--that is,
so great that we can not compete on an even basis with foreign buyers.
In fact, we might be practically excluded from these markets if a
makeshift were not possible. Our importer gets around our lack of
banking facilities by having his bank arrange a credit with its London
correspondent. He receives an undertaking, called a commercial letter of
credit, giving the terms of the credit--that is, the name of the London
bank upon which the bills are to be drawn, the amount which may be
drawn, the character of the goods which are to be purchased, the tenor
of the bills, and the documents which must accompany them. On the
strength of such a letter of credit, the shipper in South America, for
example, is able to dispose of his bills on London and thus receive
immediate payment for his goods. The local bank which buys the bills
sends them with the documents to its London correspondent, which
presents the bills to the bank on which they are drawn--that is, the
bank with which the credit was opened. Upon the acceptance of the bills
the documents are delivered. They are then sent by the London accepting
bank to the New York bank which opened the credit and the latter
delivers them to the importer against his trust receipt. Twelve days
prior to the maturity of the bills in London the New York bank presents
a statement to the importer indicating the amount of pounds sterling
which must be remitted to London to provide for their payment at
maturity or rather a bill stated in dollars for the amount of pounds
sterling drawn under the credit. In this purchase of exchange the
importer makes payment for his goods. This method while workable is
obviously cumbersome, yet it is practically the only one which the
American importer can follow in connection with such imports. It is
expensive for the importer, for not only must he pay his bank a
commission for arranging the credit, but there is included in this
commission a charge made by the London bank for its acceptance. Further
than that the importer must take a material risk in exchange. At the
time a credit is opened the cost of remitting, say £10,000 to take up
the bills in London, might be only $48,600, or at the rate of $4.86,
whereas by the time the bills actually mature exchange may have risen
and cost him $4.87, or $48,700.

As a result of the inability of our banks to finance imports through the
acceptance of time bills, American importers are, then, made dependent
to a large extent upon London, and are required to pay London a
considerable annual tribute in the way of acceptance commissions. This
practice not only adds to the importance of London and militates against
the development of New York as a financial center, but it at the same
time works serious injury to our export trade. Since time bills can not
be drawn on our banks from foreign points against shipments of goods to
the United States, there are consequently in such foreign countries very
few bills which can be purchased for remittance to the United States in
payment for goods which have been bought here. In other words, under our
present banking system our imports do not create a supply of exchange on
New York, for example, which can be sold in foreign countries to those
who have payments to make in New York. This means that our exporters are
also, to their great disadvantage, made dependent upon London. It means
that when they are shipping goods to South America and to the Orient
they can not, when they are subject to competition, advantageously bill
them in United States dollars. They naturally do not care to value their
goods in local currency--that is, in the money of the country to which
the goods are going--so their only alternative is to value them in
francs or marks or sterling, preferably the latter, owing to the
distribution and extent of British trade, creating throughout the world,
as it does under the English banking system, a fairly constant supply of
and demand for exchange on London. When we come to bill our goods in
sterling, however, it is at once seen that our exporters are obliged to
take a risk of exchange, which is a serious handicap when competing with
British exporters. Our exporters who are to receive payment for their
goods in sterling must previously decide on what rate of exchange will
make the transaction profitable. If, in an effort to safeguard
themselves against a loss in exchange, they calculate on too low a rate
for the ultimate conversion of their sterling into dollars, their prices
become unfavorable compared to those made by British exporters and they
lose the business. If they do not calculate on a sufficiently low rate
they get the business but lose money on the transaction through a loss
in exchange.

The prohibition of bank acceptances not only acts as a hamper upon our
domestic and foreign trade, but is detrimental to our banks as well. It
is the small country bank which is chiefly affected. The business of the
country bank, so far as the employment of its funds is concerned, may be
divided into two classes--that which relates to advances to local
customers and that connected with the investment of its surplus. It is
in respect to the latter that the matter of acceptances is important.
Under the present limitations of the National Bank Act there are three
principal ways in which a country bank may render its surplus funds
productive. It may deposit them with its reserve agent. This means a low
interest return, too low in fact to permit of only a relatively small
amount being thus employed. It may invest in bonds. In this way an
increased interest return can be secured, providing a wise selection of
securities is made, but it partakes of the nature of speculation. The
third way is to buy commercial paper. Such purchases give an ample
interest return and there is no savor of speculation. Even this method
of employing a bank's funds, however, is far from satisfactory. It means
the investment in a security for the strength of which the bank must
depend on the word of note brokers, the rating of the mercantile
agencies, or the opinion of some correspondent bank. It means,
furthermore, the tying up of the bank's funds for a fixed period. If
national banks were permitted to accept time bills the country bank
could then invest its funds in paper bearing the guaranty of some great
bank with whose standing it is perfectly familiar. Risk such as now has
to be taken would be eliminated. What is vital, however, is that with a
national discount market an investment in a bank-accepted bill is one
which could be realized upon immediately. Commercial paper and bank
acceptances are both discountable. The prime difference between them, as
affecting a country bank, is that they are not both readily
rediscountable. Herein probably lies the reason for the strong prejudice
against rediscounts which exists among bankers in the United States. In
this country when a bank discounts a piece of commercial paper it is
discounting something which for its security depends solely on its
maker. Should the bank desire to realize on this paper it could do so
by rediscounting it, but such a rediscount would be practically
equivalent to a loan to the bank on the strength of its own name. In
other words, to rediscount its commercial paper would affect a bank's
credit. To ask for a rediscount is to ask for accommodation. This would
not be the case with bank-accepted bills. If such bills were discounted
by a country bank as a means of investing its surplus and it was desired
to realize on them such a rediscount would be made not on the name of
the country bank, but on the name of the accepting bank. A rediscount in
this instance would not constitute a loan to the country bank and would
have absolutely no effect on its credit. It would merely indicate that
some more profitable business had arisen in which to employ its funds or
that it was desirous of increasing its reserve.

Since the reserves of interior banks are so largely concentrated with
them and it is essential that they keep their assets in an especially
liquid condition, the prohibition of bank acceptances works injury to
the banks at the country's financial center, New York, in a different
way. It deprives them of what London banks, for example, have--that is,
a mass of the soundest securities against which to loan their money on
call or in which they may invest their funds for very brief
periods--bills of exchange, covering genuine commercial transactions,
bearing the acceptance of prime bankers. Unquestionably such securities
as a basis for loans are preferable to stock and bonds, but without them
New York banks must have recourse to day-to-day loans on the Stock
Exchange. Moreover, when the demand for such loans is limited. New York
banks are forced into the keenest kind of competition, a competition
which, as has been pointed out, is not only of little benefit to trade
but which, through the lowering of the money rate, actually stimulates
speculation. Furthermore, without a steady money rate such as exists in
countries possessing discount markets, New York banks are left with no
reasonable or satisfactory basis upon which to fix a rate of interest to
pay for the deposits of country banks. In London interest on bank
deposits is fixed at a certain percentage below the Bank of England
discount rate, usually 1-1/2 per cent.--that is, a rate which
fluctuates with the value of money and normally leaves a certain margin
of profit to the London bank. The same practice is followed in all the
great financial centers of Europe. With us, country banks receive a
fixed rate of interest for their deposits, usually 2 per cent., the year
around, regardless of fluctuations in the value of money. The
unscientific nature of such a rate is obvious. When the call loan rate
is high country banks do not receive interest in proportion to the value
of their deposits. When it is low the New York banks pay more interest
than the deposits are worth. In the latter instance the New York banks
are forced into injurious competition with one another. They are in much
the same position as competing railroads were earlier in our history,
with results similarly baneful. With the railroads it was worth while to
secure traffic even at a losing rate, as no matter what the return it
helped, if only a little, toward meeting fixed charges. Oftentimes with
the New York banks to-day any rate which they can secure for their money
whether losing or not is acceptable as helping to meet this fixed
interest charge on bank deposits. To pay 2 per cent. for deposits and to
keep a 25 per cent. reserve a bank must loan its money at 2-3/4 per
cent., to come out even, taking into consideration the actual expense of
making and recording the transaction. It is better to loan at 1-3/4 per
cent., however, than to let the money lie idle. It is better to lose 1
per cent. than to lose the entire 2-3/4 per cent., as would be done in
case no loans at all were made, clerk-hire being just as much a fixed
charge as interest. With the amendment of the National Bank Act, to
permit the acceptance of time bills, such ruinous competition would
cease. The funds of the banks would come to be principally invested in
trade paper and stock-exchange loans would be relegated to a position of
secondary importance, as in London and on the Continent. The field for
the investment of their deposits would be greatly broadened, to the
benefit both of the banks and trade in general.

To remedy this primary defect in our banking system, to make possible
the financing of our domestic and foreign trade along the lines which
have proved so advantageous in other countries, to provide negotiable
paper of a character suitable to the investment of foreign funds, paper
which can not only be discounted but rediscounted, to give trade the
advantage of bank surpluses accumulated both in the country at large and
in New York, to lessen the evils of speculation, to afford a reasonable
basis for the calculation of interest rates on bank deposits in central
reserve cities, to bring New York into the circle of those financial
centers between which funds move naturally as discount rates rise or
decline, to secure the advantage of the competition of foreign capital
for our trade paper, can be put in the way of accomplishment by the
insertion of a paragraph or two in the National Bank Act.

* * * * *

[275]The European financial system is constructed upon discounts as its
foundation; the American system is constructed upon bonds and stocks as
its foundation. Bank notes in Europe are issued mainly against bullion
and discounts; in the United States mainly against bullion and bonds.

The quick assets held by European banks against their deposits consist
of discounts or call loans, largely secured by discounts. The quick
assets of American banks ... are primarily call loans on stock and bond
collateral.

In Europe the daily plus and minus of money requirements are adjusted by
the use of the discount market--that is to say, in a final analysis, by
purchase or sale of bills. (Calling in or putting out money on call
where the loans are secured by bills amounts, in effect, to a sale or a
purchase of bills.) In a last analysis this means that in Europe
attempts to liquidate are primarily appeals to the whole nation to
liquidate its temporary commercial investments, the brunt of such
liquidation being borne by the entire community, and the pressure being
constantly subdivided, every member of the community thus contributing
his share.

As a majority of discounts represent goods in process of production or
on the way to consumption, liquidation with them primarily expresses
itself by a falling off in new production, while the consumer, on the
other hand, can not stop consuming and must therefore continue to pay.
The brunt is thus borne by the whole nation and adjustment follows
without violent convulsions.

In sharp contrast with such a system the attempts to liquidate in the
United States are directed primarily at the contractors of stock
exchange loans. This means that a comparatively limited number of
debtors are called upon to sell their securities. This they can do only
by finding new investors, who, as a rule, are at such times
comparatively rare, because when acute pressure arises it generally
originates in the inability of the investor to purchase because of lack
of funds or in his unwillingness by reason of his distrust of the
financial situation. The concomitant of this is that those forced to
sell securities at such times must offer them at sufficiently reduced
prices to bring about an entire change in the attitude of the investor.
The difficulty here is that violent reductions of prices in themselves
cause distrust, and low prices caused by distrust not only frighten away
purchasers but, in addition, unsettle the owners of securities and thus
cause them to join the ranks of the sellers. An acute convulsion,
therefore, must inevitably follow before the tide can be turned....

Of course, general liquidation in Europe includes a liquidation of
securities, just as liquidation in the United States also includes
liquidation of commercial paper as it matures. But the difference is
that in Europe bills will be the main factor and securities will play a
much more subordinate part, while with us just the reverse is true.

THE ESSENTIAL CONDITIONS FOR THE ESTABLISHMENT OF AN INTERNATIONAL
DISCOUNT MARKET

[276]The essential conditions for the establishment of an international
discount market are:

1. Every bill offered for discount should be based on a commercial
transaction where value passes. Finance or accommodation bills should
be extremely rare and capable of satisfactory explanation.

2. It follows that almost invariably the bill will arise out of a sale
of goods and will be in the form of a draft by the seller upon the
buyer, and accepted by the buyer.

3. It will thus be a two-name bill, and not an individual promissory
note. How far you can change your system in this respect and how far the
powers of your new Federal banks can be used to induce such a change, is
a question which I cannot pretend to answer, but which you will no doubt
be able to answer.

4. The bill should be drawn for a period neither too long nor too short.
The period should be sufficient to allow of a resale of the goods on
which the bill is based, thus making the bill in a sense
self-liquidating. The usual period is three months.

5. While there should be a large proportion of trade bills, there should
be a still larger proportion of acceptances by banks and finance houses,
based, of course, on collateral, which usually takes the form of
imported produce. In Germany, however, I understand that banks accept a
good many drafts arising out of internal transactions.

6. If the market is not to be merely a home market, but international:
that is, attractive to foreign bill buyers, an important and desirable
step would be the opening of American banks or branches of American
banks in foreign exchange centres, such as London, Paris, Berlin,
Amsterdam, Buenos Aires, Shanghai, and so on, and these banks should
always be prepared to encourage American bills by buying, at reasonable
rates of exchange, bills on New York, Chicago, and other American
centres, payable in dollars.

7. Your usury laws would have to be modified so as to allow discount
rates to move freely upwards if required.

8. Your Federal reserve banks which are intended to be the equivalent of
the Central banks of other countries, such as the Bank of England, Bank
of France, and the Reichsbank, should be prepared to rediscount approved
bills at all times and to any extent.

The advantages to you of such a market would be the same advantages
that we possess, namely, liquid employment for short money; power to
meet demands for money without disorganizing stock exchange prices;
power to check overtrading at home, and finally, power to check a
foreign drain of gold.

CASH STOCK EXCHANGE DEALINGS

[277]In England, France, and Germany there exist monthly or half-monthly
settlements of stock exchange transactions, and as stock exchange loans
run from one settlement to the next the amount of money employed on the
stock exchange between settlements remains stationary. If, at the
settlement, it develops that commitments on the stock exchange have
increased and that a larger amount of money is needed there, so much
additional money will under normal circumstances be withdrawn from the
bill market and go into the stock exchange. If less money is wanted on
the stock exchange, so much more will go into the bill market.

Without entering upon a discussion of the question of cash stock
exchange dealings versus stock exchange dealings per settlement (for
which, be it said in passing, a suitable method of weekly stock exchange
settlements can probably be devised for this country, combined with
provisions for proper margining in order to prevent over-stimulation to
gambling), we are, for the purposes of this article, interested only in
the effect of this method of cash dealings on the whole financial
system. An exclusive system of cash dealings brings about the
pre-ponderance of the call loan on stock exchange collateral. But for
the existence of the seducing call loan, which is one of the gravest
dangers and curses of our system, we should have been forced to develop
our bill market as a regulator of our daily money requirements. In that
case, instead of seeing the idle money of the whole nation poured into
stock exchange loans when trade is inactive--thus unduly stimulating
speculation when it should be discouraged--and again withdrawing money
from the stock exchanges in order to provide for the business of the
whole nation when trade becomes active--thus bringing about anxiety and
convulsions on the stock exchange in the face of prosperity--we should
have a system based on bills; that is to say, based on the broad
foundations consisting of the commerce and trade of the whole nation,
and we should then enjoy an almost uniform rate of interest all over the
country, gently rising and falling within moderate bounds, instead of
the violent fluctuations and unbearable conditions to which we are now
subjected.

The aggregate amount invested by a nation in trade and commerce should
be and is many times the amount invested in stock exchange loans, which
latter represent undigested securities and securities carried for
speculative investors. Our way of doing business may be illustrated by
two adjoining reservoirs, one small and one very large. The small one
represents the stock exchange and contains the call loans; the large one
represents the general business of the country, as expressed by commerce
and industry. In Europe the small reservoir is regulated by pumping
water into it from the large one or by withdrawing water from it into
the large one. In this way the outflow and inflow of the large reservoir
are scarcely perceptible, and yet there is no difficulty in regulating
the small one. With us, the reverse is done. If there is a shortage of
water in the large reservoir we draw on the small one and, in order to
increase the water in the large reservoir by perhaps an inch, we empty
the small one altogether, or else in order to decrease the amount of
water in the large reservoir by an inch, we fill the small one to
overflowing.

NO POWER TO LEND ON REAL ESTATE[278]

Most of the restrictions in the national banking law have to do with
loans, reserves, or the issue of notes. Of these the restrictions upon
loans are by far the most serious impediment in competing for business
with state banks and trust companies. For the banks outside the large
cities this is particularly true of the provision which forbids loans
upon real estate as security.

This restriction is based upon a sound banking principle, learned after
much bitter experience. But the experience which led to a complete
prohibition of real estate loans was gained amid the economic conditions
of the first half of the last century, and the principle itself is one
which is applicable only to a particular form of banking organization.
While the country was in process of settlement, with an abundance of
unoccupied fertile land, real estate was a security of most uncertain
value. Moreover, the wildest of the speculative movements which preceded
all our early crises were invariably in land. At present, land values
are far more stable, and real estate is everywhere included among the
most conservative of investments, proper for all with the one exception
of commercial banks.

For banks, all of whose obligations are payable upon demand, the real
estate loan, quite regardless of its safety, is wisely considered
unsuitable. Such loans are commonly wanted by borrowers for a
considerable period of time and, therefore, they can not readily be
reduced in amount even by an individual bank. In other words, they are
not liquid. But the importance of this quality in all its assets
disappears when a bank begins to acquire time or savings deposits, as
well as those payable on demand.... The example of the trust companies
shows that a great variety of financial business can be carried on
safely and profitably under a single management. Failures among them
have been comparatively few in number, and it would be difficult to find
a single instance of disaster which could be attributed to the variety
of business carried on.

Some of the advantages which the banks would derive if they were able to
lend on real estate are so evident that they require little more than
mere mention. It would give them more of the most profitable kind of
business, that which has its origin in the neighborhood of the bank. The
immediate return is generally greater than can be secured from the
employment of funds in the money centers or in the purchase of paper
from note brokers. Moreover, in fostering the growth of wealth and
population in its locality a bank is laying a solid foundation for the
future expansion of its own business. Finally, the ability to lend on
real estate will often enable a bank to secure valuable customers who
would otherwise go elsewhere. It has been the unpleasant experience of
many a national banker to be obliged to refuse a loan to a would-be
borrower who has nothing but real estate to offer as security and to see
him enter a neighboring state bank or trust company where there was no
legal obstacle to the transaction. Relations once established are pretty
certain to continue even after the borrower has security which falls
within the provisions of the national law.

There are then at least three distinct advantages which may be expected
to follow if the national banks are permitted to lend on real estate. It
would be profitable for the banks; it would be of advantage to the
localities served by the banks; and, finally, it would enable the banks
to compete with state institutions upon a more equal footing,[279] thus
checking to some extent the relative decline of banking under the
national law.

THE INDEPENDENT TREASURY AS A SOURCE OF WEAKNESS IN OUR BANKING
SYSTEM[280]

For many years the banks of this country have conducted a persistent
agitation for the abolition of the Independent Treasury system. It has
been their contention that the Independent Treasury was an archaic and
inefficient system of administering the finances of the nation; that it
worked serious hardship upon the banks and the business of the country,
and that any system of reform should include its abolition.

The treasury is, in reality, a central bank of deposit with branches,
run by the Government, in which the Government is the only depositor,
and from which there are no borrowers. The central office of the
Treasury is situated in Washington, while there are ten subtreasuries or
branches scattered among the various large cities of the country. The
most important subtreasury, from the standpoint of the volume of
business handled, is located in New York City....

The United States is the only large nation in the world which has a
treasury system of this sort, and this fact has been made much of in the
agitation for its abolition.

DIFFICULTIES ARISING FROM THE TREASURY SYSTEM

There is no room for dispute that many features of the Independent
Treasury have, in the past, been the source of serious difficulties.
However, we must recognize that within the last decade, and particularly
within the last two or three years, most of the glaring defects have
been eliminated through a liberalization in methods, involving, in
brief, a deposit of a very considerable amount of the Government's money
in national banks rather than carrying it locked up in the vaults of the
Treasury, through more liberal administrative regulations by which
payments to the Treasury could be made with certified checks, and
through facilitating in other ways the transactions of business men with
the Treasury Department.

CORRESPONDENCE OF TREASURY RECEIPTS AND DISBURSEMENTS

... The real criticism against the Treasury is that it causes the tying
up of money, not over a series of years, but during the months in which
the banking system of the country most needs it. This condition is the
result of the lack of correspondence between government receipts and
disbursements.

During the first four months of the year the receipts are less than in
any other period. During the month of May, the receipts sharply
increase, reaching their maximum about the first of June, and continuing
at a very high rate over that month. In July the income falls off,
reaching by the end of the month a point a little above that which
prevailed in April, after which it gradually increases during August and
September. About October first the tide turns and the receipts fall off
sharply during that month, while during December the revenue again
increases. As contrasted with this the government expenditures change
only in a general way....

EXAGGERATION OF TREASURY EVILS

It should be stated that whatever embarrassment exists because of this
condition, and which as a matter of fact has been grossly exaggerated,
is found almost entirely in New York City.

However, in order to reduce as much as possible the objections raised by
the bankers and to prevent money being taken out of circulation and
buried in the Treasury, where it would be of no service to the country,
the Secretary of the Treasury, on January 9, 1913, issued the following
order, which inaugurated a radical change in the manner of handling and
disbursing the public funds. The objects to be accomplished were
announced in the order as follows:

"For the purpose of bringing the ordinary fiscal transactions of the
Federal Government more nearly into harmony with present business
practices, it has been determined that the daily receipts of the
Government shall be placed with the national bank depositaries to the
credit of the Treasurer of the United States. Disbursements will be made
by warrant or check drawn on the Treasurer, but payable by national bank
depositaries, as well as by the Treasury and subtreasuries."

Secretary McAdoo, in his report for the fiscal year ending June 30,
1913, in speaking of this, stated that while it had caused some
embarrassment "the difficulties at first encountered are disappearing,
and the system appears to respond to the public requirements, and to be
accomplishing the purposes for which it was devised."

LACK OF CENTRAL CONTROL

[281]There is no country in the world where the volume of currency in
circulation and the demand for bank credits fluctuate more widely than
in the United States. This is due to the great expanse of our territory,
to the annual harvest requirements of the agricultural sections, to the
prevailing business activity and enterprise, and to the rapid and
unequal increase of population and wealth in different sections.
Furthermore, there is no country in the world where intelligent control
over bank credits and bank reserves is needed more than in the United
States. There are in the United States nearly seven thousand national
banks, besides twice as many state banks and trust companies. Each of
these institutions acts for its individual interest alone, independently
of the others, and the prevailing tendency of each at all times is to
expand its credits to the limit permitted by law. The country banks lend
their surplus resources in the form of deposits at interest to the banks
in the larger cities, and the banks in the principal money centres
commonly expand their credits as much as practicable by lending on call
such sums as they deem it unsafe to lend on time or by discount of
commercial paper. Each bank with a deposit in another bank assumes that,
in case of need, it can strengthen its reserve by drawing upon this
deposit; but it fails to consider that, when thus it strengthens its own
reserve, it must to the same extent weaken the reserve of the other
bank, and that the deposits of banks with other banks add no strength to
the general credit situation. Each bank that has loaned money on call
assumes that, in case of need, it can strengthen its reserve by calling
such loans; but it fails to consider that, generally, when a loan is
called the borrower is obliged to borrow the same sum from some other
bank, although a high rate of interest may be exacted, and, therefore,
that call loans affect the security of the entire bank situation
practically to the same extent as time loans.

In the United States there is no way of regulating the supply of bank
credits and of holding part of the potential supply in reserve for
periods of financial stringency. Consequently, nearly always there is
either an over-abundance of money (meaning credit which the banks are
ready to lend) or a money famine. It has been argued that the volume of
credits granted by the banks depends upon business activity and upon the
consequent demand for credit and not upon the power of the banks to
grant credits, and, therefore, that low interest rates have little
effect in causing an expansion of bank credits. Experience, however,
shows that the contrary is the case, at least in the United States. It
is true that, when there is loss of confidence and when business is
depressed, interest rates are low, because there is less currency in
circulation and more in the bank reserves, while at the same time the
demand for bank credits is diminished. It is true, also, that low
interest rates will not stimulate speculation and enterprise unless
people have confidence and are ready to speculate and to embark in new
enterprises. But we know by experience that when people are in a mood
for speculation and for business expansion low interest rates operate as
a powerful stimulus to speculation and business expansion. A leading
banker has said: "In the long run commerce suffers more from the periods
of over-abundance (of money) than from those of scarcity. The origin of
each recurring period of tight money can be traced to preceding periods
of easy money. Whenever money becomes so over-abundant that bankers, in
order to keep it earning something, have to force it out at abnormally
low rates of interest, the foundations are laid for a period of
stringency in the not far distant future, for then speculation is
encouraged, prices are inflated, and all sorts of securities are floated
until the money market is glutted with them."[282] [The need of
intelligent control over discount rates and bank credits is (was)
imperative.]

ABSENCE OF REGULATION OF RATIO OF DEPOSITS TO CAPITAL AND SURPLUS

[283]The reports of condition of the national banks, according to the
statements of September 12, 1914, to the Comptroller of the Currency,
show that, on an average, the total deposits of all national banks
amount to about four and six-tenths times their total capital and
surplus. This means that the average capital and surplus of these banks
is equal to approximately 21 per cent. of the total amount of deposits.
There are, however, national banks whose deposits amount to ten or more
times their capital and surplus, and in these cases the margin of
protection to depositors is only 10 per cent. or less of the sum total
of deposits. Usually the amount of money which a bank has invested in
loans approximates the amount of its deposits. In the case of a bank
whose loans equal its deposits, and whose deposits are approximately ten
times its capital and surplus, it is obvious that the loss of over 10
per cent. in loans would wipe out both capital and surplus and destroy
the solvency of the bank, rendering it unable to pay its depositors.

The view is held by many practical bankers and experienced economists
that it is not sound banking for an active commercial bank to be allowed
to receive deposits in excess of ten times its capital and surplus. I am
firmly impressed with the correctness of this view, and respectfully
recommend to the Congress that the national-bank act be amended so as to
provide that no national bank shall be permitted to hold deposits in
excess of ten times its unimpaired capital and surplus. Perhaps it might
be wiser to make this limitation eight times the capital and surplus.

Such a limitation need not interfere with the growth and development of
the bank. When its deposits approach an amount equal to ten times its
capital and surplus, or whatever other limitation may be fixed,
arrangements may be made to increase its capital. A bank whose deposits
amount to ten times the capital and surplus, if efficiently managed,
should be so profitable that there would be no difficulty in providing
for an increase of capital by the sale of additional stock, and when the
proposed increase shall have been authorized by two-thirds of its
stockholders and approved by the Comptroller of the Currency, it can be
made promptly effective. A commercial bank whose capital and surplus
amount to less than one-tenth of its deposits is, except possibly under
very exceptional conditions, doing business on too small a capital and
upon too narrow a margin for safety, and does not furnish its creditors
the protection to which they are entitled against unexpected losses and
contingencies which are liable to, and do, so frequently arise....

BANKING ABUSES

[284]... Among the many abuses and violations of law and regulations
with which the department has to contend are excessive loans;
overdrafts; loose and unbusinesslike methods of accounting; excessive
borrowings by the banks; investment of the bank's funds in securities
not authorized by law; charging of usurious rates of interest; unlawful
loans on real estate; excessive loans to officers, clerks, and employés
of the bank employing them; loans to a bank's officers or employés and
others through "dummies"; loaning money, directly or indirectly, upon
the bank's own stock; transaction of a brokerage or commission business
by the bank's executive officers, the commissions thus collected being
sometimes appropriated personally by the officers and sometimes going
directly or indirectly to the bank; false statements of directors as to
ownership of stock; false statements made by bank officers, such as
including as cash or cash items memoranda of moneys due from one source
or another which do not represent actual cash and can not be immediately
converted into cash; and failure or refusal when so directed to charge
off bad debts and other ascertained losses; delay on the part of
directors in taking the oath of office.

For many of the offences indicated the only penalty which can be
enforced by the Comptroller's office is the forfeiture of the bank's
charter by suit in the United States Court. This in many cases would
prove a great hardship to innocent stockholders and depositors, and can
only be resorted to with much reluctance by this office....

USURIOUS INTEREST RATES

[285]All the national banks of the country have been required in each
report of condition made to the Comptroller's office since January 1
last to state under oath the highest rate of interest they have charged
since the preceding report and the average rate of interest charged by
them on all loans since the preceding report.

The reports received at the Comptroller's office show indisputably that
in some States and sections borrowers, especially small borrowers, have
been and are being subjected to extortions and exactions which the
average man would consider impossible in this enlightened age.

One thousand and twenty banks in different sections of the country, out
of the total of 7,615 banks, admitted that they were receiving an
average of 10 per cent. or more--some an average of 18 per cent.--on all
their loans.

Those receiving an average of 10 per cent. and upwards included 2 banks
in Illinois, 6 in Minnesota, 2 in Missouri, 23 in Georgia, 6 in Florida,
21 in Alabama, 2 in Louisiana, 315 in Texas, 17 in Arkansas, 3 in
Tennessee, 90 in North Dakota, 25 in South Dakota, 18 in Nebraska, 5 in
Kansas, 38 in Montana, 14 in Wyoming, 37 in Colorado, 25 in New Mexico,
300 in Oklahoma, 12 in Washington, 10 in Oregon, 13 in California, 2 in
Utah, 1 in Nevada, and 33 banks in Idaho.

Let me illustrate the methods of some of these bankers by giving you the
facts and figures as taken from the sworn statements submitted to the
Comptroller's office by the national banks in two particular States in
the Southwest.

In one of these States there were 131 banks which reported that they
charged a maximum rate of interest ranging from 15 per cent. to 24 per
cent. per annum, 67 banks whose maximum rate ranged between 25 per cent.
and 60 per cent. per annum, 22 banks which charged between 60 per cent.
per annum and 100 per cent. per annum, 18 banks whose maximum rate was
from 100 per cent. to 200 per cent. per annum, and 8 banks which owned
up to having charged maximum rates ranging between 200 per cent. and
2,000 per cent. Most of these disgraceful and unprecedented rates were
for comparatively small loans....

These figures are not results of the rule, applied by many banks, not to
pass a loan on their books for less than a dollar.... When we find loans
made by national banks for $25, $50, $100, $200, $500, and $2,000 or
more, at 40, 50, 100, or 1,000 per cent., it is merely a hideous gamble
on how long the borrower can keep starvation from his door and live and
work. Yet I am told on good authority that in one State, largely
agricultural, reports from nearly 200 banks--lending chiefly or largely
to farmers--show losses of only a fraction of 1 per cent. on farmers'
loans, while the average interest rate in these particular banks is 12
per cent. to 15 per cent.--and the maximum rate 30 per cent. or 40 per
cent., the banks paying large dividends.

We read much of the infernos of the slums of the great cities, of
degradation and misery and squalor, of the grinding callousness of
tenement landlords and sweatshop operators. Here in the country we find
bankers, men in business that should be the most respectable, as it is
the most responsible, of all secular avocations, literally crushing the
faces of their neighbors, deliberately fastening their fangs in the very
heart of poverty....

A well thought out, carefully constructed, conservative system of rural
credits for the development of agriculture and the increase of our
wealth and resources by offering encouragement and opportunity to the
ambitious farmer will come presently. When it comes all of us will share
the splendid results....

BANKERS' VIEW OF USURIOUS INTEREST RATES

[286]On February 25 the following statement was "given out" from the
office of the Comptroller of the Currency:

The Comptroller of the Currency received to-day from the
Farmers' Grain Dealers' Association of Iowa notification of
the adoption at the convention of that association in Des
Moines, Iowa, on the 17th instant, of the following
resolution:

_Be It Resolved_, By the Farmers' Grain Dealers' Association
of Iowa, representing 40,000 members, as follows:

That we are as much opposed to bank discrimination in
interest rates as to railroad discrimination in freight
rates.

We oppose private control of the public currency.

That we strongly commend the Comptroller of the Currency for
his courageous exposure of bank usury; and we unalterably
oppose the efforts of the guilty parties to abolish his
office.

There has been no better statement of the Comptroller's position than is
here given--credit standing and variations of it must have no influence
on interest rates and anyone who wishes his office abolished is guilty
of usury; or, conversely, only those guilty of usury wish the office
abolished.

The statement is inadequate only in the failure to define what is meant
by "private control of the public currency."

FOOTNOTES:

[249] Conway and Patterson, _The Operation of the New Bank Act_, pp. 1,
2. J. B. Lippincott Company, Philadelphia, 1914.

[250] John Skelton Williams, Comptroller of the Currency, _Democracy in
Banking_, Address delivered before the annual convention of the North
Carolina Bankers' Association, Raleigh, May 13, 1914. Printed in
_Congressional Record_, 63d Congress, 2d Session, Vol. 51, pp. 10150-53.

[251] A. Piatt Andrew, _The Essential and the Unessential in Currency
Legislation_, in Questions of Public Policy, Addresses delivered in the
Page Lecture Series, 1913, before the Senior Class of the Sheffield
Scientific School, Yale University, pp. 62-70. Yale University Press,
New Haven, Connecticut, 1913.

[252] Adapted from John Perrin, _What is Wrong with Our Banking and
Currency System?, The Journal of Political Economy_, Vol. 19, No. 10,
December, 1911, pp. 856-865.

[253] Paul M. Warburg. _The Discount System in Europe_, Publications of
the National Monetary Commission, Senate Document, No. 402, 61st
Congress, 2nd Session, pp. 33, 34.

[254] Conway and Patterson, _The Operation of the New Bank Act_, pp.
203-207. J. B. Lippincott Company. Philadelphia. 1914.

[255] Fred Rogers Fairchild, _Bond-Secured Bank Notes and Elasticity_,
_The Outlook_, Vol. 88, No. 11, March 14, 1908, pp. 590-93.

[256] [As was pointed out in an earlier chapter, the autumnal demand for
currency in the agricultural sections of the country has fallen off
appreciably since 1907.]

[257] Fred Rogers Fairchild. _Fundamental Defects of the Bond-Secured
Bank Notes_, _Bankers Magazine_, Vol. LXXVI, No. 4, April, 1908, pp.
487-90.

[258] We are not considering the third alternative of issuing bonds at a
heavy discount.

[259] Adapted from W. H. Lyon, _A Gamble in Governments_, _Moody's
Magazine_, Vol. XI, No. 1, January, 1911, pp. 181-186.

[260] [In this extract the explanation of the so-called perverse
elasticity of our national bank notes is given incidentally but very
clearly.]

[261] Adapted from John Perrin, _What is Wrong with Our Banking and
Currency System?_, _The Journal of Political Economy_, Vol. 19, No. 10
December, 1911, pp. 856-865.

[262] Eugene E. Agger. _The Commercial Paper Debate. The Journal of
Political Economy_, Vol. 22, No. 7, July, 1914, pp. 663-667.

[263] _Annalist_, March 9, 1914, p. 293.

[264] _Annalist_, March 9, 1914, p. 294.

[265] J. J. Klein, _Annalist_, March 23, 1914, p. 361.

[266] _Ibid._

[267] During 1912 over $1,700,000,000 in notes were sold by reputable
brokers, and they represented in these transactions from 2,500 to 3,000
concerns. In one large eastern state over two-thirds of the state banks
and trust companies regularly invest a portion of their funds in this
class of paper (J. A. Broderick, _Finance_, October 4, 1913, p. 328). On
August 9, 1913, according to the report of the Comptroller of the
Currency, the national banks held over six billions of dollars of
commercial paper, most of which was single-name.

[268] _Financier_, June 22, 1912.

[269] J. G. Cannon, _Financial Age_, October 19, 1908.

[270] P. M. Warburg, _The Discount System in Europe_, in Report of the
National Monetary Commission.

[271] _Ibid._: see also William Jacobs, _Bank Acceptances_, in Report of
the National Monetary Commission.

[272] Warburg, _loc. cit._

[273] E. D. Page, _Annalist_, March 16, 1914, p. 324.

[274] Lawrence Merton Jacobs, _Bank Acceptances_, Publications of the
National Monetary Commission, Senate Document No. 569, 61st Congress, 2d
Session, pp. 9-19.

[275] Paul M. Warburg, _The Discount System in Europe_, Publications of
the National Monetary Commission, Senate Document, No. 402, 61st
Congress, 2nd Session, pp. 23-25.

[276] Adapted from James H. Simpson, General Manager, Bank of Liverpool,
Ltd., _Some Leading Features of the London Money and Discount Markets_,
an address delivered at the annual banquet of the bankers of the city of
New York, January 19, 1914.

[277] Paul M. Warburg, op. cit., pp. 28-30.

[278] O. W. M. Sprague, _Banking Reform in the United States_, pp.
72-75, Harvard University, 1911.

[279] The importance of real estate to the state banking institutions is
shown in the Special Report from the Banks of the United States on April
28, 1909, recently published by the National Monetary Commission. For
state banks real estate loans and mortgages amounted to $414,000,000 or
12-1/2 per cent. of total resources and for the trust companies to
$377,000,000, more than 9 per cent. of their resources.

[280] Conway and Patterson, _The Operation of the New Bank Act_, pp.
184-192. J. B. Lippincott Company. Philadelphia, 1914.

[281] Victor Morawetz, _The Banking and Currency Problem in the United
States_, pp. 47-50. North American Review Publishing Company. 1909.

[282] From an address by Mr. James B. Forgan to the Texas Bankers'
Association.

[283] Report of the Comptroller of the Currency, 1914, pp. 20, 21.

[284] _Ibid._, pp. 16, 17.

[285] John Skelton Williams, Address before the Kentucky Bankers'
Association, October 6, 1915. _The Commercial and Financial Chronicle_,
Vol. 101, No. 2624, October 9, 1915, pp. 1137, 1138.

[286] _Journal of the American Bankers' Association_, Vol. VIII, No. 9,
March, 1916, pp. 755-6.

CHAPTER XXXI

THE FEDERAL RESERVE SYSTEM

THE FEDERAL RESERVE ACT[287]

THE SPIRIT AND OBJECTS OF THE ACT

The primary purpose of the Federal Reserve Act of December 23, 1913, is
to make certain that there will always be an available supply of money
and credit in this country with which to meet unusual banking
requirements. Banks of a new class, to be known as Federal Reserve
Banks, are to be established, and upon these banks is to rest the heavy
responsibility of supporting the structure of credit in periods of
financial strain. The new banks are expected to keep themselves in a
condition of such strength in ordinary times that the other banks may
safely rely upon them for all needed cash and credit in emergencies. In
the past, the banks in this country, when subjected to financial
pressure, have relied mainly upon loan contraction and the selling of
securities. In future it is expected that they will resort to the
Federal Reserve Banks, securing additional funds from these by
rediscounting commercial loans. If the new arrangements work well, loans
in future will not be reduced merely for the purpose of strengthening
the banks. Loan contraction will take place only when there is evidence
of an over-extended condition of business; and even then contraction
will be carried through gradually, so as to conserve all interests so
far as may be possible. Under the new system a most important influence,
if not the most important single influence determining the character of
banking operations, will be just the reverse of what it has been in the
past.

To meet the heavy responsibilities placed upon the Federal Reserve
Banks, two things are absolutely essential--good management, and ample
powers and resources. Good management cannot be secured with certainty
by means of legislative provisions, however carefully designed with that
end in view. In the particular instance of the Federal Reserve Act, an
ingenious combination of government and banking influence in selecting
the management is provided. Purely banking operations are very largely
to be handled by boards of directors, a majority of the membership of
which is to be chosen by banks. General supervision, and for some
purposes control, is placed with the Federal Reserve Board, which is to
be appointed by the President of the United States, by and with the
advice and consent of the Senate. Experience alone can determine the
wisdom of these arrangements for securing effective management.

The Federal Reserve Banks are to exercise wide powers, and would seem
likely to have ample resources. The country is to be divided into not
less than eight, nor more than twelve districts, in each of which a
federal reserve bank is to be established.[288] All national banks are
required, and qualified state banking institutions are invited, to
subscribe to the capital of the reserve bank in their district.
Subscribing banks, to be known as member banks, are required to keep a
part of their reserve with their Federal Reserve Bank. These banks will
presumably receive most if not all of the general funds of the United
States Government. They will provide an elastic currency, issuing notes
secured by their commercial assets. They are also empowered to undertake
the business of collecting, and clearing checks throughout the entire
country, thus providing an organization for making settlements between
banks in different places, the lack of which has been one of the most
serious defects in our banking system.

Each Federal Reserve Bank will be a central bank for the section of the
country which it is to serve. It will have all the responsibilities and
most of the powers of central banks in the various European countries;
but largely because the system is to be superimposed upon a fully
developed banking system, some important provisions of the Federal
Reserve Act are unlike anything to be found in European legislation. The
Federal Reserve Banks are to receive deposits from the Government and
from member banks only. Ordinarily they will lend to member banks only.
All European central banks, though the bulk of their business is with
banks and bankers, may deal with the general public and do so. The most
striking divergence from European example, however, is the really novel
plan of a system of regional banks in place of a single central bank.
But the extent of this divergence is generally exaggerated. Political
boundaries are indeed in large measure economic and financial boundaries
as well; but central banks in the European countries do act and react
upon each other, often working in harmony, and yet at times very much at
cross purposes. If all Europe were brought under a single government,
very likely the various existing central banks would be merged into a
single institution. In some respects this would be advantageous, but it
would not be absolutely necessary. Certainly European arrangements are
not so fundamentally unlike those of a system of regional banks in a
single country of great size, as to afford ground for the opinion that
in setting up this system foreign experience has been altogether
disregarded.

The various considerations which led to the adoption of the plan for
regional banks, rather than a single central institution, deserve
careful attention, since they indicate the spirit and purpose of the
Federal Reserve Act. A single central bank was the solution of the
banking problem reached without a dissenting voice by the members of the
National Monetary Commission. The bill which the commission prepared was
a notable achievement. Pioneer work though much of it necessarily was,
very few defects on the technical banking side were disclosed in the
discussion which followed the statement of the proposed measure. Its
provisions regarding banking operations, including relations with other
banks, are embodied with few changes of an essential character in the
Federal Reserve Act. Most of the important differences between the bill
and the Federal Reserve Act reflect differences in spirit and purpose
rather than in methods. A central bank and also the system of regional
banks necessarily involve placing somewhere very extensive power to
influence and control credit. In the present temper of public opinion,
the possession of great economic power is not tolerated in the absence
of a large measure of government supervision and control. But
unfortunately, in framing its measure the monetary commission failed to
realize the fundamental importance of this consideration as a factor in
securing general public approval. In devising a form of organization,
competent management and approval in banking circles were evidently the
controlling factors. An organization was proposed under which out of
forty-five directors, but three were to represent the Government, the
remainder being selected in various ways by bankers. Support from some
who were the most bitter opponents of the measure might have been
secured if the bill had provided for a larger measure of government
control; but an equal or even greater number of adherents would probably
have been lost. Under the plan of the commission and indeed under any
central bank plan, government supervision and control cannot be made
effective without at the same time placing the details of operation in
charge of government officials. Few of the most ardent advocates of a
central bank were prepared to take this extreme step.

Under the plan of organization of regional banks, the difficulty of
combining government control and private management vanished. Purely
banking matters, such as the granting of loans, could be placed with
boards entirely or mainly composed of persons selected by the bankers
whose funds were to provide most of the necessary resources. On the
other hand, supervision and whatever measure of control might be deemed
advisable, could be placed with a board mainly or entirely appointed by
the President of the United States. Differences of opinion may be
entertained regarding the particular arrangements in the Federal Reserve
Act for selecting the various administrative bodies, and regarding the
division of power between the directorates of the federal reserve banks
and the Federal Reserve Board. If experience should disclose defects in
this form of organization, it is flexible enough to permit at any time
an extension of government or of banking influence.

Another important advantage of the regional system is to be noted. The
operation of a central bank would be far more likely to give rise to
sectional antagonism. This danger was apparently fully realized by the
members of the National Monetary Commission, and elaborate arrangements
for selecting the management were devised in order to make certain that
each section of the country should be properly represented. But
obviously regional banks, managed by local people, are very much more
certain to meet this requirement. Apparently it was an endeavor to
remove still further the danger of sectional dissatisfaction that led
the Monetary Commission to make its one serious departure from sound
banking principle in framing its bill. A provision was inserted
requiring rediscounts to be made at a uniform rate throughout the entire
country, regardless of the wide differences in the demand and supply of
capital, which occasion the existing wide differences in lending rates.
Under the regional plan no such indefensible provision was found
necessary. This important feature of the Federal Reserve Act outweighs
such advantages in economy of resources and effectiveness in management
as were sacrificed in substituting for a central bank the regional
banks.

The Monetary Commission in framing its bill seems to have been guided by
two principles generally wise in legislation--the scope of the measure
was limited to the single purpose of removing purely banking defects in
our banking system, and no greater departure from existing arrangements
was proposed than was essential for the purpose in hand. The Federal
Reserve Act certainly runs counter to the first of these principles. Its
primary purpose is similar to that of the bill of the monetary
commission; but a secondary purpose evidently exercised a potent
influence. This purpose was to decentralize credits by lessening the
concentration of banking funds in a few large banks in the chief
financial centers, and especially in New York. The regional system
itself gained much support because it was believed by many that it would
lessen the financial predominance of New York City. No comprehensive
scheme of legislation with this object in view was inserted in the bill;
but wherever two or more means of accomplishing the primary purpose of
the bill were open, that one was evidently selected which it was
believed might tend toward decentralization. In general the desire to
decentralize credits explains why the act makes very much greater
changes in existing arrangements than were proposed in the bill of the
Monetary Commission. In the latter, the practice of depositing a part of
the required reserves of the banks with reserve agents was left
undisturbed. Under the terms of the Federal Reserve Act, such deposits
are to be reduced by successive installments, and discontinued entirely
three years after the passage of the act. From a purely banking point of
view, much can be said for this great change; but it was certainly not
absolutely necessary in order to secure the desired improvements in the
working of our banking system.

The new banking institutions for which the Federal Reserve Act makes
provision cannot be put in successful operation (and in this it
resembles the bill of the Monetary Commission) unless a considerable
number of the existing banks enter into relations with them. An
institution might have been established with large capital, and a
monopoly of the right of note issue, authorized to act as government
fiscal agent, and to deal with the general public. Such an institution
would presumably in the course of time have become a central bank, the
main reliance of other banks in emergencies. In order to avoid
competition with existing banks, the act provides that the receipt of
deposits by the Federal Reserve Banks, and their normal lending
operations shall be confined to those banks which subscribe to the
capital and maintain balances with them. Obviously, then, if banks in
large numbers do not accept the arrangement, subscribing to the capital
and relying upon the new banks for accommodation, the system cannot be
put into effective operation. Moreover, it is necessary that many banks
shall enter the system at the outset. An attitude of hesitation would
change to one of positive distrust, if the initial response were
inadequate.

In the case of the bill of the Monetary Commission, reliance was placed
simply upon the attractiveness of the measure. No bank would have
suffered positive loss from failure to enter the system, though certain
slight inducements were held out to those banks which accepted the
arrangement at the outset. Whether a sufficient number of banks would
have entered that system, if it had been established, may be thought
probable but is not certain. Bankers are naturally and properly a
conservative class and the inclination of many would have been to wait
until the system was in successful operation. The attitude of bankers
toward the Federal Reserve Act while it was passing through Congress was
distinctly unfavorable. Most of its provisions already referred to, as
well as others in which it differed from the Monetary Commission bill,
were disliked. It was evident that in the absence of positive pressure,
the number of banks which would accept its terms would be too small to
make successful operation possible. No attempt was made, however, to
insert provisions which would bring pressure upon state banking
institutions. Perhaps it would be possible, either under the inter-state
commerce or the postal clause in the Constitution; but it would have
been contrary to the constitutional traditions of the party in power,
and it was not necessary. If the national banks very generally enter the
system, the resources of the Federal Reserve Banks will be sufficient to
test the effectiveness of the measure. Accordingly the Federal Reserve
Act contains a number of provisions designed to bring pressure to bear
upon these to enter the system immediately. Failure to accept the terms
of the act within one year after its passage involves forfeiture of the
national charter. This alone would be no great business sacrifice, since
banking in most States is quite as profitable under a state as under a
national charter. Loss of the national charter, however, involves a loss
of the right to issue bank notes and calls for the deposit of lawful
money in Washington equivalent to the amount of outstanding circulation.
Most national bank notes are secured by 2 per cent. government bonds,
the price of which, in the absence of the circulation privilege, would
be perhaps about two-thirds of the price (somewhat above par) at which
they were purchased by the banks. No considerable number of national
banks could refuse to enter the system without involving themselves in a
heavy immediate loss. A further provision in the act puts more immediate
pressure upon the national banks in reserve cities. If within sixty days
after the passage of the act, a reserve agent bank fails to signify
acceptance of its terms, it must cease to exercise the reserve-holding
right upon thirty days' notice from the Federal Reserve Board.

Many bankers bitterly condemned the compulsory features in the act while
it was on its passage through Congress. This feeling was perfectly
natural, but it was not very generally shared outside banking circles.
Impartially considered, the act imposes no unreasonable burden upon
those who have invested capital in national banks. No one fears the loss
of the funds which may be subscribed to the capital stock of the federal
reserve banks or placed on deposit with them. If loss should be
incurred, it would be primarily due to unsound banking on the part of
the boards of directors of the Reserve Banks, a majority of the
membership of which is to be chosen by the banks themselves. Some
bankers have doubted whether the act would prove an effective measure of
banking reform; but few if any have felt that results under its
operation could possibly be more unsatisfactory than those under the
present system; and all agree that it is a long step toward a perfected
system.

ORGANIZATION

The new system is to be organized under the supervision and direction of
the "Reserve Bank Organization Committee," consisting of the Secretary
of the Treasury, the Secretary of Agriculture, and the Comptroller of
the Currency. The most important function of this committee is to
determine, "with due regard to the convenience and the customary course
of business," the number and area of the Federal Reserve districts into
which the country is to be divided, and to designate the city in each
district in which a Federal Reserve Bank is to be established. Not less
than eight, nor more than twelve districts are to be created. This is a
most difficult task. However carefully the initial lines of demarcation
may be drawn, more or less modification is to be expected after there
has been some experience with the working of the system. Changes in area
of districts, and additional districts if the organization committee
designates less than twelve, may be made at any time in the future by
the Federal Reserve Board. While the rivalry of cities may tempt the
committee to start the system with a larger number, it is to be hoped
that it will be found feasible to begin with no more than eight or nine
districts. The problems which will confront the management of the
Federal Reserve Banks are in many respects unlike those with which our
bankers have had experience. A somewhat higher average of capacity in
the management may more confidently be looked for if the smaller number
of banks is established. Moreover, especially at the outset, mere size
will contribute not a little to the prestige of the banks, and so
inspire public confidence in the new system. A greater variety of
occupations in large areas will lessen, though not much, extremes of
seasonal variation in demands for accommodation upon the federal reserve
banks. Then, too, the task of the Federal Reserve Board in supervising
and co-ordinating the system will be materially simplified, if the
minimum rather than the maximum number of federal districts is decided
upon.

Within sixty days after the passage of the act, in other words before
February 22, 1914, national banks are required, and properly qualified
state banks are invited, to signify their acceptance of the terms of the
act. Within thirty days after the reserve districts have been
designated, each national bank must subscribe to the capital of the
reserve bank of its district an amount equal to 6 per cent. of its
capital and surplus. One-sixth of this subscription is to be paid at the
call of the organization committee, another sixth within three months,
and still another within six months thereafter. The remaining half of
the subscription may be called at any time by the Federal Reserve Board.
All these payments are to be made in gold or in gold certificates. It
will be observed that the exact time when the system will be established
is uncertain. The organization committee is only required to designate
the reserve districts as soon as is practicable; thirty days is then
allowed for the banks to subscribe; and payments will begin sometime
thereafter at the call of the committee....

After the minimum capital (four million dollars for any federal reserve
bank) has been subscribed, the certificate of organization is to be
executed by any five member banks designated for the purpose by the
organization committee. The final duty of the committee will be to
supervise all arrangements for the election of the six of the nine
directors of each Federal Reserve Bank, who are to be chosen by the
member banks. For electoral purposes the banks of each district are to
be divided into three groups--each group to "contain as nearly as may be
one-third of the aggregate number of the member banks ... and as nearly
as may be banks of similar capitalization." While the number of banks in
each group will be the same, the capitalization will be very different.
All the banks with a capitalization above the average in a district will
certainly be in one group; those of somewhat less than average capital,
in the second group; while the third group will be composed of banks
having a very small capitalization. Under this ingenious arrangement, it
is evident that the direct influence of the banks of the large cities in
selecting the directorates of the Federal Reserve Banks is limited.
Local alignments are also avoided. On the other hand, this is not a
grouping to which the banks have been accustomed in the past, and
therefore there is some uncertainty as to whether at the outset it will
be conducive to the selection of capable directorates.

Each group of banks is to choose two directors: a Class A director, who
is to be an active banker representing the stock-holding banks, and a
Class B director, who must be actively engaged in commerce, agriculture,
or some other industrial pursuit in his district. The board of directors
of each member bank is to elect a district reserve elector. Candidates
for the position of director of a Federal Reserve Bank may be nominated
by any member bank; but nomination is not necessary. Electors are to
signify their first, second, and other choices for one director in each
class on a preferential ballot.

In addition to the six directors chosen by the banks, three directors
(Class C) are to be appointed by the Federal Reserve Board. Two of these
must be persons of "tested banking experience," one to serve as chairman
of the board of directors and district reserve agent, the other as
deputy chairman and deputy reserve agent. These reserve agents are the
official representatives of the Reserve Board, through whom it will
exercise its powers of supervision and control over the reserve banks.
The act contains no provision regarding the officers to whom the
operation of the banks will be entrusted. Presumably each board of
directors will appoint one of its members (probably one of the Class A
directors) as president and manager. The term of office of all directors
is three years, but at the outset they are to be classified so that the
term of one director of each of the three classes shall expire annually.
The appointment of Class C directors will be the first duty of the
Federal Reserve Board; inasmuch as the organization of the system can
hardly be completed before the beginning of the summer, the appointment
of this board could be deferred until that time. The selection of these
directors for each of the eight or more Federal Reserve Banks is,
however, no small task in itself; and since public confidence in the new
system will largely be based at the outset upon the character of the
Federal Reserve Board, its early selection is much to be desired.

The Federal Reserve Board itself is to consist of seven members: the
Secretary of the Treasury and Comptroller of the Currency _ex officio_,
and five members appointed by the President of the United States by and
with the [advice and] consent of the Senate. Of the five appointed
members, at least two must be persons experienced in banking or finance.
Not more than one shall be appointed from any federal reserve district,
and due regard is to be given to the different commercial, industrial,
and geographical divisions of the country. The term of office of the
appointed members is ten years; but those first selected are to serve
one for two, one for four years, and so on, so that the term of office
of one member may expire every two years.

Under this arrangement a majority of the board, in the absence of death
and resignation, will never be reconstituted at any one time. Each
President will select two of the appointed members: one in the second
year of his term of office, and one in the fourth. The Secretary of the
Treasury will, of course, be a new member appointed at the beginning of
each presidential term. The term of office of the Comptroller of the
Currency is for five years, so that here a variable element is
introduced. It may happen that some Presidents will never appoint more
than three members during their term of office. Generally, however, each
President will appoint four members; but the last appointment, giving a
majority on the board, will not be made until his final year of office.
Lack of continuity and the possibility of a political board were much
greater under the provisions for selecting the Federal Reserve Board
which were in the measure at various stages while it was passing through
Congress. The arrangements finally adopted would seem to make it
reasonably certain that the Federal Reserve Board will be free from both
these defects.

Organization of the system will be complete[289] with the selection of
the members of the Federal Advisory Council. This Council is to consist
of as many members as there are Federal Reserve districts, the board of
directors of each Federal Reserve Bank selecting one member. The
function and powers of the council are purely consultative. It is to
meet regularly four times each year at Washington, and at other times
there or elsewhere if deemed necessary by the Council itself. It is
authorized to confer directly with the Federal Reserve Board, to call
for information, and make oral or written representations concerning
matters within the jurisdiction of the Federal Reserve Board. It may
prove to be an important part of the organization, but this does not
seem probable. With a scattered membership and holding regular meetings
only at long intervals, it is not to be expected that the Council will
be in close touch with the Federal Reserve Board, or in a position to
formulate policies and urge them effectively. From individual members of
the Council, the Federal Reserve Board should secure valuable
information regarding conditions in different parts of the country; but
the work of the council itself as an organized body seems likely to be
of a formal and perfunctory nature. The importance of the Council would
doubtless have been measurably increased if the proposal had been
adopted that its chairman should sit, even though without a vote, on the
Federal Reserve Board.

CAPITAL, EARNINGS, DEPOSITS OF THE FEDERAL RESERVE BANKS

Since the capital stock of each of the Federal Reserve Banks is to be
exactly 6 per cent. of the capital and surplus of the member banks in
its district, it will always be subject to slight variations. If all
national banks enter the system at the outset, the total subscribed
capital of the Federal Reserve Banks will be a little more than one
hundred million dollars. Subscriptions may perhaps fall somewhat below
this amount, since with the exception of the reserve agent banks, no
penalty attaches to failure to subscribe until twelve months after the
passage of the act. Few state banking institutions will enter the system
at the beginning. In many states legislation is necessary to permit them
to invest in the stock of the Federal Reserve Banks, and to enable them
to count balances with the Federal Reserve Banks as a part of their
required reserves. It is to be presumed also, that such institutions,
since they can enter at any time, will wait to see whether the system is
working to the satisfaction of neighboring national banks.[290]

There will always be wide differences between the capital and other
resources of the various Federal Reserve Banks. Neither the capital nor
the resources of existing banks can be made the basis for dividing the
country into Federal Reserve districts. Geographical consideration will
necessarily require the creation of a number of districts in sparsely
settled parts of the country, in which banking resources are
comparatively small. No Federal Reserve Bank may, however, be
established until it has a subscribed capital stock of at least four
million dollars. It would, therefore, seem to follow that the
organization committee is precluded from forming any district in which
6 per cent. of the capital and surplus of the national and state banks
is less than this minimum amount. There are indeed provisions in the act
designed to meet the contingency of failure by banks to subscribe in
sufficient numbers to provide a minimum capital; but they would not seem
to authorize the organization committee to create districts in which
resort to these provisions would be inevitable.[291]

Whether the capital of the Federal Reserve Banks is large or small is a
matter of no great importance. Subscriptions to capital provide a
comparatively small part of the resources of banks. The capital is an
indication that those conducting a bank have something at stake, and is
also a margin of safety against loss to depositors. These Federal
Reserve Banks are, however, to accept deposits from banks only, and are
ordinarily to confine their dealings to the banks. In these
circumstances, there is practically no difference between the funds
which the federal reserve banks will secure from member banks in payment
of subscriptions to capital stock, and the funds which will be deposited
with them by member banks. The depositors are the stockholders and,
therefore, there is no separate interest to be protected by a margin of
safety.

Shareholders in the reserve banks are entitled to a cumulative dividend
of 6 per cent. A limited dividend is obviously wise, since it tends to
eliminate the profit-making motive in the management. Whether all the
Federal Reserve Banks will regularly earn the 6 per cent. dividend is,
of course, not certain; but it seems highly probable, since the danger
of serious losses is remote, and interest will presumably not be paid to
the member banks on their balances. All earnings in excess of the
dividend are to be paid to the Government of the United States as a
franchise tax; but half of these surplus earnings are to be paid into a
surplus fund until it has become 40 per cent. of the capital stock.
Whatever is received by the Government from the Federal Reserve Banks is
to be used at the discretion of the Secretary of the Treasury, either to
increase the gold reserve against United States notes or for the
reduction of the interest-bearing debt.

The federal reserve banks will doubtless secure very large resources
through the deposit with them of the moneys held in the general fund of
the Treasury of the United States, although no power over the
disposition which shall be made of these funds is granted either to the
Federal Reserve Banks or to the Federal Reserve Board. Entire discretion
remains with the Secretary of the Treasury. He may continue the
independent treasury system without change; he may continue to deposit
funds with member banks, just as hitherto he has placed deposits with
national banks; and finally he may deposit with any or all of the
Federal Reserve Banks, using them as government fiscal agencies. The
responsibility of the Secretary of the Treasury is in no way changed.
Almost certainly in practice, however, the bulk of the free funds of the
Government will be placed with the Federal Reserve Banks, and doubtless
the opinion of the Federal Reserve Board will determine the distribution
of these funds between the various banks.

The lion's share of the cash resources of the Federal Reserve Banks will
come from the reserves and working balances deposited with them by
member banks. Under the terms of the act, part of the required reserves
of member banks _must_ be placed with Federal Reserve Banks. This is a
novelty in central banking legislation, but is based upon sound
principle, and is especially to be commended for this country where, on
account of the absence of branch banking, the number of banks to be
served by the regional banks will be very great. It makes certain some
increase in the resources of the Federal Reserve Banks, along with the
expansion of the credit liabilities of the member banks. It also lessens
somewhat the danger of unnecessary withdrawals of funds from the reserve
banks in emergencies.

Reserve requirements of the national banking law are radically changed.
In addition to the requirement that a part of the reserve of the banks
be kept with the Federal Reserve Banks, the reserve ratio is reduced for
all classes of banks: the practice of keeping a part of the reserve of
country and reserve city banks with reserve agents is to be
discontinued; and a distinction for reserve purposes is made between
time and demand deposits. Some of these changes become effective as soon
as the new system is established; others are to be made in a succession
of steps and completed three years after the passage of the act.

Time deposits are to comprise deposits payable after thirty days, and
are to include certificates of deposit and savings accounts subject to
thirty days' notice. A reserve of 5 per cent. is required against these
deposits, and no distinction is made between country and city banks.
This low reserve requirement will certainly lead the banks to encourage
the conversion of demand obligations into time obligations. A relatively
large part of the deposits of banks in most European countries is
payable at notice. It is obviously an arrangement which shields the
banks somewhat from the effects of sudden waves of distrust.

Against demand deposits the ratio of reserves is also to be reduced at
once; but the existing classification of banks is to be retained. The
required ratio for country banks is reduced from 15 to 12 per cent., for
reserve city banks, from 25 to 15 per cent., and for central reserve
city banks from 25 to 18 per cent. A provision in the bill excluding
from reserves the 5 per cent. fund held in Washington against
outstanding circulation is a slight offset to this reduction in reserve
ratios.

As regards the banks in central reserve cities, the initial arrangement
regarding the disposition to be made of their reserve is also the
_final_ arrangement. They must hold 6/18 of their reserve in vault, 7/18
in their Federal Reserve Bank, and the remaining 5/18 either in vault or
with their federal reserve bank. Other banks are allowed a period of
transition. Reserve city banks for three years must hold 6/15 of their
reserve in vault, thereafter 5/15; for twelve months they must keep with
their Federal Reserve Bank 3/15, adding an additional 1/15 every six
months; so that at the end of two years they will have a deposit of
6/15. During the three year period the remainder of the reserve may be
deposited with reserve agent banks in a central reserve city, or by what
would seem to be an inadvertent extension of existing practice with
those in reserve cities; but thereafter it must be either in vault or
with a Federal Reserve Bank. Country banks must hold in vault 5/12 of
their reserve for three years, thereafter 4/12; for twelve months must
deposit with their Federal Reserve Bank 2/12, and an additional 1/12
every six months until 5/12 are deposited at the end of two years. The
remainder of the reserve may be kept for three years with reserve agent
banks, but at the end of that period must be either in vault or in a
Federal Reserve Bank.

Whether these changes in reserves, together with payments by the banks
of subscriptions to the capital stock of the reserve banks, will make
necessary any considerable amount of loan contraction, cannot be
precisely determined. If numbers of state banking institutions enter the
system at the beginning, some strain may be occasioned, since, although
these requirements are less than those to which the national banks have
been subject, they exceed those imposed upon banks by the law of many of
the states. In order to enable the banks to avoid contraction, the act
contains a provision under which one-half of each instalment of reserve
to be placed in reserve banks may be received in the form of the kinds
of commercial bills of exchange which the reserve banks may purchase in
the open market. It is, however, most unlikely that the banks will be
able to make much use of this arrangement, because of the scanty amount
of such paper available.

FEDERAL RESERVE NOTES AND NATIONAL BANK NOTES

The power to issue notes is a useful but not indispensable resource for
institutions having the responsibilities which are placed upon the
Federal Reserve Banks. The issue of notes by a central bank enables it
to supply domestic requirements for currency without reducing its
holdings of reserve money. In the absence of the right of issue, it
would only be necessary to accumulate in ordinary times a somewhat
greater amount of reserve money, to provide for seasonal and emergency
needs. General public confidence in the Federal Reserve Banks would,
however, be far less secure if they were not empowered to issue notes.
This is because of the exaggerated importance almost universally
attached to the right of note issue, even in countries in which the
check has become a universal medium of payment.

The particular provisions in the act regarding the issue of notes are
extremely complicated, and are in some respects quite without precedent.
The notes for which provision was made in the bill of the Monetary
Commission were to be bank notes pure and simple, subject to a variety
of restrictions designed to keep the total amount issued within safe
limits. The notes which are to be issued under the provisions of the act
are certainly quite as well safeguarded in this respect. In addition,
the notes are made obligations of the Government of the United States,
which also undertakes to redeem them at Washington. The obligation of
the Government is in addition to and does not take the place of any
banking safeguard. It is designed to meet the desires of the very large
number of people throughout the country who believe that the issue of
money is a government function. To many bankers and others familiar with
our past financial history, this provision in the bill was most
distasteful. Their opposition, though natural, was, however, neither
very practical nor reasonable. It was based very largely upon the fear
that the government obligation on the notes would prove an entering
wedge for an issue of fiat money at some future time. But paper money
cannot be issued under the terms of the act for the purpose of meeting
government expenditures. Additional legislation would be necessary, and
the possibility of such legislation is not appreciably increased by
making the notes which are to be issued by the reserve banks an
obligation of the Government. On the other hand, this provision won many
friends for this important piece of banking legislation; it allayed
opposition which would always have been a serious menace to the
permanence of the new system.

The quantity of the new notes which may be issued is wholly within the
control of the Federal Reserve Board; but the initiative in taking out
circulation rests entirely with the boards of directors of the reserve
banks. Applications for notes may be made at any time by a reserve bank
to its district reserve agent, the member of its board of directors who
is the medium of communication between the bank and the Board.
Rediscounted commercial loans equal in amount to the notes applied for
must be deposited with the agent, and a reserve in gold of 40 per cent.
must be maintained. (A reserve of 35 per cent. in gold or lawful money
is required against deposits.) The Board may grant in whole or in part,
or reject entirely, applications for notes, and may also impose such
interest charge upon the notes as it may deem advisable. The notes are
to be a prior lien on the assets of the issuing banks, and there is,
therefore, no possibility of loss to note holders, nor any to the
Government on account of the obligation which it assumes.

Such part of the 40 per cent. gold reserve against the notes as may be
deemed advisable by the Secretary of the Treasury, but in no case less
than 5 per cent., must be deposited in the Treasury of the United States
for the redemption of the notes in Washington. Each Reserve Bank is
required to redeem not only its own notes but also those of the other
Reserve Banks either in gold or in lawful money; redemption in
Washington is in gold alone. In practice it is certain that Reserve
Banks will redeem the notes in gold over the counter; and it is also
certain that slight use will be made of the redemption machinery at
Washington. Member banks will certainly deposit the notes with their own
reserve banks, which are required to accept the notes of other banks at
par. The reserve banks, in turn, are required under the law to return
for redemption the notes issued by other reserve banks. Redemption at
Washington has apparently been provided because national bank notes are
redeemed there in large volume every year; a result of the circumstance
that the present number of issuing banks is so large as to make counter
redemption much more costly.

Various provisions in the act are evidently designed to keep the issue
of notes within safe limits; but not much reliance should be placed upon
them. Reserve Banks may not, under penalty of a prohibitive tax of 10
per cent., pay out the notes of other Reserve Banks. If these banks,
like the Scotch banks, were working in the same territory, regular
redemption would check over-issue on the part of any one of them. But
under a system of regional banks, each with its own territory, there
will be only a very irregular relation between the amount of notes put
out by any one and the amount which will be received by the others.
Moreover, it should be borne in mind that regular redemption is no check
whatever upon general expansion, either in the form of notes or of
deposits, when all banks are expanding credit at the same time.

Not much effect also in checking over-issue is to be looked for from
those provisions in the act which require a 40 per cent. reserve in gold
and impose a graduated tax upon reserve deficiencies. A considerable
part of the total reserves of the Reserve Banks is certain to be in
gold; and deposit liabilities are certain to be vastly greater than
those for notes in circulation. The circumstances are hardly conceivable
in which a Reserve Bank would not have an amount of gold in its entire
reserve ample to provide a gold reserve for such notes as it might
issue. The special tax on note reserve deficiency can therefore be
readily evaded by shifting the deficiency to the reserve against
deposits. Deficient reserves are only allowed when reserve requirements
are suspended by the Federal Reserve Board. The Board is to impose a
graduated tax on all deficiencies except in the note reserve. On note
reserve deficiencies, the tax imposed in the law is to be added to the
rate of discount of the reserve banks. The arrangement would seem to be
a most unworkable one, since there is no means of knowing to what extent
a borrowing bank will have occasion to use the proceeds of its loan in
the form of notes. Fortunately this provision of the act is never likely
to become operative.

After all, for proper use of the right of issue under the act the main
reliance must and should be on wise and experienced management for the
reserve banks, and above all on a conservative Federal Reserve Board.
Restrictions which would make over-issue impossible would also deprive
the right of issue of all usefulness as a means of extending credit.
Moreover, the danger of the over-expansion of credit in the form of
deposits is vastly greater than it is in the form of bank notes in any
country in which deposit credits have become the more important credit
medium.

One of the most perplexing questions that presented itself in framing
the act was the disposition to be made of the national bank notes and
the 2 per cent. government bonds which secure very nearly all of them.
When the measure reached the Senate, it contained provisions which
contemplated the gradual substitution of Federal Reserve notes for the
national bank notes. But when it was pointed out that this would require
the Reserve Banks regularly to rediscount at least seven hundred million
dollars of commercial paper, in order to support the existing volume of
currency, it was felt that some other arrangement must be made. A plan
to unify all the varieties of paper money now in circulation, with the
exception of the silver certificate, by the issue of an equal amount of
United States notes, backed by an ample gold reserve, found influential
support; but it was wisely decided to present this in a separate
measure. The particular provisions regarding the national bank notes and
the bonds contained in the act should be regarded, therefore, as a
temporary arrangement pending future legislation.

In order to avoid the contraction of the currency which would follow the
refusal of many national banks to enter the system, each Reserve Bank is
authorized to purchase bonds and take out circulation similar in all
respects to the notes issued by the national banks. After the end of a
period of two years, additional bonds may be purchased, but only from
member banks, and at the discretion of the Federal Reserve Board. Member
banks desiring to retire circulation and dispose of their bonds, may
make application to the Board, which may require the Reserve Banks to
purchase them. No more than twenty-five million dollars of bonds may be
purchased in any one year, and the amount purchased is to be distributed
among the various Reserve Banks in proportion to their capital stock.
Bonds thus purchased may be used as a basis for additional national bank
notes by the reserve banks, or they may be converted into 3 per cent.
government obligations--one-half into thirty-year 3 per cent. bonds, and
one-half into one-year 3 per cent. notes, both issues without the
circulation privilege. In taking the one-year notes, a Reserve Bank
enters into an obligation to purchase an equal amount at each successive
maturity for thirty years. The purpose of the notes is to provide the
Reserve Banks with a readily marketable asset, the sale of which abroad
may prove serviceable in periods of strain, and the domestic sale of
which will enable the Reserve Banks to make their discount rates
effective in the money market. Government short-term obligations are
used for these purposes by many of the European central banks.

The existing volume of national bank notes will not be reduced under the
terms of the act, except in so far as the Reserve Banks convert 2 per
cent. bonds into 3 per cent. bonds or notes. There may even be some
slight increase in the total of national bank notes in circulation,
since banks may use for this purpose the small quantity of bonds not
already absorbed in this way. Little concern, however, need be felt
because the national bank notes are not to be retired. Present
requirements for money to be used outside the banks are sufficient to
absorb all the notes at present; and with the growth in population a
somewhat greater quantity could be absorbed in future.

LENDING OPERATIONS OF THE FEDERAL RESERVE BANKS

The normal lending operations of the Federal Reserve banks are limited
to the rediscounting for member banks of commercial loans maturing
within ninety days. Commercial loans are generally defined in the act as
"notes, drafts, and bills of exchange arising out of actual commercial
transactions; that is, notes, drafts, and bills of exchange issued or
drawn for agricultural, industrial, or commercial purposes, or the
proceeds of which have been used or are to be used for such purposes."
The Federal Reserve Board is authorized to define more precisely the
nature and character of eligible paper. To make assurance doubly sure,
the rediscount of loans secured by stocks and bonds is specifically
prohibited. The act also provides that six months' maturities of paper
drawn and used for agricultural purposes or based on live stock may be
rediscounted.

In confining rediscounts to commercial loans, the act is more stringent
than that governing the operations of central banks in Europe. In
practice, however, the bulk of the loans of these institutions are in
connection with commercial transactions. While this restriction may in
some particular emergency hamper the Reserve Banks in giving assistance
to some threatened bank, it is upon the whole amply justifiable. Under
our banking system in the past the collateral loan has enjoyed a
prestige which it is hoped will be transferred to commercial loans.
Exclusion of collateral loans from rediscount will certainly contribute
much to bring this about. The restriction also gives the public greater
confidence that the resources of the Reserve Banks will be generally
available throughout the entire country.

One of the reasons which has been advanced for confining rediscounts to
commercial loans is based upon certain misconceptions of the true nature
of commercial paper--misconceptions which, if adopted by the management
of the Reserve Banks in formulating their policy, may have disastrous
consequences. It has been contended on all sides during the last few
years that commercial paper was from its very nature liquid; and
further, that credit could therefore safely be granted to an extent
limited only by the amount of such paper. Both of these contentions are
hopelessly fallacious. In an emergency, no kind of loan is liquid to any
considerable extent. Business cannot suddenly be deprived of the amount
of credit to which it has become adjusted. It is, indeed, often said
that loans based upon any commodity entering into general consumption
can be quickly liquidated. This can be done as regards any particular
loan; but supplies for the immediate and distant future must be in
process of production and they will require a new batch of loans. The
view that credit can be safely granted to the full extent of merchandise
in process of distribution and even in process of manufacture is equally
fallacious. Credit affects price. Liberal discounts may cause
speculative advances in commodity prices, stimulating excessive prices
by wholesalers, jobbers, and retailers, as well as by speculative
holders pure and simple. There is no mechanical or statistical test for
the amount of credit which may be safely granted, whether the loans be
commercial or collateral. Over-expansion is possible by both operations.

Commercial loans will become the most liquid asset that member banks can
hold, simply because they can be rediscounted with the Reserve Banks. A
smaller amount of Bank funds will be employed in the call loan market.
But whatever amount remains available for that use will be subject to
far less seasonal fluctuation both in volume and in rates. The retention
of fixed reserve ratios, even though they may be suspended by the
Federal Reserve Board, will probably lead many city banks to use the
call loan market to a moderate extent, since it will enable them to
avoid the necessity of resorting to the reserve banks for rediscounts
whenever reserves momentarily drop below legal requirements. A somewhat
larger proportion of time loans will doubtless be used in connection
with stock exchange dealings; but the available supply of call money
will presumably be sufficient to permit the continuance of the present
American practice of daily delivery of securities.

At the outset, on account of the widespread prejudice among bankers
against rediscounting, the demand for accommodation from the Reserve
Banks may not be large; but this prejudice will surely die away in time,
and most if not all of the Reserve Banks will suffer from no lack of
regular business, except in periods of business depression. Member banks
in those parts of the country in which the supply of credit is
inadequate for local requirements will lend more closely, while banks
which regularly have more funds than can be thus employed will purchase
more commercial paper from note brokers and perhaps rediscount for banks
in those parts of the country in which rates are normally high.

Aside from the government account, member banks are to provide the funds
for the reserve banking system. Competition with member banks would
therefore and justly occasion serious dissatisfaction. Managed by boards
of directors a majority of the membership of which is to be selected by
the member banks, there would seem to be little danger of serious
competition from the Reserve Banks. Nevertheless the act places such
restrictions upon dealings by the Reserve Banks with the general public
that little or no competition will be possible.

The Reserve Banks are permitted to engage in three kinds of open market
operations: (1) dealings in government securities, and also in
obligations of the states and local bodies, maturing within six months
and issued in anticipation of taxes; (2) dealings in foreign exchange;
and (3) dealings in domestic bills of exchange.

The purchase and sale of government bonds and notes and state and local
short-term obligations require no detailed consideration. In periods of
inactive demand for rediscounts, investments of this kind will doubtless
be made by the Reserve Banks in order to employ surplus funds.

The right to engage in foreign exchange dealings will also be similarly
useful, surplus funds being invested in foreign bills. Moreover, if any
of the Reserve Banks find that their resources are regularly in excess
of domestic requirements, they may be used to facilitate the financing
of the foreign trade of the country with domestic capital. It is also
very generally believed that the power to engage in foreign exchange
operations may be so used that it will be possible to rely upon securing
abundant foreign funds in periods of financial strain. This is most
unlikely. It is entirely possible for a small country to rely upon
holdings of foreign bills as a means of influencing the foreign
exchanges, and even for such supplies of gold as may be needed on
occasions when confidence is threatened. But the banks of a large
country must rely mainly upon domestic resources, since the amount of
cash and credit needed in an emergency is too great to be secured from
foreign money markets. It should be the policy of the Reserve Banks to
maintain themselves in a condition of such abundant strength as to be
wholly independent of foreign assistance. Moreover, if they maintain
strong reserves in ordinary times, they will not be disturbed on account
of gold exports. Gold exports amounting to fifty, or even a hundred
million dollars should not be made the occasion for obstructive measures
such as are adopted by many of the European central banks. Measures of
this kind are generally an indication that the credit structure rests
upon an inadequate foundation. New York has been a free gold market in
the past, and even under our imperfect banking system, there has always
been a sufficient amount of gold for every banking purpose. Moreover,
restrictions placed upon gold movements can have but temporary effects;
in the long run the distribution of gold among the various commercial
countries is determined by fundamental influences which override all
such artificial barriers.

The act permits only one kind of banking business between Reserve Banks
and the general public. They are allowed to buy and sell to or from
individuals, firms, and corporations, as well as domestic and foreign
banks, bills of exchange of the kinds which are made eligible for
rediscount. The purpose of this provision in the act is to enable the
Reserve Banks to secure some employment for their funds when the demand
for rediscounts slackens, and to develop a broad discount market. A
broad discount market may be developed under the new banking
arrangements; but the prediction is ventured that this provision in the
act will not contribute to its development and that in general it will
be barren of results. It should be observed that the promissory note,
the usual borrowing instrument in this country, although it may be used
for rediscounting purposes, cannot be bought and sold in the open market
by the reserve banks. Aside from foreign trade, the mercantile bill of
exchange, payable at a future date, has largely fallen into disuse in
most advanced commercial countries. More and more cash payments are
either insisted upon, or are favored by the offer of trade discounts for
cash considerably greater than bank discounts. When a purchaser pays
cash, obviously a mercantile time bill of exchange cannot come into
existence. In European countries, many purchasers who pay at once often
draw a bill of exchange on their own bank and, after it has been
accepted, discount it in the open market. In this country banks are to
be allowed under the act to accept only bills drawn in connection with
merchandise exports and imports. Material will, therefore, be lacking
for a broad discount market, if its development is dependent upon open
market operations by the Reserve Banks.

Fortunately the development of a broad discount market does not require
open market operations on their part. A broad discount market is one to
which many borrowers resort with full assurance that they will find many
lenders. Even under past banking arrangements, many borrowers and
lenders have been brought together through note brokers; but owing to
the lack of an available supply of cash and credit with which to meet
emergencies, this market has been subject to violent perturbations, and
at times dealings have been almost entirely discontinued. In the future
a solvent borrower will feel more certain that his paper can always be
marketed by his note broker; and banks will purchase more largely, since
they will prefer to use such paper for rediscounting purposes rather
than that of their own regular customers.

ADDITIONAL POWERS OF NATIONAL BANKS

Nearly half of the national banks have established savings departments
and now hold more than eight hundred millions of savings deposits. This
has been a recent development, and one for which there was no specific
authority in the national banking law; but under the liberal
interpretation of that law by the Comptroller of the Currency in recent
years, it has been permitted because it was not forbidden. Many have
doubted, however, whether the banks could enforce the thirty and sixty
days' notice of the withdrawal of deposits which, following the practice
of regular savings banks, appeared on the passbooks issued to
depositors. This uncertainty has been removed by implication by the new
act, which includes in its definition of time deposits, savings accounts
subject to at least thirty days' notice. It is of course a great
advantage to the national banks, that in the employment of these
deposits they are subject to much less restriction than is imposed upon
savings banks in many of the states.

Subject to the permission of the Federal Reserve Board, and when not in
contravention of state laws, national banks may act as trustees,
executors, administrators, and registrars of stocks and bonds. Many
banks will find this a useful extension of their powers. If trust
companies may properly engage in banking, there can be no good reason
why banks should not undertake trust functions. The department store
principle in banking has made rapid headway in most countries in recent
years. Under proper supervision every kind of reasonable and safe
financial business can be handled by a single institution safely and in
a way which is convenient for the business community. In some states
legislation may be necessary to permit national banks to undertake
trust functions. In Massachusetts, it seems to be the opinion among
lawyers that no legislation is required.

Inability to lend on mortgage security has been the most serious
disadvantage experienced by country national banks in competition with
state institutions. Land has been by far the best local security
available over large parts of the country. Rural bankers have, in fact,
taken it into account in making loans and by various devices have
succeeded in making it the security for many of the loans which they
have granted. Under the Federal Reserve Act all banks, except those in
central reserve cities, may lend for periods not exceeding five years 25
per cent. of their capital and surplus, or one-third of their time
deposits, on the security of unencumbered and improved farm land to 50
per cent. of its market value.

Two changes are made in the law for the purpose of facilitating
financial business with foreign countries. National banks having a
capital of at least one million dollars may establish foreign branches,
subject to the approval of the Federal Reserve Board, and to such
regulations as it may formulate for conducting this business. Banks may
also accept bills of exchange maturing within six months drawn in
connection with exports and imports of merchandise. These are desirable
changes in the law. It is not, however, probable that many foreign
branches will be established in the near future, and it is most unlikely
that the American acceptance will make rapid headway in foreign markets.

The scope of the following provision in the act is uncertain. "Other
than the usual salary or director's fee paid to any officer, director,
or employee of a member bank, and other than a reasonable fee paid by
said bank to such officer, director, or employee for services rendered
to such bank, no officer, director, employee, or attorney of a member
bank shall be a beneficiary of, or receive, directly or indirectly, any
fee, commission, gift, or other consideration for or in connection with
any transaction or business of the bank." This prohibition obviously
covers payments to bank directors and officers in return for aid in
securing accommodation from the banks. It may be held that all purchases
by a bank of commercial paper from a firm of note brokers, or of
securities from a banking house, are forbidden if any of the partners of
such firms are on its board of directors. In this event, a few banks
would lose valuable directors; but the question of the wisdom of such
exclusion is too complex to be given consideration in this paper.[292]

SUPERVISORY FUNCTIONS OF THE FEDERAL RESERVE BOARD

A variety of functions of a supervisory or administrative nature are to
be exercised by the Federal Reserve Board. It is to formulate detailed
regulations regarding various matters concerning which only general
provisions are contained in the act. Among important matters regarding
which the Board is to formulate regulations may be mentioned: rules for
conducting branch offices; the regulation of state banks which become
member banks; rules defining precisely commercial loans eligible for
rediscount; and the regulations for the operation of foreign
branches.[293] The Board is to exercise many supervisory functions over
the reserve banks which are similar to those which have long been
exercised by the Comptroller of the Currency over the national banks.
Examination of the Reserve Banks is under its direction. There must be
one examination each year, and additional examinations must be ordered
upon the application of ten member banks.[294] The Board is also to
publish once each week, a statement showing the condition of each
Reserve Bank, and a consolidated statement for all these institutions.
It is also given a number of important powers to be exercised at its
discretion. It may suspend reserve requirements for a period of thirty
days, and renew such suspension for successive fifteen day periods. For
violations of law, it may suspend the operation of a reserve bank, and
administer or liquidate it. The Board may also reclassify cities as
reserve or central reserve cities, or terminate their designation as
such.

The method of banking reform which has now been adopted, necessarily
involves placing somewhere enormous power to expand credit. This power
cannot be surrounded by sufficient safeguards to prevent all possibility
of its misuse, because in so doing, its wise use would be quite as
seriously interfered with. Competent management is therefore absolutely
essential if satisfactory results are to follow the passage of the
Federal Reserve Act. In the operation of the new system, the boards of
directors of the reserve banks may prove the most important part of the
organization; or that place may be occupied by the Federal Reserve
Board. The boards of directors will exercise all the ordinary powers of
such boards, except in so far as they are subject to control by the
Board. All the loans of the Reserve Banks are to be made by the boards
of those banks. In this matter, the Board has no power whatever, except
that it may require, on the affirmative vote of five members, one
Reserve Bank to rediscount paper for others. Here is a power that seems
to be designed merely to prevent any working at cross purposes among the
Reserve Banks. Few or no occasions for its use will present themselves
if all the Reserve Banks are well managed by their own boards. All rates
of discount are to be fixed in the first instance by the boards, subject
to review and determination by the Federal Board. Here again the
decision of the Reserve Bank boards is altogether unlikely to be
overruled if these banks are skilfully managed.

[Illustration: THE FEDERAL RESERVE DISTRICTS]

The power of the Federal Reserve Board to restrain the Reserve Banks is
vastly greater than its power to force them to take positive action
which might lead to the inflation of credit. This was clearly the
purpose in view in giving the Board the more important of its many
powers. It may, for example, reject applications of Reserve Banks for
notes, but this will not endanger assets, it will simply lessen power to
expand operations. Its power over the discount rates of Reserve Banks
will obviously be more effective when used to advance rates which it
deems too low than it will be if used to enforce a rate lower than the
management approves. The directors of the Reserve Bank would still
determine the amount of accommodation which it might safely grant to
member banks at the enforced low rate. Officers and directors of Reserve
Banks may be removed at any time by the Federal Board, which is merely
required to communicate its reasons for removal in writing; but the
right of member banks to choose successors will still remain.

While it is impossible to make any prediction as to the relative place
which the Reserve Bank directors and the Federal Board will hold, it is
evident that, in the absence of harmonious co-operation, the system will
not work smoothly, even if it can be made to work at all. If all the
Reserve Banks and the Federal Board adopt a wise and conservative
policy, the system will surely work well. If the Reserve Banks alone are
conservative, the system may work well but with much friction. If the
Federal Board alone is conservative, it may force good results from the
system. On the other hand, if some of the Reserve Banks and the Federal
Board are reckless, the system will probably break down; and if all the
Reserve Banks and the Federal Board adopt a reckless policy, the results
will be disastrous.

Both the directors of Reserve Banks, and the Federal Board will be
confronted with numerous problems, many novel and some intricate. The
possibilities of the new system cannot be foreseen, and the extent and
nature of the responsibilities resting upon the Reserve Banks cannot be
determined beforehand....

THE FEDERAL RESERVE ACT--AN EXPERIMENT

[295]Banking is the most delicate and sensitive of all businesses in
which men engage. It goes without saying that it is a business in which
the law maker should not needlessly interfere. Perhaps some of you may
not know that modern banking is a product of evolution. In this respect
it is like all great human institutions. No language worth while was
ever invented by a human being. Speech, with all its intricacies and
inconsistencies of grammar and syntax, was not planned by some master
mind centuries ago, but is the result of countless ages of effort on the
part of the human animal, guided only by his sub-conscious
intelligence--that which we call instinct in the lower animals--to give
expression to his emotions and his more or less hazy concepts. Language,
like the comb in which the bee stores its honey, has come to us as the
product of the labor of our ancestors through many millions of years.
Money, credit, and banking are in like manner evolutionary products. If
we attempt to tinker with them artificially without regard to the
lessons of experience and in disregard of the forces of evolution,
believing that our reason transcends the consolidated experience of our
ancestry, we shall meet the fate that we deserve, the fate of the
conceited bee who thinks he can improve the honey comb, or of the
conceited grammarian who would make me walk a literary Bridge of Sighs
for saying "it is me."...

I am quite willing to admit that in some of its details the Federal
Reserve Act[296] has taken leaves from the experience of banking
institutions of this and other countries, but in its essentials, in its
anatomy, in its bony structure as it has been called, it is an animal
absolutely unknown to the natural history of finance. Let me briefly
call attention to the following novelties in banking:

First. It provides for a system of twelve competing banking institutions
which shall control the currency supply of this country, and over which
there shall be no controlling body with power sufficient to compel them
to regard the national welfare in the issue of currency and in the
extension of their credit. It is taken for granted that the financial
welfare of the people will be safe provided that these competing
regional banks are required to hold gold or lawful money reserves of 35
per cent. against deposits and 40 per cent. gold (free from tax) against
notes, and are not permitted to issue notes except upon deposit of good
commercial paper.[297]

Second. The act provides that the Federal Reserve Banks shall have the
right to deal only with banks, nay more, they may deal only with such
banks as have contributed to their capital stock. This again is a
novelty in the banking world. If these banks are to be in touch with all
American business and industry and be powerful agents for the prevention
and alleviation of panic, why should they be thus restricted in their
operations?

Third. The capital of these regional banks is not a matter of voluntary
subscription. It is not founded on business principles. The framers of
the measure seemed to fear lest the banks they were planning might not
prove profitable investments, hence, they have provided that our
national banks must subscribe the necessary capital or forfeit their
charters. No country on this green and prosperous earth has ever found
it necessary to resort to such undemocratic compulsion in order to
persuade people to go into the profitable business of banking.

Fourth. The bank notes issued by these Federal Reserve Banks are called
government obligations and must be redeemed on demand by the United
States Treasury. In no country will you find that any such bank note has
ever been issued or even proposed, and I submit that in the United
States, whose people for half a century have confessedly been subject to
periods of anxiety and distress and panic because of the Government's
liability for the daily redemption of paper money, this provision of the
Federal Reserve Act is amazing, inexplicable, and indefensible. The
United States Treasury is not a bank and is not made one by this act. It
cannot control the issue of the notes, nor the credit operations of the
banks who do issue them. Why then should the treasury be compelled to
redeem these notes?

Fifth. The Federal Reserve Act provides for an arbitrary shifting of
bank reserves such as has never been attempted before. Nobody can
foretell what the result will be, but we know nothing of the sort has
ever been attempted before and we also know that many banks will be
obliged to reduce their loans and discounts, and that their customers,
the business men of the country, may suffer serious losses in
consequence.

The United States has tried many financial experiments--indeed, our
present national banking system was an experiment in finance and has
been found wanting--but the Federal Reserve Act, if it could be put on
exhibition in a world's financial museum, would, I feel sure, be voted
the newest and most spectacular thing we have yet constructed.

THE FEDERAL RESERVE ACT AND DEMOCRACY IN BANKING

[298]Beneath his skin every American citizen of every station and
avocation, and whatever party name he may wear, is a Democrat in all the
essentials and fundamentals. That is, he is attached passionately to the
principles of local self-government, of the widest individual liberty
compatible with the general weal and order of society. This new currency
measure is democratic essentially. It looks to decentralisation of
direct financial control, to financial local self-government, so far as
is consistent with stability and the general safety; to a currency which
will be worth its face value everywhere, which will be based on the
actual values it purports to represent, as well as the faith and credit
of the General Government, and which yet will be elastic, expanding to
meet needs where and when they develop, receding when not needed; a
system fitted to meet any emergency, moving smoothly and noiselessly for
the ordinary uses of business in tranquil times.

Too much money and too little money are alike evil and dangerous.
Opinions differ as to which is the worse. Probably one is as bad as the
other. The design of the new law is to supply just enough money or
credit, when and where business needs it, to create for our commerce, as
has been said, foundations so even, so broadly laid, and so deeply
planted that they can not be shaken.

As it is, the country bleeds and sweats to the big financial centres.
Take the South as an instance--and the conditions with which you here in
North Carolina are familiar exist everywhere in the country. Most of our
railway systems are controlled frequently through the trust known as the
voting trust--by men who are interested in the great banks in the three
central reserve cities. So it happens that the large deposits of the
railways, their collections from the Southern people, as also from the
Western people, are sent on largely to those banks. The same is true of
the telegraph and telephone companies, the life and fire insurance
companies, and of many of the larger manufacturing enterprises. The
merchants and manufacturers of North Carolina pay their freight bills to
the railways. The money goes largely and promptly to New York, and is
lent out and used there in stock-market operations, or as the directors
of the banks, who are also often the directors of the roads and other
corporations, may elect. Of course there is no law which provides for
the carrying of the reserves and bank balances of railways and
industrial corporations in the central reserve cities, where the
national banks of the country have also been accustomed to keep their
reserves.

When North Carolina needs money to move the cotton crop her banks must
call on New York for money which should be in their own vaults; for the
return of money paid in here in freight bills, insurance premiums, and
otherwise; and your banks sometimes think themselves lucky if they can
be allowed the use of any part of it....

It is not hard to see how centralization of financial resources and
money supply and concentration of financial power has been forced, and
the invisible and irresponsible despotism created by acts of Congress
and policies of government made necessary by those acts.

Now, we do not propose to use violence to force disintegration and
decentralization, to do anything with a jolt and a jerk. It is
understood clearly that to rush headlong and at full speed over an evil
or an obstacle may cause derailment or jarring, uncomfortable and bad
for passengers. The thought or plan, as I understand it, is to invite
decentralization, to encourage it, to give opportunity for it, to make
local self-government possible, to remove the influences which draw to a
few centres the money that is paid out to the corporations and deposited
in the local banks....

The law does not require a single business man to change his account
from the bank with which he has kept it or any business man or bank to
suspend dealings with the bank or banks in the central reserve or
reserve cities with which they have in the past been doing business. It
does offer to banks freedom of choice. It says to the banker that he can
follow his preferences, sentiments, or habit in selecting the source of
his borrowing; and the member banker of any federal reserve district may
feel free and peaceful and at ease when he knows that he has in his
portfolio notes, drafts, and bills of exchange arising out of actual
commercial transactions, which he can convert into money at his federal
reserve bank with greater ease and promptness than it has sometimes been
possible for him to withdraw his cash balances from his reserve agents
and almost with as much ease as it has ever been possible to draw on
credit balances with any correspondent. He is not dependent on the whims
or fortunes of any other bank. He need not shiver at the prospect of
abundant crops for fear he may not have available the funds with which
to meet demands for moving them. He will know that if he needs money to
accommodate the bank's customers he can, as a matter of right, call on
his federal reserve bank.

Among other benefits the new currency law, by its direct system of
clearances, will release and make available for purposes of trade and
commerce hundreds of millions of dollars which under the old system have
been tied up in tedious processes of collection. It will also save to
banks and to merchants and business men generally some millions of
dollars which they are now paying, directly and indirectly, for the
collection of country checks and checks on outside cities.

To refer more particularly to your own district, the fifth, I will try
to explain to you how the new method will work in transactions of
domestic exchange.

In this district, embracing the States of North and South Carolina,
Virginia, West Virginia (except four counties), the District of
Columbia, and Maryland, there are some 475 member banks.

A cotton mill at Columbia, S. C., under the old plan sends its check on
its Columbia bank for a shipment of coal to the coal company at
Bluefield, W. Va. The local bank at Bluefield forwards this check to its
correspondent in Richmond. This correspondent sends the check to its own
correspondent in Columbia, who makes the collection from the Columbia
bank and then draws a check on New York for New York exchange, which it
remits to Richmond. The Richmond bank thereupon notifies the Bluefield
bank of the collection of the item. The collection and exchange charges
on distant country banks amount usually to from one-tenth to one-fourth
of 1 per cent., or possibly more, and probably a week or more elapses
between the remittance of the South Carolina check to the Bluefield bank
and the time when the Bluefield bank gets its report that the item has
been collected and placed to its credit in Richmond.

Under the new currency act "every Federal Reserve Bank shall receive on
deposit at par from member banks ... checks and drafts drawn upon any of
its depositors." That means that the Bluefield bank receiving the check
on the Columbia, S. C., bank mails it to the federal reserve bank at
Richmond. The federal reserve bank at Richmond thereupon charges the
Columbia bank with the amount of the check, credits the Bluefield bank
with the proceeds, and notifies the two banks accordingly.

The Federal Reserve Act also provides that each federal reserve bank
shall receive at par, and credit accordingly, all checks and drafts
drawn upon any of its member banks, from every other federal reserve
bank; that all checks and drafts drawn by any depositor--that is to say,
by any member bank--on any federal reserve bank shall be received and
credited at par by every other federal reserve bank. This means that the
checks of the member banks in the country towns throughout these five
States are worth their full face value, without deduction for exchange
or collection charges, to every other member bank, and that the amount
of each check may be cashed at par immediately, without following the
devious and roundabout courses now observed in the collection of checks.
Virtually every bank in the fifth district is only one night distant
from Richmond, and a check mailed one afternoon in the most distant
portions of the district should reach Richmond the following day in time
to be included in that day's operations of the federal reserve bank.

Let us now consider another aspect of the new law: Under the old
National Bank Act a national bank with a capital of, say, $200,000,
deposits of, say, $1,500,000, bills receivable amounting to $1,200,000,
and $300,000 reserve, would only be permitted to borrow a total of
$200,000, the amount of its capital. If a run should start on such a
bank, the amount which it could raise by loans, if strictly held to the
old law, would be but $200,000, the amount of its capital, which might
be quite inadequate to meet a run, and the bank, though thoroughly
solvent, might be forced to suspend.

Under the new law, however, if a bank with $200,000 capital and deposits
of $1,500,000 should have loaned $1,200,000 to its customers on
commercial paper and should encounter an unexpected run, in addition to
borrowing $200,000, the amount of its capital, such a bank would have
authority to rediscount with the federal reserve bank of which it is a
member, notes, drafts, and bills of exchange issued or drawn for
agricultural, industrial, or commercial purposes, having not more than
ninety days to run, to any reasonable extent which may be approved by
the federal reserve bank to which application for such rediscounts may
be made....

We can not overestimate the value of the additional security which this
provision of the act confers upon every honestly, capably managed member
bank, and the relief from strain and anxiety and from the fear and
apprehension of panics and unreasoning runs which it gives to the
officers of every member bank.

Another important change provided by the Federal Reserve Act is the new
arrangement for the compensation of national bank examiners. Under the
present law the compensation of national bank examiners is based, except
as to reserve cities, on the capital stock of the bank examined. Under
the operations of this law a national bank examiner has been receiving
for the examination of a certain national bank in the fifth district,
with over $9,000,000 of assets and many thousands of accounts, the
munificent sum of $25. It is, of course, clear that an examiner could
make only an imperfect examination of such a bank in the space of three
days at a compensation of, say, $8 per day, out of which $8 allowance he
has to pay his own railroad fare, hotel expenses, as well as clerical
assistance. It is not unnatural that but few examiners would willingly
spend the ten days or two weeks which it might require to make a
thorough examination of such a bank when he is running personally in
debt in doing so.

Under the new currency law the Federal Reserve Board, upon the
recommendation of the Comptroller of the Currency, is given authority to
fix the compensation of bank examiners on the basis of annual salary, so
that those banks which need additional time and attention from the
examiner may receive the careful, close scrutiny which the case may call
for. It is believed that the new system of bank examinations will reduce
materially the number of bank failures and enable the department to
check up many abuses and correct many evil situations which in the past
have been ignored or glossed over by examiners in their hasty and
incomplete investigations.

I thank you, gentlemen, for the opportunity to address you. Approaching
the study of this new and revolutionary measure with the caution natural
to every man trained in banking under the system with which we have
grown up, I have become more thoroughly aroused to its merits and more
deeply impressed as I have watched the methods of construction, the
processes of growth, and have considered the underlying principles
directing those who did the work.

THE ELASTICITY OF NOTE ISSUE UNDER THE NEW CURRENCY LAW[299]

To anyone who has been interested in currency reform for, say, twenty
years, probably nothing is more striking than the change in emphasis
which has taken place among the advocates of reform during this period.
The typical reform plan of the earlier time, for example the so-called
Baltimore plan brought forward in 1894, devoted itself almost
exclusively to providing a thoroughly elastic note issue, based on
ordinary assets. In contrast, the new law has as its central, primary
object the organization into at least regional unity of something like
the entire banking system of the country. Doubtless this difference in
the two reform plans was not altogether due to a fundamental difference
of opinion with respect to what would be the ideal scheme. The reformers
of the earlier period were not indifferent to the need for centralized
organization in the banking system. But they considered any scheme
involving a central bank, like the old Bank of the United States, quite
chimerical; and they were probably right. But times change; and men
change with them. For one reason or another we have all become more
tolerant of centralization in business matters, as also more tolerant of
that increase in governmental control which increased centralization in
business seems to make necessary. With at least fairly general approval,
a system of regional organization has been set up, involving a very high
degree of centralization and a very high degree of governmental control.
But with this change in the method of reform, it became inevitable that
the more important ends which earlier schemes sought to accomplish by
giving the note a high degree of elasticity should be, in no small
measure, attained by other means. In consequence, the need for
elasticity in the note issue will be much diminished under the new law.
Nevertheless, it is admitted that this need will not disappear
altogether. Elasticity in the note issue will be wanted partly to assist
in utilizing the newer methods of dealing with the difficulties
involved and partly to supplement those newer methods. Accordingly, the
question "How far does the note issue under the new system seem likely
to prove an elastic one?" is still important.

From the beginnings of agitation for currency reform the advocates of
elasticity have recognized more or less clearly two kinds: (1) what we
may call _seasonal_ or ordinary elasticity, and (2) what we may call
_emergency_ elasticity. By the former was meant the power of a note
issue to adjust its volume to those moderate changes in the need for
money which show themselves in the course of an ordinary year. By
emergency elasticity was meant the power of a note issue to adjust its
volume to those extraordinary changes in need which connect themselves
with the typical banking panic. The evils which it was believed that
seasonal or ordinary elasticity would remedy were principally (1) the
summer shortage of currency for moving crops, together with the
temporary but more or less serious stringency in the New York money
market which accompanies that shortage, and (2) the plethora or excess
of currency which usually appears three or four months after the
crop-moving period has terminated. The evils which emergency elasticity
was expected to relieve were principally (1) the stringency which
precipitates the panic, (2) the money famine consequent on general bank
suspension after the panic has fully developed, and (3) the glut of
currency which attends the depression following a panic, often leading
to excessive exports of gold and thus endangering the whole credit
system of the country.

Let us, now, take up seasonal or ordinary elasticity, and ask ourselves
whether the new notes are likely to possess this characteristic. First,
how about the expansibility needed to supply adequate funds for
crop-moving? At this point, it must at once be admitted that the new
currency does not meet the demands of the case in quite the
thoroughgoing way which the earlier schemes thought to be necessary. The
ideal of the earlier plans was to provide an adequate and easily
utilized power of issue, located at the very place where the need for
expansion is felt, _i. e._, in the local bank. The new law gives up this
idea entirely. The local bank will not have power to issue the new
currency at all. In so far as its customers are to get any benefit from
that currency the benefit must come through two channels which the
country bank could use in getting the needed funds, even if the currency
had no expansibility, namely, (1) calling in its balances kept with
banks more centrally situated, and (2) borrowing from such central
banks. In other words, the new power of issue will help out in the
crop-moving period merely because it will put the reserve banks in a
better position to respond to the call of the country banks for the
return of their own balances and for advances on discounted paper.
Judged from this point of view only, the elasticity provided by the new
law is doubtless adequate. If the reserve banks have not kept themselves
in a position to meet the calls of their country members from money
already in possession, they will surely be able to put themselves into
such a position by expanding their issue of notes. In one sense, then,
the new issue has adequate expansibility for ordinary needs. There still
perhaps remains a doubt whether effective elasticity is after all
assured, for it is not clear that the country bank which needs money for
crop-moving purposes will have the wherewithal to get advances from the
reserve bank--that is, that it will have paper of the proper kind and in
sufficient amount for rediscount. However, it seems probable that the
act as finally passed has met this need by providing that agricultural
paper shall be admitted on rather more liberal terms than paper arising
out of ordinary commercial or manufacturing business. If this be so, it
would seem that the provisions of the new law for securing one phase of
seasonal elasticity--expansibility--are fairly adequate.

Passing, now, to the other side of elasticity--_i.e._,
contractility--can we say as much? Will the new issues promptly retire
when their special task is over? _Prima facie_, the verdict here is less
favorable than in the previous case. In general, there are two principal
processes by which a note circulation may be contracted: (1) _driving_
the notes out of circulation, and (2) _drawing_ them out. In so far as
the former process is depended upon, means are devised to make sure that
the notes shall persistently return to the issuer even against his
will--they shall have good homing power. By the second process, it is
made to the advantage of the issuer of the notes to hasten their
withdrawal himself.

As respects insuring contractility by the former of these processes, the
act certainly cannot claim to promise high efficiency. The driving-out
process requires roughly the fulfilment of two conditions: (1) keeping
the channels for the return of notes to the issuer fairly open, and (2)
supplying outsiders with a motive for sending the notes home. As regards
the former of these conditions, the new system probably is all right.
The return of the notes to the issuer seems not to be impeded by the
inconvenience or expensiveness of the process. All member banks and all
reserve banks must receive these notes; and the reserve banks will
probably have branches within easy reach of any part of the district.
Hence, any holder desiring to get notes back to the issuing bank will
find the process easy and the way open. But good homing power requires
more than this. It requires, namely, that adequate motives be supplied
to people generally, or, at least, to banks generally, for seeing that
the notes get back. It is not enough that the track be smooth; people
must desire to use it. Now, earlier plans for securing elasticity relied
on two principal motives for inducing holders to send notes back to the
issuer: (1) the desire of such holders to make room for their own notes,
and (2) their desire to exchange money which has various limitations
imposed upon it for money which is free from those limitations. It is
plain that the new system makes only a limited use of the former of
these methods of procedure. _Within_ the district for which any
particular reserve bank is the central bank, this particular force will
be practically inoperative; for the power to issue notes on the basis of
common assets is not given to any but the reserve banks, and the
profitableness of the power to issue the old type of note has always
proved too low to induce banks generally to take much trouble to get
their own notes into circulation. As between the reserve banks of the
different districts, however, this particular motive will, of course, be
more or less in evidence, since these reserve banks will all be
competitors for this opportunity. But even here the motive in question
will not play a large part, since more effective means for insuring the
return of the notes from outside reserve banks are provided in other
parts of the law.

As regards the second motive for returning idle notes--that is, the
desire to exchange a money subject to various limitations or
disabilities for one not subject to those limitations--the new act does
somewhat better than it does in respect to the first motive. It is,
indeed, true that, within their own district, no special disability,
like being forbidden to be paid out by other banks, is put on the new
notes. But they are always subject to the disability of not being legal
reserve money in the case of federal banks; and hence such banks will be
more or less disposed to return the notes issued by their own reserve
banks, in order to exchange them for reserve money. It may be doubted,
however, whether in ordinary times this will prove a very potent force,
since country banks will usually keep reserves considerably in excess of
legal requirements, and so will not need to discriminate nicely between
the two sorts of money. As between different districts, the case for the
homing power of the new notes is rather stronger, since reserve banks
are prohibited from paying out the notes of other reserve banks under
penalty of a 10 per cent. tax. Even here, however, the provisions are
none too adequate. While the notes of a particular reserve bank must not
be paid out by the reserve banks of other districts, there is no
prohibition against their being paid out by the member banks of other
districts; and it is doubtful whether there is sufficient motive to
induce said member banks of other districts to send in these notes to
their own reserve banks and so start them on their homeward journey. The
desire to exchange money which cannot be used as reserve for that which
can be would have some force; but, under many circumstances, it would
probably prove rather inadequate.

Another disability which contributes to the homing power of a bank note,
and which is actually used in the case of our old note, is not used with
this new note--I mean, the fact that they are not receivable for customs
dues. The decision to omit this provision was perhaps wise; but it
throws out a potent motive for sending notes home, and thus throws away
an opportunity to make better provision for their contractility.

On the whole, then, it must be acknowledged that, in so far as homing
power is dependent on giving to outsiders strong and persistent motives
for sending notes home, the new law is not altogether satisfactory.

We have seen that there is very little in the new system to secure that
the notes shall have good homing power--shall get home by what we have
called the _driving-in_ process. Is the system better off as respects
the _drawing-in_ process? Are matters so arranged that the issuing bank
will have the power and the desire to withdraw its notes--or at least
contract the currency proportionately--when the need for the notes has
fallen off? As respects the first part--making sure that the issuing
bank shall have the power to retire its notes, or at any rate to effect
a corresponding contraction of the currency--the new system is
practically perfect, as indeed was the old one. That is, any reserve
bank desiring to contract its note obligations may at its discretion
deposit with the federal reserve agent reserve notes, gold, or lawful
money. Obviously, this, if not strictly a contraction of its note
circulation, at least brings about the desired contraction of the
general circulation.

When, however, we consider the provisions of the new law for insuring
that reserve banks shall desire to contract their circulation when the
special need has passed, we find that the law does not promise quite so
well. The favorite device for accomplishing this result has been, of
course, a tax on issues, similar to the 5 per cent. tax of the German
system. Apparently, the new law provides for something equivalent to
this in the shape of an interest charge by the Federal Reserve Board,
the rate to be fixed by said board. How far this device will prove
effective in practice it is not safe to predict. In order that it should
induce the banks to contract their circulation, circumstances must have
arisen under which the issuing bank would be earning on its outstanding
notes a profit smaller than the tax itself. Now, it does not seem
certain that an excessive issue of notes would necessarily bring about
this condition. In the first place, in the absence of good homing power,
a volume of notes in excess of business needs would not necessarily
cause an accumulation of those notes in the vaults of the bank issuing
them. Secondly, so long as member banks are free to keep their balances
in banking institutions other than their reserve banks, an excess of
notes would not necessarily cause the general cash holdings of reserve
banks to be abnormally large. For, so long as the ordinary New York
banks are permitted to pay interest on bankers' balances, country banks
will to a considerable extent keep their balances with these outside New
York banks; and it seems not unlikely that the excessive monetary stock
thus accumulating in New York City would, instead of getting into the
hands of the New York reserve bank, largely remain in the hands of the
outside banking institutions and be employed more or less as it has been
in the past, that is, in financing doubtful enterprises and supporting
excessive speculation. But if the reserve banks do not feel the pressure
of excessive issues in the shape of accumulations of notes or some form
of money in their own vaults, they may conceivably be able to invest
advantageously all the funds in their possession, and, in that case, the
rate of interest charged by the Federal Reserve Board will not furnish
an adequate motive for the retirement of their issues. Doubtless,
however, this may in some degree be answered by saying that even an
excess which was felt only outside the reserve bank would, after all,
compel the reserve bank to contract its issues, since it would lower the
rate of discount so greatly that reserve banks could not profitably
invest their ordinary holdings, and consequently would wish to get rid
of the interest charge. Perhaps this is true; but it would by no means
insure the prompt and full contraction which most reformers have
considered desirable.

From the foregoing it would seem that one of the devices for inducing
the reserve banks to contract their issues after the need for them had
passed--that is, charging interest upon such issues--is not certain, at
any rate, to prove adequate; it will not surely eliminate the winter
plethora in New York City which is supposed to stimulate and support
excessive stock speculation. But the new law contains another provision
which may be viewed as a device for supplying the issuing banks with a
motive for contracting their issues, namely, the requirement that such
banks shall keep a gold reserve equal to 40 per cent. of their issues.
Is this likely to prove effective? Probably not. Whatever might be true
in panicky times, it seems certain that in an ordinary year the gold
holdings of a reserve bank will be much above 40 per cent. of its note
issue. If this be true, the maintenance of this 40 per cent. could
become difficult only when the excess of money was so great as to cause
a dangerous exportation of gold from the country, and this surely would
show a very inadequate degree of contractility. In short, the new law
does not insure that issuing banks shall be sufficiently disposed to
draw in their notes any more than it insures that outsiders will drive
them in. It would seem, then, that the new law does not promise to give
to the note issue the degree of contractility which has hitherto been
considered desirable. In other words, there is some point in the fear
expressed by many bankers that the new law will result in note
inflation--at least in so far as the avoiding of this danger is
dependent on the contractility of the note issue. Very likely, however,
the possibility of such inflation is sufficiently guarded against by
other provisions of the law.

We have discussed the adequacy of the new note issue in respect to
seasonal or ordinary elasticity. We pass on now to consider its adequacy
in respect to emergency elasticity--the elasticity which enables a
currency to adjust itself to those extraordinary fluctuations in need
which mark a banking panic and the depression that follows. Broadly
speaking, it is pretty certain that at this point the new law will get a
more favorable verdict than in the previous case. As pointed out in an
earlier connection, the banking panic, when fully developed, gives rise
to three difficulties and so to three needs: (1) funds to relieve the
antecedent stringency which threatens a complete collapse of the credit
structure; (2) a circulating medium for ordinary trade when a general
suspension of payment by the banks has brought on a money famine; and
(3) a prompt and thoroughgoing contraction of the circulation in the
depression which follows the panic. Now, there surely can be no doubt
that, under the new law, the availability of an issue sufficient in
volume instantly to relieve the antecedent stringency, and so to put a
stop to a panic before it had developed serious dimensions, is assured.
In fact, it is not at all improbable that, under the new system, the
reserve banks will be able to check the development of such a panic at
the very outset without increasing at all their note issues. But, if
this does not prove true--if it turns out that more currency is needed
for this purpose--there would seem to be no shadow of doubt that the new
system will insure the forthcoming of such currency both of a quality
and in a quantity which will be fully adequate to the task put upon it.
(1) The notes to be issued, being obligations of the Federal Treasury,
will be as acceptable as gold even on the eve of a panic. (2) There is
no limit to the absolute amount of these notes. (3) The practical limit
set by the requirement that discounted paper shall be furnished as a
basis for their issue is of no real significance, since such paper will
undoubtedly be vastly greater in volume than any need which could arise.
Accordingly, there can be no doubt that the new system provides all the
expansibility needed to abort, or reduce to comparative harmlessness,
any panic which might arise.

A word now with respect to the second need which an emergency
circulation is supposed to meet, that is, an ordinary circulating medium
for trade when banks have by common consent suspended payment. In the
first place, if we are right in supposing that the new law will surely
prevent any panic from reaching such a degree of intensity, it is
obvious that we shall not have occasion to meet the particular
difficulty here under consideration--that our note issue will not be
called on to display this particular sort of elasticity. If, however, it
be supposed that the foregoing prediction does not turn out to be
correct--if experience proves that panics can still go so far as to
cause banks generally to suspend payments, to hold on to every form of
reasonably solid money, and to try to satisfy the public with
substitutes--our verdict for the new currency would necessarily be less
favorable. We should have to admit that the new law does little or
nothing to relieve such a situation. Broadly speaking, the new money
will be altogether too good to meet this particular need. Banks that had
reached a stage of panic sufficiently intense to cause them to suspend
payment--to hoard the ordinary forms of money--would be sure to hoard
money as good as those notes are bound to be. That is, the new issue
would immediately pass into hoards, as did the greenbacks which the
Secretary of the Treasury reissued during the panic of 1873, and,
therefore, would bring little if any relief to the currency famine which
had developed. In fact, it is almost impossible to conceive any form of
note fitted for this particular task except one which was so bad that
there was no danger of its being hoarded. That is, the only proper way
to meet this particular need of a severe panic is to make sure that it
does not arise at all; and, in this respect, the new law promises well.

We come, finally, to the third need which emergency elasticity is
supposed to meet, that is, a prompt and great contraction of the
circulation when the panic has passed and the inevitable business
depression consequent upon such a panic has set in. Here, again, though
not in the same degree as in the last case, if the new law proves as
successful as many conservative students expect, the need in question
will be little, if at all, experienced. We shall usually escape the
extreme business inflation of the antepanic period; the panic itself
will be much abated, if not completely eliminated; and, in consequence,
the trade reaction which naturally follows a panic will be much
diminished in intensity. If this turns out to be true, the circulation
will never again show such an extraordinary glut as characterized the
winter of 1893-94. Nevertheless, it can hardly be doubted that, after
even an incipient panic, there will be some reaction, and consequently a
more or less plethoric condition of the currency will follow. Will the
new issue have sufficient contractility to meet this need? Earlier in
this paper we have seen that the conditions attached to the new issue
are in general not favorable to contractility, in that they do not
provide for either the prompt driving home or the prompt drawing home of
the notes when the necessity for their issue is past. Outsiders lack
adequate motives for sending the notes home; issuers lack adequate
motives for calling them home. The case for emergency contractility,
however, is somewhat better than the case for ordinary contractility.
First, it is probable that the homing power of the note will prove
greater at such a time than in an ordinary year, for, at such a time,
outside banks will not be able to find investments for their funds,
since speculative trading will disappear altogether and business
generally will be at a very low ebb. Again, it seems certain that the
issuing bank will, in this case, have more than the usual motive for
bringing about a contraction of the circulation. The chief reason why
such a bank may not be eager in ordinary times to hasten the retirement
of its notes is the fact that, provided the notes do not accumulate in
its own vaults, such a bank will gain more by using the funds in its
possession to make loans than it would by using them to retire notes,
assuming that the interest charge made by the Federal Reserve Board is
not placed excessively high. But it is practically certain that, in the
depression which follows a panic, no reserve bank will have
opportunities for keeping all of its funds busy; and since, in that
case, the interest charge, however small, will be a dead loss, the bank
will have adequate motive for effecting, as promptly as possible, an
adequate contraction of its note liabilities. This motive would be still
further strengthened should the glut prove sufficient to cause a decided
drain of gold, since, in that case, the reserve banks will find
difficulty in maintaining the required 40 per cent. reserve. On the
whole, then, we seem warranted in affirming that, as respects emergency
elasticity, the new notes will give no serious disappointment.

Finally, as respects elasticity in general, though the note issue,
viewed by itself, does not seem quite fitted to satisfy the tests which
an old-fashioned advocate of elasticity is inclined to impose upon it,
yet, when we take the new law as a whole, it seems not unreasonable to
affirm that it promises to accomplish, directly or indirectly, most of
the ends which we had hoped to attain through elasticity and hence
promises to give us a system which in essentials is truly and adequately
elastic.

NOTES PRINTED AND ISSUED

[300]During the year 1915 the circulation of Federal Reserve notes has
increased to $188,817,000 as of December 31, 1915. Believing that the
country should be prepared against any contingency, the Board had
authorized the printing of about $700,000,000 of these notes. Almost
one-quarter of the total supply printed has been placed in circulation.
On December 31, 1915, however, only $16,675,000 of notes secured by
commercial paper pledged with the Federal Reserve Agents was outstanding
as an obligation of the Federal Reserve Banks. The liability of the
Federal Reserve Banks as to the remainder has been discharged by the
deposit with the Federal Reserve Agents of a like amount of gold and
lawful money. This result has been achieved by the Federal Reserve Banks
in responding to requirements, for currency by issuing Federal Reserve
notes rather than by parting with gold. While the gold pledged with the
Federal Reserve Agents represents a very valuable protection in case of
a substantial demand for gold, it must be observed that the process is
expensive without, at the same time, giving to the Federal Reserve Banks
that additional strength and lending power which they would secure in
case the law were amended so that the Federal Reserve Banks would remain
liable for the outstanding notes, but, on the other hand, would retain
property title to the gold delivered to the federal reserve agents,
which, in that case, would not be paid in to extinguish the liability
upon the notes but would be deposited as collateral security against
them.

IMPOUNDING GOLD

[301]On November 16, 1914, the first shipment of Federal Reserve notes
was received by the Federal Reserve Agent [of the Federal Reserve Bank
of New York] from the Comptroller of the Currency. On November 19 the
bank pledged with the Federal Reserve Agent $500,000 of commercial paper
rediscounted by member banks and received from him a similar amount of
Federal Reserve Notes. These notes were not required by the banks
which made the rediscounts, as they had already withdrawn by checks
the credits so established. They were taken by this bank for its
general use. The issue of Federal Reserve notes gave the reserve
bank the opportunity of affording to its member banks complete
interchangeability between book and note credits. The bank therefore
established the policy of issuing Federal Reserve notes freely to
any member bank desiring them whether the credit thus withdrawn was
established by it through rediscounting, or the deposit of checks, or
the deposit of gold or lawful money. In practice, however, most credits
withdrawn by notes have been established by the deposit of checks which
have been collected by this bank in gold or lawful money through the
clearing house. Accordingly, the accumulation of cover in the hands of
the Federal Reserve Agent has been mainly gold, with but a small amount
of rediscounts. The processes provided by the act for the issue of
Federal Reserve notes to the reserve bank permit complete
interchangeability between gold and rediscounts held by the agent. Gold
may be substituted for rediscounts and rediscounts for gold, in
accordance with the requirements of the reserve bank. During the entire
period its requirements have been for notes with which it might exercise
its statutory right to "exchange federal reserve notes for gold, gold
coin, or gold certificates."

The policy of the Federal Reserve Bank has resulted in greatly
strengthening its gold position and its ability to assist its member
banks or other Federal Reserve Banks should they at any future time seek
credit in order to withdraw gold for domestic or foreign uses. Through
this policy also it has been able potentially, at least, to retard the
expansion of credit by impounding in the hands of the agent a large
volume of gold which might otherwise have found its way into bank
reserves already superabundant.

Furthermore, through this policy it has been able to take the first step
toward accomplishing one of the purposes of the act set forth in its
title, _e. g._, "to furnish an elastic currency." There are two forms of
elasticity, one of _quantity_ and the other of _quality_, both provided
for in the act.

From the point of view of cover, the gold certificate is completely
inelastic. It stands at one extreme of our currency, with a dollar of
gold set aside behind each dollar of paper. At the other extreme stands
the national-bank note, with only 5 cents of gold set aside behind each
dollar of paper. The assets of the issuing bank make it good, but its
elasticity is nullified by the requirement that it must be secured
dollar for dollar by government bonds.

Between these two extremes the Federal Reserve note, a new form of
currency, has been introduced. For each dollar of this paper there is
set aside from 40 cents to $1 of gold. As in the case of the
national-bank note, the obligation of the United States and the assets
of the issuing bank secure it.

The process in which this and other Federal Reserve Banks have been
engaged is the substitution, as a circulating medium, of a note which is
elastic in quality for the inelastic gold certificate. Gold is the most
uneconomical medium of hand-to-hand circulation since, when held in bank
reserves, it will support a volume of credit equal to four or five times
its own volume. What the reserve bank does in accumulating gold behind
its Federal Reserve notes is to establish with the holder of each note a
credit which may be availed of whenever the occasion requires. With this
credit established it can convert at will its gold-covered notes into
notes covered partly by gold and partly by commercial paper. In times
when credit is becoming strained and bank reserves need strengthening or
when gold must be exported, this conversion will take place, and after
the strain is over the gold cover will be restored through the repayment
of the rediscounts substituted for it. In this way elasticity of quality
in our currency is obtainable. But it should not be construed as in any
way a deterioration of the currency contemplated by the act. Quite the
reverse is true. The act provides for the issue of Federal Reserve notes
in unlimited amounts, with 40 cents of gold behind each dollar of paper.
This is elasticity of quantity and it becomes operative with the minimum
of gold cover. Elasticity of quality, on the other hand, operates with a
gold cover always above the 40 per cent. minimum and ranging as high as
100 per cent.

In order to be prepared for any currency demands which might be made
upon it, the Federal Reserve Bank of New York in the spring of 1915
adopted the policy of having printed and keeping constantly on hand a
supply of Federal Reserve notes substantially in excess of the amount of
emergency currency which, experience shows, this district might be
called upon to supply. The maintenance of this policy and of the policy
of issuing Federal Reserve notes freely has entailed a heavy cost upon
this bank. Unissued Federal Reserve notes are carried at cost on the
books of the bank, and at the end of each month the amount of notes
issued to the bank during the month is charged off at cost. The shipment
of notes unfit for circulation to the Comptroller of the Currency at
Washington for cancellation and destruction is a further item of expense
in connection with the maintenance of these policies. The directors and
officers of the bank, however, feel that the results accomplished amply
justify the expense incurred, and consider that the added strength
furnished the bank by the gold thus accumulated is perhaps the most
important result of the operations of the period.

Some reduction has already been made in the cost of printing Federal
Reserve notes, and it is to be hoped that further experience and study
will enable other substantial reductions to be made in the cost of
preparing for issue what has already become an important element of the
circulating medium of the country. The act provides that all expenses in
connection with the issue and redemption of Federal Reserve notes shall
be borne by the Federal Reserve Banks, and in view of the service the
banks are performing in accumulating gold through the medium of these
notes, the feeling is quite general among their officers that the notes
should be furnished to them at the lowest possible cost consistent with
the high quality of workmanship required.

The design of the notes is not altogether satisfactory for efficient
handling. In sorting notes it is necessary to be able readily to
distinguish between notes of this bank and notes of other reserve banks.
This would be greatly facilitated if the printing of the distinctive
number and letter of each bank were made more general on the face of the
note.

THE FINANCIAL POLICY OF THE FEDERAL RESERVE BANKS[302]

It seems clear that the cardinal principle in the management of the
Federal Reserve Banks will be to disregard the course which will lead to
maximum profits, following instead the path which will lead to the
greatest safety and which will permit these banks to be of the greatest
service to the nation. Large reserves should be maintained, and these
should consist chiefly of gold. The payment of interest upon bankers'
deposits and government deposits should be avoided, if possible, for the
reason that the payment of interest will force the keeping of smaller
reserves, if the cumulative dividend is to be earned. The banks should
be managed, not from the standpoint of profit, but from the standpoint
of safety.

Yet this is but one side of the policy of the Federal Reserve Banks.
Their power and influence can be made to extend much farther than would
result solely from the wise management of their own affairs. These banks
are the financial trustees of the nation. The country will look to them
to see that they exercise over the member banks a closer supervision and
discipline than has been possible in the past. Supplementing a negative
control by the bank examiners, who are powerless so long as the letter
of the law is observed, the federal reserve banks will be a great
positive force. The Federal Reserve Banks, with the approval of the
Federal Reserve Agent or the Federal Reserve Board, may conduct
examinations of a member bank, both for the purpose of ascertaining its
condition, and, what will be of equal importance, for the purpose of
determining the lines of credit which are being extended by it.

In the long run, the greatest work which the Federal Reserve Banks can
do for the business men of this country is to improve and standardize
the methods of commercial borrowing. I believe it is possible for these
banks, with the approval of the Federal Reserve Board, under the power
just quoted, to establish a comprehensive credit information clearing
service through which the aggregate loans of all large borrowers can be
known by any bank official and through which excessive borrowing or the
lending of money to concerns pursuing unwise financial policies can be
checked before disaster overtakes them. This is one of the greatest
needs of our banking system....

RELATIONS OF FEDERAL RESERVE BANKS WITH MEMBER BANKS[303]

The aim of this bank [Federal Reserve Bank of New York] at all times has
been to maintain frank and friendly relations with its member banks. At
every meeting of the New York or New Jersey Bankers' Associations, or of
their groups, to which invitations have been received, one or more of
the directors or officers have been present and discussed the
development of the various functions of the system.

When the establishment of an intradistrict collection system was under
consideration, the directors and officers invited representative member
bankers from all parts of the district to confer with them at the office
of the bank. The plan finally adopted was thoroughly discussed in all
its aspects and a consensus of opinion seemed to prevail that it was a
fair and reasonable plan.

When the conditions under which State banks should be admitted to the
reserve system were under consideration three conferences were held by
the directors and officers of the bank, one with national bankers, one
with State bankers, and one with trust company officers, from various
parts of the district, to ascertain their views upon the question at
issue. In every case the policy has been pursued of dealing frankly with
those present, in order that they might understand fully how the action
under consideration would affect them.

The officers have expressed themselves at all times as desirous of
establishing personal relations with officers of member banks and have
invited them to call at the bank when in New York City. Yet a year has
gone by and officers of probably not over 15 per cent. of the member
banks have done so. Many of them still have the feeling that the bank is
a branch of the Government. Their experience with the Government
consists principally of the statutory and supervisory relationship which
exists between them and the Comptroller's office. The conception of the
relation of this institution with them as co-operative makes headway
slowly. The fact that the national banks were practically compelled to
join the system naturally retards the development of the co-operative
idea. The change of attitude, upon which the success of the system will
ultimately depend, will probably come slowly, but there are already
signs, as we enter upon the second year of the system, that the banks
are getting more accustomed to it and appreciate the results it has
already accomplished. It is hoped that during the coming year, with
organization pressure somewhat lessened, more time can be devoted by the
officers to developing personal relations with the officers of member
banks.

The present attitude of the member banks toward the reserve bank may be
summarized as follows:

The New York City banks, upon which the strain of all crises first and
chiefly falls, fully understand the value and benefits of the system.
While regretting the loss of bank deposits which will probably be drawn
from them (estimated to be as high as $250,000,000), they are
nevertheless hearty supporters of the system, at all times co-operative
in their attitude.

Many of the banks in other large cities are unable to take full
advantage of the lowered reserve requirements, but in spite of the loss
of interest on their reserve balance, most of them understand what the
system in its larger aspects means for American banking and generally
give it their support.

While the same may be said of many of the country banks, yet it is among
the country banks as a class that most of the apathy and hostility to
the federal reserve system which still persists is found. Their
opportunities and earnings are relatively small, and in order to live
they must figure closely. They feel the loss of interest on reserve
deposits; the absence, as yet, of dividends on their capital
contribution; and the prospective loss or decrease of the exchange they
generally charge on remitting for checks drawn upon them. Many banks in
industrial centres are precluded by the activity of their business from
taking advantage of the reduction in the required reserve. They believe
that they will, in fact, be required to carry an even larger reserve
than heretofore in order to obtain collection service for notes, drafts,
and non-member bank checks and the various other services now rendered
by their reserve agents, but not yet undertaken, by the reserve banks.
It is very natural that they should view with reluctance the termination
or diminution of long-standing business associations with their reserve
agents. Few of them, as yet, conceive of the reserve bank as their
active reserve agent, performing all the services which go with the
relationship. The dormant accounts most of the banks maintain with the
reserve bank are, perhaps, indicative of their attitude toward it.
Relatively few banks of this district are borrowers; in good times and
bad they have been able when necessary to borrow from their city
correspondents on bonds or on the indorsement of their directors, two
avenues which are now to be closed to them. The rediscounting privilege
has been little availed of and the larger functions of the Federal
Reserve System, such as influencing domestic rates and international
gold movements through the development of a discount market and by
dealing in foreign bills, appear remote from their spheres of activity.
They feel that the system has few advantages to offer in return for the
cost it entails upon them.

All of these points will be felt with increasing acuteness by the
country banker as his reserve transfers approach completion and as
reduced balances result in reduced service from his city correspondent.
His point of view is outlined thus frankly in order that the
difficulties he sees may be clearly recognized and steps taken gradually
to remove them. The development of a more satisfied relationship
requires progress on the part of the reserve bank and a willingness to
co-operate on the part of the country banker.

The reserve bank should organize a complete collection system embracing
the handling of notes, drafts, and items on non-member banks, which
eventually will bring all the members into daily active relations with
the bank. It must be ready to act for member banks in the purchase,
sale, and custody of securities; to supply credit information on names
whose paper is offered by brokers; to give its members information
concerning methods of developing the new functions which the act
authorizes them to exercise; to perform the services now rendered by
their reserve agents; and generally to assist them in every reasonable
way.

The member banks should look upon the reserve bank not as an alien but
as their own institution. They own all its capital and most of its
resources, and they control its management through the directors they
elect, subject always to the supervision of the Reserve Board. At the
reserve bank they may borrow as a standing right and not as a favor
which may be cut off. They no longer have to buy or carry bonds to serve
as security for loans; the paper of their own customers, large or small,
will now serve as their security. While panics in the past may not have
affected them, they have been disastrous to the business interests of
the country, who are their customers; and their contributions to the
reserve bank should be recognized as a form of insurance not merely for
themselves but for their customers as well. If this insurance is
expensive and makes some changes in the nature of their business, the
act should be carefully studied with a view to making the most of the
new functions it provides. New avenues of activity should be looked for.
The banks which will get the most out of membership are those which are
the first to see and develop the opportunities it provides and to
educate their customers to the protection and facilities they will enjoy
through the system. The occasion is a favorable one also for the
correction of abuses. Customers will do things in the name of the
Federal Reserve System which they have never done before. The experience
of banks in using the forms provided by the reserve bank to get
statements from their borrowers is evidence of this. The occasion should
be seized also to increase the balances of depositors who carry
unprofitable accounts. To assist member banks in studying their accounts
this bank has had under preparation by chartered public accountants a
reasonably simple form for analyzing accounts which may be obtained by
banks desiring to use it.

It is the duty of the directors and officers to understand not only the
problems of the reserve bank but those of the member banks as well; and
it has been their endeavor during the past year to give special study to
those of the country bank. Several suggestions for the relief of the
country bank have come to their notice.

One of these, which the American Bankers' Association at its 1915
Seattle convention favored, was to permit the 3 per cent. of reserve
which the member bank may carry either in its vaults or in the reserve
bank, to be deposited with member banks not more than 300 miles distant
and count as reserve. This seems to be contrary to the spirit and intent
of the act, which is primarily to centralize reserves in Federal Reserve
Banks.

Another suggestion which seems more worthy of consideration is that the
percentage of reserve required for country banks should be somewhat
further reduced. When the reserve transfers are completed checks in
transit can no longer count as reserves. It is clear, therefore, that
the reserve reduction contemplated by the act will not be realized in
practice. A further reduction in the reserve requirements would, in the
case of many banks, result in a reserve less than the amount their
business actually required, and would enable them to carry the amount
thus freed wherever it would best serve their particular business, and,
if they so desired, to maintain some relations with present city
correspondents. It would lead away from the present rigidity of bank
reserves toward greater flexibility and a better understanding of their
meaning and purpose.

RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF MINNEAPOLIS AND ITS
MEMBERS

[304]The Ninth Federal Reserve Bank has sought to make the Federal
Reserve Act fully operative within its district. During the spring of
1915 it had opportunity to demonstrate its effectiveness in meeting the
requirements of agriculture in the Northwest during the planting season,
and rediscounted liberally for member banks, in order to enable them to
better satisfy the requirements of farmers. It relieved local pressure
at a number of points where manufacturing enterprises and general
business were depressed because of war conditions, and had opportunity
to show that it can efficiently meet the demands of industry. Again, in
the fall of the year, when an adverse season had created large amounts
of immature corn, it was able to perform a very valuable service in
assisting member banks to meet the requirements of farmers who were
suddenly compelled to make provision for utilizing a valuable forage
crop. During the prevalence of the foot-and-mouth disease it was able to
come to the assistance of many banks in the western part of its
territory, which had applications for loans from numerous stockmen who
had cattle ready for market, but were unable to ship on account of
quarantine conditions. The service above indicated, while not perhaps of
notable consequence in any single case, consists in the aggregate of a
very valuable degree of assistance, which would not have been available
except for the Federal Reserve Bank, and without which, portions of the
district would have encountered considerable hardships.

RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF BOSTON AND ITS MEMBER
BANKS

[305]Owing to the unusual conditions existing in the money market, and
to the fact that the reserve city banks offer facilities to the country
banks which this bank has not yet developed, more particularly in
connection with the collection of checks and other items, the latter
banks have carried only their minimum reserve requirements with this
bank and have used its facilities only to a limited extent. The
relations between country bank officials and the officials of this bank
have been most cordial. While many of the banks in this district are
borrowing, most of them find it much more convenient to go to their
correspondent bank and borrow, either in the form of a demand loan, with
or without collateral, or against a certificate of deposit.

The Comptroller's calls on the several dates show the total borrowings
of member banks in the district as compared with their rediscounts with
this bank, as follows:

_Total _Borrowed,
Borrowed._ F.R.B._
Dec. 31, 1914 $4,738,416 $105,000
Mar. 4, 1915 4,047,708 234,531
May 1, 1915 3,969,796 410,723
June 23, 1915 4,284,445 270,441
Sept. 2, 1915 3,398,856 190,849
Nov. 10, 1915 2,985,406 131,725

The officials of the city banks on the other hand are apparently
satisfied with the progress made in the development of this bank's
functions. While but few of the Boston banks have rediscounted with us,
almost all have intimated that should occasion arise they would do so.
Furthermore, several Boston banks have entered into the acceptance
business to a large extent, and the assistance that this bank has given
in the matter of rates and market for acceptances has done much to bring
it into favor with those banks. The Boston banks have also used this
bank to a large extent in exchange transactions, and the services
offered by the gold settlement fund have been used almost exclusively by
those banks.

Thus far Boston banks have received more benefits from this bank than
have the other banks in this district. A possible exception to this is
in Aroostook County, Me., where, owing to an unusual situation
surrounding the principal industry, the potato crop, banks have relied
on this bank to a considerable extent to carry them through a trying
period. The moral effect of having the Federal Reserve Bank of Boston
stand behind them was not only appreciated by those banks, but enabled
them to handle their business much more satisfactorily and to finance
themselves without having to call upon this bank to an undue extent for
rediscounts or without embarrassing their customers.

FEDERAL RESERVE BANKS AND THE ACCEPTANCE MARKET

[306]The right to accept drafts was conferred on New York State banking
institutions by the act of April 16, 1914. Shortly afterwards a few
acceptances were reported, principally against securities. It was not
until the derangement of international credit facilities at the opening
of the European war that American bankers' acceptances, especially those
relating to foreign commerce, came into existence in substantial volume.
At that time some of the trust companies with foreign connections
extended credits freely to their customers to replace credits formerly
granted by European banks which had been either withdrawn or reduced;
they also accepted drafts in large volume. On and after May 18, 1914,
member banks were authorized also to accept drafts drawn upon them
involving the importation or exportation of goods....

The monthly purchases of acceptances by this bank [the Federal Reserve
Bank of New York] in the New York market have been:

1915 _Number_ _Number_
_of pieces._ _Amount._ _of pieces._ _Amount._

_For itself._ _For other reserve banks._
February 41 1,659,740.21 86 1,263,871.25
March 140 3,343,143.17 250 3,799,809.42
April 86 1,272,694.36 84 1,700,396.57
May 46 867,420.18 48 1,305,873.80
June 132 3,083,261.75 34 602,558.89
July 106 2,496,865.67 147 2,348,050.89
August 103 1,597,630.63 89 1,910,417.47
September 89 1,769,880.50 172 1,948,243.05
October 68 2,199,679.95 163 2,028,098.36
November 115 1,899,606.56 246 2,594,951.04
December 310 5,648,708.78 313 2,809,823.59

Total 1,236 25,833,631.76 1,632 22,312,094.33

The policy pursued by this bank thus far has been to purchase good
acceptances whether or not the acceptor was a member bank....

The reserve bank and the market rate for the discount of such bills in
New York has been for nearly a year, and is now, lower than the rate for
similar bills in London. The relatively small volume of such credits
which American banks have succeeded in making operative even under the
unusually favorable opportunity which the war presents for their
extension, is evidence of the difficulty which will be encountered in
developing the acceptance business in the United States. Some of the
fundamental difficulties are:

(1) The disinclination to break old banking connections.

(2) The difficulty of educating handlers of bills in distant places as
to American credits.

(3) The lack of bill buyers in foreign countries who will quote as low
rates on dollar as on sterling bills.

(4) The natural prejudice of bill buyers in foreign countries in favor
of a bill of known currency and against a bill of as yet unknown
currency.

(5) The lack of men trained to exercise the judgment and financial
responsibility required of them as managers of branches or agencies
which American banks might establish in foreign countries.

(6) The inferior communications for both goods and mail between the
United States and foreign countries as compared with those between Great
Britain and foreign countries.

Only time, experience, and patient effort will remove these handicaps to
the elevation of dollar exchange to its proper position in international
finance. The business, however, is developing and will continue to grow
as our banking machinery and connections extend throughout the world.

The Act permits member banks to accept an amount of bills not exceeding
50 per cent. of their capital and surplus. By the amendment of March 3,
1915, under certain conditions they may be authorized by the Federal
Reserve Board to accept up to 100 per cent. of the capital and surplus.
The following banks in this district have received such authorization:

_Amount of
capital and
surplus._
Bank of New York, New York $6,000,000
Mechanics & Metals National Bank, New York 12,000,000
Atlantic National Bank, New York 1,600,000
American Exchange National Bank, New York 8,000,000

As this bank has probably been the largest single purchaser of bankers'
acceptances, it has been able, as it gained experience, to exert some
influence toward standardizing practice and form....

The amended regulation[307] issued September 7, 1915, considerably
broadened the field of acceptances eligible for purchase and encouraged
an increased volume of these instruments. The further amended regulation
issued December 4, 1915, covering the purchase of bankers' acceptances
arising out of domestic transactions relates to a class of bills which
national banks are not authorized to accept. When accepted by
institutions of high credit they have a ready market, though at a
fractionally higher rate than acceptances based on foreign transactions.

[308]New England imports a large volume of hides and wool from South
America and cotton and jute from the Orient and other sections of the
world. These shipments in the past have been financed through credits
drawn on European centers. Since the opening of the Federal Reserve
Banks these foreign trade transactions have been financed to a large
extent through dollar credits drawn on this country and the acceptances
arising there from have found a ready market in the Federal Reserve
Banks. Several of the member banks in this district have entered this
new field of finance and the Federal Reserve Bank of Boston has used
every effort to further and develop that business, not only by buying a
large amount of that class of paper, but also through furnishing
favorable forward discount rates to assist in protecting its member
banks. The following member banks have entered this field:

1. First National Bank, Boston, Mass.
2. Fourth-Atlantic National Bank, Boston, Mass.
3. Merchants National Bank, Boston, Mass.
4. National Shawmut Bank, Boston, Mass.
5. Old Colony Trust Co., Boston, Mass.
6. Second National Bank, Boston, Mass.
7. Merchants National Bank, Worcester, Mass.

Under special permission of the Federal Reserve Board the First National
Bank, of Boston, and the National Shawmut Bank, of Boston, have been
given authority to accept up to 100 per cent. of their capital and
surplus. It is of interest to note that the former bank has reported the
largest amount of acceptances of any member bank of the Federal Reserve
System.

CLEARINGS AND COLLECTIONS IN PRACTICE

[309]Section 16 of the Federal Reserve Act made general provision for
the establishment of a system of clearance of checks throughout the
United States, each Federal Reserve Bank being required to act as a
clearing house for its members if directed by the Federal Reserve Board,
while the Federal Reserve Board was authorized to clear for the reserve
banks themselves.

The Board had from the first recognized its duty to make this provision
of the law effective as fully and at as early a date as conditions would
permit; and in its first report spoke of this as "one of the most
important responsibilities with which it is charged under the Act." So,
regarding its duty in this particular, it undertook early in 1915 the
preparation of a general circular and regulations intended to provide
for the clearing of checks within the several Federal Reserve districts,
while it also took under advisement the establishment of a gold
settlement fund at Washington for the purpose of clearing obligations
between Federal Reserve Banks. The latter undertaking has been carried
to a successful conclusion and the gold settlement fund has been in full
and satisfactory operation since about the first of June. The Board,
however, had not advanced far with its work relating to the
intradistrict branch of the clearance system before technical and other
difficulties began to make their appearance. Many banks, both city and
country, throughout the system were opposed to the enforcement of the
provisions of the law because of the loss of exchange charges which
would thereby be entailed upon them. Legal questions were also raised,
it being argued that there is no power to compel a member bank not
located in a Federal Reserve city to pay or have charged to its account
at the Federal Reserve Bank of its district a check which it had not
seen and approved prior to the time of presentation at its own counter.
For the purpose of ascertaining the Board's powers in this connection
the opinion of the Attorney General has been requested.

While the Board was not inclined to attach undue importance to
objections based upon self-interest, it felt that it must take
cognizance of all legal objections, and it recognized that the clearing
question was essentially a reserve problem rather than a technical
question or a mere matter of administration. Inasmuch as the Federal
Reserve Act had granted a period of three years within which to effect
the final transfer of reserves to Federal Reserve Banks (balances with
correspondents counting as reserves in the meantime), there was a
certain ground for objection to the immediate introduction of complete
clearance at Federal Reserve Banks. As is well known, reserve balances
in some reserve cities have heretofore been used for the purpose of
providing for exchange and collection operations, and so long as this
function on the part of city correspondents continued there was some
argument in favor of deferring any compulsory application of par
clearance at the reserve banks. Study of the problem, moreover, shows
that, pending the time when state banks enter the system in larger
numbers, it may be necessary for some member banks to collect and clear
through their correspondents in reserve cities.

So complex was the situation and so serious the difficulty involved in
the compulsory application of any system, however carefully conceived,
that the Board felt it would be well if member banks could be brought to
recognize of their own free will the advantages of a general and
nation-wide clearing system--advantages which would inure not only to
the benefit of the public at large, but ultimately to the direct benefit
of the member banks themselves from the purely business standpoint. It
therefore took under favorable consideration the question of a voluntary
clearing system. Both the difficulties of a compulsory plan and the
probable merits of a voluntary system had been strongly represented to
the Board by the governors of the respective Federal Reserve Banks who
at various meetings had thoroughly canvassed the whole situation. Under
a plan, proposed by the governors, which in most districts became
effective during June, 1915, provision was made for the acceptance at
par by the Federal Reserve Bank of each district of checks drawn upon
any member bank of that district which had previously assented to the
provisions of the scheme. It was hoped that a very large number of
member banks would promptly affiliate themselves with the new system of
clearing and that the natural force of economic competition would
ultimately attract to it those who at first might hesitate.

This system, as already stated, became operative in most districts
during June, 1915. Prior to this whole discussion, however, two
districts had already undertaken the application of the clearing
provision of the law. Early in December, 1914, district No. 10 and
district No. 8 (Kansas City and St. Louis) had sought and obtained
permission to apply to their members a complete system of required
clearing. This system had been in full operation in both districts prior
to the general application of the voluntary system. Upon the
inauguration of the latter the directors of the Federal Reserve Bank of
St. Louis deemed it wise to offer to their member banks the option of
withdrawing from the clearance system if they so desired; but so
successful had been the working of the plan that comparatively few
retired, about 80 per cent. of all continuing their membership. The
Federal Reserve Bank of Kansas City continued its required system as
before for the benefit of all its member banks, numbering 950. As about
365 banks continued their membership in the St. Louis district, a total
of approximately 1,300 was included in the clearing system of the two
districts in question. Outside of these two districts about 1,100 member
banks voluntarily affiliated themselves with the clearing system within
a short time after its inauguration, and there was a subsequent net
inward movement of about 50 additional members, making approximately
1,150 banks which of their own free will have assented to the voluntary
clearing plan. This is considerably less than 25 per cent, of the
institutions eligible for membership, and the proportion has been so
small as to prove a severe disappointment to those who had confidently
expected that the foresight and enlightened self-interest of the member
banks would speedily accomplish the desired result. Some progress has
been made through the action of the banks, both member and non-member,
in improving exchange conditions and in providing for the clearance of
country checks at points where this practice has never before prevailed;
but in the main comparatively small advance has thus far been made in
rendering effective the provisions of the law requiring the
standardization of exchange and clearance practices. This slowness is
largely due to the failure of jobbers and merchants to appreciate the
advantages of the clearance system and to enlarge its membership by
insisting that their own banks join and co-operate in the plan. The
subject has recently been reopened at the conferences between the
governors of the Federal Reserve Banks, the Federal Reserve Agents, the
transit managers of the reserve banks, and the Board itself, with a view
to extending the present system not only in the several districts
themselves but as between the various districts. For many years it has
been lawful for banks to count as reserves deposits with other banks. It
was never the intention of the Federal Reserve Act that member banks
should continue the maintenance of these reserve accounts. On the
contrary, the full meaning of the act is manifestly opposed to such an
idea. It is the plain conception of the Act that the reserve banks
should, to a very large extent, if not entirely, perform the work that
is now being done by correspondent banks in this respect. This means
that the reserve balances to be carried in the future by the reserve
banks instead of by the correspondent banks should serve as the basis
for a system of clearing and collecting the exchanges of the country.
Whatever can be done to bring about the prompt and effective use of this
new system of bank settlement will be done.

BRANCHES AND AGENCIES

[310]The question of branches of federal reserve banks has received
careful attention during the past year. There has been intimation from
several quarters that the establishment of a branch at a given point
would be acceptable to the banks of that place. Only in one
instance--that of New Orleans--did the Board receive a definite request
from a Federal Reserve Bank to establish a branch. Believing that New
Orleans and the adjacent territory could make advantageous use of this
additional banking machinery, the Board authorized the establishment of
a branch of the Federal Reserve Bank of Atlanta to be located in New
Orleans, and this branch was opened for business on September 10.
Operations at the New Orleans branch have proceeded satisfactorily, and
the institution has been of considerable use to the local banks. The
branch is already more than self-supporting.

Investigation and experience have seemed to show that, at least for some
years to come, the organization of branches with completely equipped
offices, vaults, and the like, and with a full staff of salaried
officials, will be too heavy an expense for most of the reserve banks,
yet, that valuable service could be performed by local offices of the
several banks in not a few places. The Board has, therefore, had under
consideration the question whether establishing local agencies might not
meet the requirements of the case better than the more fully organized
branch office. Competent legal opinion is to the effect that the
creation of such local offices is permissible under the terms of the
law, and the Board believes that it may prove practicable to meet
banking necessities in many sections of the country by this means.

PROPOSED AMENDMENTS TO FEDERAL RESERVE ACT[311]

A year's experience in the operation of the Federal Reserve Act has
confirmed the Board in its profound conviction that the act has been one
of the most beneficial pieces of legislation ever adopted by Congress.
Not only have its fundamental principles been fully vindicated but in
most details the working of the measure has been successful. The act,
however, is a progressive piece of legislation and creates new
conditions as the result of its own operation. Modification in its terms
growing in part out of these new conditions will subsequently be
required from time to time.

For the present the Board presents the following suggestions for
amendments to the act:

(1) In addition to powers now possessed in this connection by Federal
Reserve Banks and national banks, the latter should be permitted to
subscribe for and hold stock in banks organized for the special purpose
of doing a banking business in foreign countries.

(2) With the approval of the Federal Reserve Board the issue of Federal
Reserve notes to Federal Reserve Banks should be permitted either
against the deposit of an equal amount, face value, of notes, drafts,
bills of exchange, and bankers' acceptances acquired by Federal Reserve
Banks under sections 13 and 14 of the Act, or of gold, or of both,
provided, however, that gold so deposited with a Federal Reserve Agent
shall count as part of the reserve required by the Act to be maintained
by the bank against such notes outstanding.

(3) The acceptance system, provision for which is made in foreign trade
operations by the Federal Reserve Act, should be extended to the
domestic trade in so far as relates to documentary acceptances secured
by shipping documents or warehouse receipts, covering readily marketable
commodities or against the pledge of goods actually sold.

There can be but little question of the safety of such acceptances, and
their use will tend to equalize interest rates the country over and help
to broaden the discount market.

(4) Permission should be granted to national banks to establish branch
offices within the city, or within the county, in which they are
located.

(5) In order to enable member banks to obtain prompt and economical
accommodations for periods not to exceed fifteen days, the Federal
Reserve Banks should be permitted to make advances to member banks
against their promissory notes secured by such notes, drafts, bills of
exchange, and bankers' acceptances as the law at present permits to be
rediscounted or purchased; or against the deposit or pledge of United
States Government bonds, the purchase of which is now permitted under
the law.

(6) The Board furthermore recommends that the power of national banks to
make loans on farm lands as provided in section 24 be extended so as to
permit any national bank not situated in a central reserve city to make
loans secured by improved and unencumbered farm land situated within its
Federal Reserve district, or within a radius of 100 miles from the place
in which such bank is located, irrespective of district lines. It also
recommends that the powers of national banks be further extended to
permit any such bank to make loans on any improved and unencumbered real
estate located within 100 miles of the place in which such bank is
located, irrespective of district lines; provided, however, that the
aggregate of farm land loans and other real estate loans made by any
national bank shall not exceed 25 per centum of its capital and surplus
or one-third of its time deposits; and provided further, that no such
real estate loan, as distinguished from a farm land loan, shall exceed a
period of one year nor exceed 50 per centum of the actual value of the
property offered as security.

It is believed that the enactment of these amendments will, besides
enlarging the usefulness of the national banks, result in greatly
strengthening the operation of the Federal Reserve Act, and more
completely realize the purposes of its framers. The text of the
amendments designed to carry out these recommendations will be submitted
by the Board at an early date. The Board has under consideration other
suggestions for amendments to the Federal Reserve Act concerning which
no conclusions have yet been reached, and regarding which the Board will
take occasion to submit its views to the Congress at an appropriate time
in the future.

STATEMENT OF CONDITION OF FEDERAL RESERVE BANKS.[312]

_Combined resources and liabilities of all Federal Reserve Banks as at
close of business on the last Friday of each month during 1915._

RESOURCES.
[In thousands of dollars.]
---------------------------+---------+---------+---------+---------+---------+
| Dec. | Jan. | Feb. | Mar. | Apr. |
| 31. | 29. | 26. | 26. | 30. |
| 1914. | | | | |
---------------------------+---------+---------+---------+---------+---------+
Gold coins and certificates| | | | | |
in vault | 228,641 | 235,417 | 248,256 | 241,344 | 237,278 |
Gold settlement fund | | | | | |
Gold redemption fund | 428 | 488 | 653 | 824 | 950 |
+---------+---------+---------+---------+---------+
Total gold reserve | 229,069 | 235,905 | 248,909 | 242,168 | 238,228 |
Legal tender notes, silver,| | | | | |
etc. | 26,578 | 20,882 | 29,085 | 23,098 | 26,518 |
+---------+---------+---------+---------+---------+
Total reserve | 255,647 | 256,787 | 277,994 | 265,266 | 264,746 |
Commercial paper | 9,909 | 13,955 | 18,577 | 22,001 | 22,774 |
Bankers' acceptances | | | 1,892 | 9,682 | 13,812 |
United States Bonds | 205 | 2,015 | 5,406 | 6,639 | 6,813 |
Municipal warrants | 734 | 11,165 | 12,011 | 14,940 | 18,656 |
Federal Reserve notes, | | | | | |
net assets | 5,418 | 3,179 | 3,215 | 6,091 | 6,909 |
Due from other Federal | | | | | |
Reserve Banks, net | 7,930 | 7,421 | 8,088 | 5,573 | 9,468 |
All other resources | 5,931 | 7,712 | 4,550 | 3,019 | 4,425 |
+---------+---------+---------+---------+---------+
Total resources | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 |
---------------------------+---------+---------+---------+---------+---------+
LIABILITIES.
---------------------------+---------+---------+---------+---------+---------+
| Dec. | Jan. | Feb. | Mar. | Apr. |
| 31. | 29. | 26. | 26. | 30. |
| 1914. | | | | |
---------------------------+---------+---------+---------+---------+---------+
Capital paid in | 18,051 | 20,440 | 36,069 | 36,105 | 39,669 |
Government deposits | | | | | |
Reserve deposits, net | 263,948 | 279,516 | 290,336 | 288,217 | 294,832 |
Federal Reserve notes, | | | | | |
net liability | 3,775 | 2,278 | 5,328 | 8,889 | 11,038 |
All other liabilities | | | | | 2,064 |
+---------+---------+---------+---------+---------+
Total liabilities | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 |
---------------------------+---------+---------+---------+---------+---------+

RESOURCES. (continued)
[In thousands of dollars.]
---------------------------+---------+---------+---------+---------+---------+
| May. | June | July | Aug. | Sept. |
| 28. | 25. | 30. | 27. | 24. |
| | | | | |
---------------------------+---------+---------+---------+---------+---------+
Gold coins and certificates| | | | | |
in vault | 219,187 | 222,746 | 212,988 | 211,145 | 229,972 |
Gold settlement fund | 23,426 | 31,360 | 52,140 | 55,930 | 59,050 |
Gold redemption fund | 1,027 | 1,081 | 1,064 | 1,104 | 1,202 |
|---------+---------+---------+---------+---------+
Total gold reserve | 243,640 | 255,187 | 266,192 | 268,179 | 290,224 |
Legal tender notes, silver,| | | | | |
etc. | 31,989 | 47,848 | 22,092 | 19,878 | 22,920 |
+---------+---------+---------+---------+---------+
Total reserve | 275,629 | 303,035 | 288,284 | 288,057 | 313,144 |
Commercial paper | 24,747 | 25,996 | 29,102 | 29,275 | 31,373 |
Bankers' acceptances | 9,204 | 10,379 | 11,625 | 13,564 | 13,058 |
United States Bonds | 6,947 | 7,601 | 7,923 | 8,836 | 9,328 |
Municipal warrants | 23,094 | 11,509 | 16,107 | 25,808 | 24,945 |
Federal Reserve notes, | | | | | |
net assets | 7,765 | 9,124 | 11,029 | 12,491 | 14,866 |
Due from other Federal | | | | | |
Reserve Banks, net | 7,435 | 8,311 | 7,078 | 6,990 | 7,409 |
All other resources | 5,426 | 5,501 | 5,904 | 4,962 | 3,577 |
+---------+---------+---------+---------+---------+
Total resources | 360,247 | 381,456 | 377,052 | 389,983 | 417,700 |
---------------------------+---------+---------+---------+---------+---------+
LIABILITIES.
---------------------------+---------+---------+---------+---------+---------+
| May | June | July | Aug. | Sept. |
| 28. | 25. | 30. | 27. | 24. |
| | | | | |
---------------------------+---------+---------+---------+---------+---------+
Capital paid in | 54,158 | 54,200 | 54,181 | 54,689 | 54,748 |
Government deposits | | | | | 15,000 |
Reserve deposits, net | 292,050 | 311,349 | 306,183 | 316,989 | 329,941 |
Federal Reserve notes, | | | | | |
net liability | 10,921 | 12,617 | 14,965 | 16,738 | 15,348 |
All other liabilities | 3,118 | 3,290 | 1,723 | 1,567 | 2,663 |
---------------------------+---------+---------+---------+---------+---------+
Total liabilities | 360,247 | 381,456 | 377,052 | 389,983 | 417,700 |
---------------------------+---------+---------+---------+---------+---------+

RESOURCES. (continued)
[In thousands of dollars.]
----------------------------+---------+---------+---------
| Oct. | Nov. | Dec.
| 29. | 26. | 30.
| | |
----------------------------+---------+---------+---------
Gold coins and certificates | | |
in vault | 218,224 | 245,986 | 266,546
Gold settlement fund | 61,960 | 73,830 | 77,293
Gold redemption fund | 1,222 | 1,252 | 1,124
+---------+---------+---------
Total gold reserve | 281,406 | 321,068 | 344,963
Legal tender notes, silver, | | |
etc. | 37,058 | 37,212 | 13,525
+---------+---------+---------
Total reserve | 318,464 | 358,280 | 358,488
Commercial paper | 30,448 | 32,794 | 32,368
Bankers' acceptances | 13,619 | 16,179 | 23,013
United States Bonds | 10,505 | 12,919 | 15,797
Municipal warrants | 25,014 | 27,308 | 12,220
Federal Reserve notes, | | |
net assets | 19,723 | 19,176 | 21,910
Due from other Federal | | |
Reserve Banks, net | 8,533 | 14,053 | 20,767
All other resources | 3,645 | 4,633 | 6,547
|---------+---------+---------
Total resources | 429,951 | 485,342 | 491,110
----------------------------+---------+---------+---------
LIABILITIES.
----------------------------+---------+---------+---------
| Oct. | Nov. | Dec.
| 29. | 26. | 30.
| | |
----------------------------+---------|---------+---------
Capital paid in | 54,838 | 54,846 | 54,915
Government deposits | 15,000 | 15,000 | 15,000
Reserve deposits, net | 343,554 | 397,952 | 400,012
Federal Reserve notes, | | |
net liability | 13,918 | 13,385 | 13,486
All other liabilities | 2,641 | 4,159 | 7,697
----------------------------+---------+---------+---------
Total liabilities | 429,951 | 485,342 | 491,110
----------------------------+---------+---------+---------

FOOTNOTES:

[287] O. M. W. Sprague, _The Federal Reserve Act of 1913_, _The
Quarterly Journal of Economics_, Vol. 28, No. 2, February, 1914, pp.
213-254.

[288] [The country has been divided into twelve districts in each of
which a Federal Reserve Bank began operations November 16, 1914.]

[289] After the Reserve Banks have been in operation long enough to be
running smoothly, not a few branches will doubtless be organized.
Branches are to have boards of directors, three of the members of which
are to be chosen by the Federal Reserve Board, and four by the directors
of the parent Reserve Bank. Branches are to be operated under rules and
regulations approved by the Federal Reserve Board.

[290] State banks and trust companies are eligible for membership, if
they have a sufficient capital to entitle them to become national banks
in the places where they are situated. On becoming member banks, they
must comply with the provisions of the national banking law regarding
reserves, examinations (the state examinations may be accepted), and
various other general provisions of the national banking law.

[291] In case subscriptions by the banks of a district are inadequate,
stock is to be offered to the general public; and if the response of the
public is inadequate, the stock is to be taken by the Government of the
United States. Neither privately owned nor government stock is entitled
to voting power. [In no district were subscriptions by the banks
"inadequate."]

[292] The inability of the Pujo money trust committee to secure desired
information from the banks evidently occasioned the following clause:
"No bank shall be subject to any visitatorial powers other than such as
are authorized by law, or vested in the courts of justice, or such as
shall be or shall have been exercised or directed by Congress, or by
either House thereof, or by any committee of Congress of either House
duly authorized."

[293] [Several of the more important regulations of the Federal Reserve
Board are contained in Appendix B.]

[294] The law regarding the examination of national banks is recast. The
only important changes are that hereafter all examiners are to be paid
salaries, and that the Federal Reserve Banks are empowered to conduct
special examinations of member banks.

[295] Adapted from Joseph French Johnson, _Fundamental Weakness of the
Glass-Owen Bill_, an address delivered before the Economic Club of New
York City, Monday evening, November 10, 1913.

[296] Although the address in part here reproduced was delivered as a
criticism of the Glass-Owen Bill, one of the measures that led up to
the passage of the Federal Reserve Act, that criticism, as a result
of a few slight changes made, applies with almost equal force to
the Federal Reserve Act itself. The preceding article by Professor
Sprague answers with striking directness Professor Johnson's trenchant
argument.--EDITOR.

[297] [It is commonly held that ample controlling power has been
conferred upon the Federal Reserve Board by the act as finally passed.
It is of interest that Senator Owen listened to the address of which an
adaptation is here given.]

[298] John Skelton Williams, Comptroller of the Currency, "Democracy in
Banking," an address delivered before the annual convention of the North
Carolina Bankers' Association in the House of Representatives at the
capitol at Raleigh, May 13, 1914. Printed in _Congressional Record_, 63d
Congress, 2d Session, Vol. 51, pp. 10150-53.

[299] F. M. Taylor, _The Elasticity of Note Issue under the New Currency
Law_. _The Journal of Political Economy_, Vol. 22, No. 5, May, 1914, pp.
453-463.

[300] _Second Annual Report of the Federal Reserve Board_, p. 16. 1916.

[301] _First Annual Report of the Federal Reserve Bank of New York_, pp.
19, 20. 1916.

[302] Thomas Conway, Jr., _The Financial Policy of the Federal Reserve
Banks_, _The Journal of Political Economy_, Vol. 22, No. 4, April, 1914,
pp. 319-331.

[303] _First Annual Report of the Federal Reserve Bank of New York_, pp.
34-36. 1916.

[304] Second Annual Report of the Federal Reserve Board, pp. 313, 314.
1916.

[305] _Ibid._, pp. 134-6.

[306] _Ibid._, pp. 23-25.

[307] [For regulations issued by the Federal Reserve Board see Appendix
B.]

[308] _Second Annual Report of the Federal Reserve Board_, pp. 134. 135,
1916.

[309] _Ibid._, pp. 14-17.

[310] _Ibid._, p. 18.

[311] _Ibid._, pp. 21, 22.

[312] _Ibid._, pp. 45, 46.

CHAPTER XXXII

THE EARLY EVENTS OF THE EUROPEAN WAR IN RELATION TO MONEY BANKING AND
FINANCE

AMERICAN FINANCE AND THE EUROPEAN WAR

[313]During the half-century that has elapsed since the Civil War, there
has probably been no period of six months within which there have
occurred transformations of so far-reaching a nature in American banking
and finance as during the half-year between July 1, 1914, and January 1,
1915. It will be long before the full meaning and significance of these
events are thoroughly understood; for what has been done cannot be
finally interpreted until facts which have not yet been ascertained have
developed their consequences. On the other hand, it would be impossible
to forecast the ultimate effect of the European war should any one of
certain tendencies which are still at least possible be fully carried
out. What has already taken place, however, comprises a range of events
full of important lessons and significant for the light they throw upon
the methods to be employed in the near future in the management of
industrial and commercial enterprises. This experience has been
particularly rich in its bearing upon the relationship between banking
and finance in the strict sense of the terms on the one hand, and the
future of commerce and industry in general on the other. Though it be
true that only hasty thinkers will endeavor to draw final conclusions
from what has thus far occurred, it is, nevertheless, also true that
much can be learned from the mere marshaling of recent events in their
relation one to another.

Upon the outbreak of the European war, it was at once evident to all
that very striking changes would result in every department of business
life. There was, of course, at the outset no knowledge of the strategy
or probable methods to be employed by any of the belligerents, and the
general attitude of the business community was based upon the assumption
that commerce would, for a time at least, become nearly impossible. As a
corollary to that assumption, there prevailed the belief in many circles
that American indebtedness to foreign countries would have to be
liquidated in cash, and that this process would result in draining away
from the United States a corresponding amount of gold. It was natural,
therefore, that the first phenomenon of the war should be the suspension
of dealings which it was believed would promote this gold movement, or
would cause more serious trouble in any direction than would otherwise
be inevitable. The closing of the principal stock exchanges of the
country almost immediately upon the definite announcement that war was
unavoidable was thus dictated by two considerations: (1) the belief that
prices for stocks and other securities would be reduced to a point so
low as to bring about the repurchase of the securities by Americans, who
would then be obliged to pay for them in gold; (2) the belief that, in
consequence of this reduction of prices, many bank loans based upon
securities would have to be "called," thereby bringing about failures
and incidentally assisting in the movement of specie out of the country.

In the case of the cotton exchanges, it was at once perceived that the
cotton crop, which is so largely produced for export, could not now move
abroad with any degree of facility, and that the demand for cotton would
undoubtedly be slack. The very fact of the war, therefore, implied heavy
reductions in the price of cotton, and the closing of the cotton
exchanges was a measure of self-preservation on the part of the
operators, who decided to protect themselves against the inevitable
failures which would result from the fulfilment of existing contracts at
very low prices. To close the exchanges would result in gaining time,
and would, therefore, enable operators to meet their maturing
obligations, besides perhaps affording an opportunity for actual
recovery in cotton prices. This very fact, however, of the closing of
the exchanges and the consequent removal of any other established method
of determining prices for standard securities and for a staple like
cotton involved most profound and far-reaching effects. The exchanges
had closed in previous years, but never for the reasons which now
controlled them. That they should close because of the fear of failure
and the loss of gold implied a serious danger of disaster which appealed
powerfully to the public mind, and which presented a problem that could
not be explained away. The fact that, coincident with this closing of
the exchanges, international trade was practically suspended for several
days, and was seriously interrupted for several weeks, until British
vessels assumed virtual control of the North Atlantic, tended greatly to
increase the public anxiety. It formed, apparently, good ground for the
suspension of business operations and for the non-fulfilment of
contracts, even when the very difficult conditions did not themselves
compel a recourse to such methods. The fact that foreign countries had
adopted legislation deferring the date when debts need be paid or
contracts fulfilled, although not paralleled here, produced a
sympathetic influence upon business in the United States, which
practically resulted in the partial or tentative adoption of a somewhat
similar relaxation of commercial requirements in many industries and
branches of trade.

It is notable that the Produce Exchange of New York and the other grain
exchanges of the country continued in operation and did an enormous
business in spite of the prevailing conditions. This was due to the fact
that grain of all kinds, provisions, and every sort of food-stuff were,
for the time being, subject to a very rapid upward movement. It was
early perceived that a long continuance of the war would bring about a
steady advance in the prices of all food products, the markets for which
are not dependent upon temporary fluctuations for support, but are
subject to far-reaching and semi-permanent influences. The fact that
these exchanges continued open while those whose staples were subject to
decline closed so speedily, naturally produced its own effect upon the
public mind. Many who had thought the exchanges invariably faithful
registers of price fluctuations were now reluctantly obliged to confess
that this could not be the case, since those exchanges where prices were
rising continued to operate without interruption, while those where
prices were falling were obliged to suspend business. From one point of
view, undoubtedly, the closing of the stock and cotton exchanges tended
still further to deepen the attitude of dissatisfaction with these
institutions that had been prevalent for some years among the American
public. On the other hand, however, as time went on, it became clear
that the exchanges of the country and the service they performed when in
operation were being appreciated as never before by the conservative
popular mind of the nation. With the exchanges closed it was seen that
the lack of a regular and established market subject to natural
conditions meant suffering and inability to secure the advantage of free
competition in the establishment of the price of products. This view was
once more emphasized when, later on, the cotton exchanges reopened; for
it was then seen that the effect of trading upon the exchanges was to
advance the price of the staple rather than to lower it, a view the
precise reverse of that which had been originally prevalent for a long
time past. Both in the psychological, as well as in the actual, effect
of these closings, and in the influence the episode exerted upon public
opinion, the suspension of the exchanges throughout the United States
must be regarded as a fact of first-rate importance in the financial
history of the United States during the European war.

Even without the suspension of certain classes of trading throughout the
country, partially due as it was to the frenzied demand of European
holders of American investments for money, the strain thrown upon our
banks as a result of the great change in conditions would have been
enormous. The closing of the exchanges, as already seen, had relieved
matters to some extent by enabling the banks to avoid the calling of
loans, and thereby to avoid the necessity of forcing customers into
liquidation, with the resultant disastrous effect upon themselves. But
on the other hand, the suspension of operations and the corresponding
loss by the public would, it was felt, tend to the hoarding of
legal-tender money. In order to meet this situation, the banks in many
of the large financial centres sought to limit specie payments, taking
out emergency currency and clearing-house certificates for the purpose
of meeting their indebtedness to the public and to one another.... A
phase of this phenomenon was seen in the tremendous rise in foreign
exchange rates, the rates becoming practically prohibitive and thereby
causing what amounted to a suspension of financial relationship between
the United States and foreign countries, particularly Great Britain.

III

It was early understood that the real difficulty and danger in the
international situation did not lie in the superficial symptoms of
trouble, but were found much deeper, being directly due to the fact that
international business had been practically suspended as the result of
the war. This was a factor of prime and material importance in the whole
situation, because the maintenance of established relations between the
United States and foreign countries was directly dependent upon the
regular exportation of goods. As was customary during the summer months,
there had been large expenditures by American tourists in Europe; and we
had become indebted to other countries, particularly Great Britain, for
material sums in excess of what we were currently able to liquidate.
This was on the assumption, as usual, that such indebtedness would be
liquidated through the shipment of agricultural products, particularly
of cotton, the country's principal cash crop. The breakdown of trade
with Europe through the inability of vessels to run regularly at the
outset of the war, and through the reduction of buying power, due to the
interruption of all regular industrial, commercial, and financial
operations, meant that in the absence of some restoration of the normal
course of business it would be necessary to find other means of
liquidating our obligations to foreign countries. The first phase of the
difficulty was met by investigating the extent of international
indebtedness, which, in the absence of other means of payment, would
necessitate the draining-away of gold from the United States. Such an
investigation was undertaken by the Federal Reserve Board, which, by
sending out questions to the principal international bankers of the
country, succeeded in forming a more or less trustworthy estimate of
the indebtedness on current accounts, these being, of course, of varying
maturities extending over several months. The problem thus raised was
how to provide for liquidating the debts without losing so much of the
underlying gold supply as to impair the convertibility of American
securities, and therewith general confidence in American ability to meet
obligations. The two chief proposals put forward for bridging over the
period of difficulty were the establishment of a joint gold fund by the
bankers of the country, and the undertaking of negotiations with Great
Britain whereby some relaxation of foreign demands on the United States
might be arranged for. These two phases of policy may best be cursorily
sketched at this point.

Since the new banks had not yet been established and could not be put
into operation for some weeks, it was deemed desirable to furnish a
makeshift substitute for the co-operative effort which would have been
available for the relief of the situation had the banks been in
existence. It was therefore determined to suggest to a number of
representative bankers the establishment of a joint gold fund to be used
in providing exchange on Great Britain, and to have this joint fund
developed at the earliest possible moment. A letter was consequently
sent out to the presidents of clearing-house associations throughout the
country, under date of September 21, in which request was made for
subscriptions to a fund intended to aggregate about one hundred million
dollars. This letter had previously been considered and approved at
meetings of representative bankers summoned to meet in Washington on
September 4 and 19 respectively, and was, therefore, issued with their
moral support. The answer to this invitation was prompt and effective, a
total of over one hundred and eight million dollars being subscribed and
rendered available.

It was almost immediately evident that the operation of this fund was
proving decidedly beneficial notwithstanding that only a comparatively
small percentage of the amount subscribed was asked for, and that a
still smaller percentage was actually used to furnish a basis for gold
shipments. Nevertheless, it seemed, during the ten days immediately
following the completion of the subscriptions, as if there might be
need for still further relief to the situation. Some of those who were
closely connected with the administration of the gold exchange fund
brought the subject to the attention of the Secretary of the Treasury
and he extended an invitation to the British Government to send
representatives to this country mainly for the purpose of considering
the possibility of further adjustment, in the event that the United
States did not succeed in liquidating its indebtedness to Great Britain
by the natural movement of commodities within a reasonably early period.
The British Government designated Sir George Paish and Mr. B. P.
Blackett, who came to the United States and on October 23 held a
conference with the Federal Reserve Board. Subsequently another
conference, attended by a number of representative bankers, was also
held and the situation was discussed in very great detail. Meantime the
establishment of a better understanding with reference to commodities to
be considered as contraband and the more effective policing of the North
Atlantic rendered possible the restoration of trade with European
nations, and the development of the export trade proceeded with a speed
which showed that current obligations of the United States to Great
Britain and other countries would be liquidated at an early date without
any necessity for further interference. By the time the reserve banks
were ready to open [November 16], exchange sales on London had fallen to
normal, and there was, therefore, no danger that when opened the reserve
banks might, as was for a time feared by some, find their gold rapidly
drawn away from them in order to meet the requirements of the gold
export movement.

In another way it was deemed desirable that the Federal Reserve Board
should help to facilitate the restoration of customary conditions in the
financial market. Almost immediately after the outbreak of war it was
seen that, unless hostilities should terminate within a very much
shorter period than anyone thought likely, serious injury would be
inflicted upon the cotton-producing states. As is well known, the cotton
crop is largely grown for export, about two-thirds of the total
production of the United States being annually sold abroad. It happened
that an unusually large crop had been planted and was approaching
maturity at the moment of the outbreak of the war. This would in any
event have depressed prices of cotton, even under ordinary conditions.
The almost immediate closing of the cotton exchanges of the country was,
however, precipitated by reason of the interruption to the movement of
cotton and the general understanding that, in view of the great area
involved in the hostilities, it would not be reasonable to expect a
normal demand for the staple to manifest itself. With the exchanges
closed, and with shipments of cotton interrupted, the price was unstable
and abnormally low, many sales undoubtedly having occurred at five cents
per pound. Inasmuch as the cotton crop is raised very largely upon
credit, it was necessary to provide some means whereby the Southern
planter could be assisted to such extension of accommodation as he might
require in meeting the obligations he would ordinarily have provided for
by the sale of his crop in the open market. Various suggestions were
brought to the attention of the Federal Reserve Board, one of them being
that of Mr. Festus J. Wade of St. Louis, who suggested, both to the
Board and to the Secretary of the Treasury, the establishment of a
cotton loan fund somewhat similar in purpose and management to the gold
exchange fund. After very anxious consideration, the conclusion was
reached that some measure of the sort would probably furnish relief to
cotton-growers. Various conferences were held with banking interests for
the purpose of securing their co-operation and advice in regard to the
matter. Ultimately the bankers of New York pledged fifty million dollars
in subscriptions to the fund, provided that fifty millions more should
be raised from other bankers in non-cotton-producing states. It was
understood that to the one hundred million dollars thus raised should be
added thirty-five million dollars contributed by the bankers of the
cotton-producing states under a special plan devised for that
purpose.[314]

It was not, however, through any of these artificial means that real
relief was brought to the community. While bankers were laboring to
perfect the gold fund, and while the negotiations with Great Britain
were in progress, foreign trade was being re-established through the
effective policing of the North Atlantic, the re-establishment of
demands, and the resumption of the ordinary course of business. What
took place during the months of August and September can be understood
from ... comparative figures for importation and exportation which make
an impressive showing of the suffering to which the United States was
subjected through this decline in business. With the opening of October
there came, however, a decided improvement. Time had now been given for
the establishment of normal conditions....

With foreign trade in a fair way to recover, it was still necessary to
secure a restoration of normal trade conditions within the United
States, and for this purpose the thing most fundamentally necessary was
the setting in motion of the federal reserve banking system which had
been provided for by act of Congress the 23d of December preceding. The
time intervening between December 23, 1913, and the opening of the war
had been occupied in carrying out the preliminaries of organization; but
it still remained for the Federal Reserve Board, the controlling
mechanism of the new system, to appoint officers and to provide for the
active operation of the banks under its direction. The first detail to
which the Board necessarily addressed itself was the completion of the
boards of directors of the several institutions, it being necessary to
select and elect three in each institution, or thirty-six in all. The
task required an elaborate process of comparison of the names and
qualifications of the several candidates and was not completed until
early in October. With the announcement of the thirty-six directors, it
was possible to proceed to the active opening of the institutions. The
Board called for the first payment of capital stock on November 2, and
the Secretary of the Treasury, who by law had been vested with that
function, named November 16 as the actual date for opening....

The establishment of the system ... greatly relieved the banking
situation.... Sec. 19 of the Federal Reserve Act provided for a
readjustment of reserves upon a new and lower basis....

This readjustment, by the terms of the law, took effect immediately upon
the establishment of the new banks, _i. e._, on November 16. From the
outbreak of hostilities in Europe, there had been a difficult reserve
situation in most of the financial centers, New York banks particularly
being much of the time largely under their reserve requirements because
of the heavy drafts made upon them by interior banks and by the public.
The change in reserve requirements, however, made a very material
alteration in this condition of affairs, and released, not only in New
York, but throughout the country, a very considerable amount of funds
which had previously been held by the banks in order to bring themselves
within the requirements of law. Precisely what amount of reserves was
thus released throughout the country has not been accurately estimated,
and probably cannot be. It is, however, an undoubted fact that the
release of actual cash was very large, and that the release of lending
power as computed on the basis of reserves on the part of member banks
was correspondingly larger. Member banks were thereby enabled to extend
loans to their customers very much more freely than they had previously
been able to do, while at the same time they were able to grant lower
rates of interest in due proportion. The prevailing rate of discount for
prime commercial paper in New York at the beginning of November was
about 6 per cent., while other paper was considerably higher than that
figure, and even more difficult conditions prevailed elsewhere. The
opening of the reserve system enabled New York banks, because of the
very great relief given to them through the release of reserves, to
reduce this rate largely, and within two weeks after the new banks had
come into existence prevailing interest rates for the best paper went as
low as 3-1/2 per cent. and 4 per cent. while acceptances, which had been
provided for by the Federal Reserve Act, were marketed at a still lower
rate. In some parts of the South, Northern bankers were able to grant
accommodation as low as 4 per cent. and in considerable amounts. In view
of the greater ease and material relief which was thus accorded, the
federal reserve banks were naturally not called upon to assist member
banks with accommodation, such banks naturally refraining from asking
aid when they themselves were fully able to meet the situation.

The opening of the reserve banks released, as already shown, a large
amount of bank funds, and thereby rendered it possible to extend many
loans which otherwise could not have been carried by the banks. It was
also seen, soon after November 16, that the existence of the cotton
fund, as was the case with the gold fund, had done its work by
stimulating confidence and by leading to a more liberal extension of
credit. With the cotton fund available for long-time loans, and with
short-term credit much more freely extended by member banks in view of
the reduction of national bank reserve requirements, it was possible for
the reserve banks to open with full confidence that the work thus done
in safeguarding the situation would relieve them from undue strain,
while fully protecting the cotton-producers who were willing to pay a
moderate rate of interest in order to carry their cotton until such time
as would enable them to realize full market value for it.

As has been shown by the Secretary of the Treasury in his annual
report,[315] an early phenomenon of the war was the issue by
clearing-houses in many cities of clearing-house certificates.
Simultaneously therewith large quantities of emergency currency were
issued under the provisions of the act of 1908, which had been amended
and extended by the Federal Reserve Act, and which were still further
amended by Congress on August 4, so as to permit the freer issue of
notes.... The total amount of the emergency currency taken out by
associations had aggregated about three hundred and eighty million
dollars, but it is probable that the clearing-house certificates were
issued to a considerably larger sum. The channels of circulation were
thus clogged long before the end of the summer, notwithstanding the fact
that large quantities of gold and gold certificates were withdrawn and
hoarded either by banks or by individuals. This condition of affairs
made it certain that the reserve banks, upon their organization, would
not be instantly pressed for the issue of reserve notes. Two factors
combined to produce this result--the circumstance that many banks had
placed their best paper with the national currency associations in order
to protect emergency currency, and the further circumstance that the tax
on this currency at the lower rate established by Congress would not,
for some considerable time, be likely to approximate the rate of
discount which every bank would have to pay to federal reserve banks in
order to get the rediscounts that would enable them to obtain the notes
they needed. Combined with these factors was, of course, the natural
inertia which in all such cases tends to prevent the withdrawal of one
kind of currency and the issue of another. Upon the organization of the
federal reserve banks, moreover, the urgent pressure for note
accommodation passed away as quickly as it had come. Gold reappeared in
circulation at an early date, and the retirement both of the
clearing-house certificates and of the emergency currency was
undertaken. In those cities where rates of interest on clearing-house
certificates were very high, the reserve banks aided in the retirement
of the certificates remaining in circulation.

The emergency currency itself immediately began to be retired by its
issuers.... Had the reserve banks been in operation at the beginning of
August, they would naturally have supplied the great volume of currency
which was called for; but not having done so, a field of business which
would naturally be theirs has been temporarily taken from them by reason
of the fact that it was occupied by the clearing-house certificates and
emergency notes.[316]

The result of the restoration of trade, banking, and credit to earlier
and more normal conditions has been steadily apparent. Cotton exchanges
reopened on November 16, and stock exchanges opened for restricted
trading shortly thereafter. In brief, by the close of the year, the
phenomenal conditions growing directly out of the European war had been
met and overcome. It is a notable fact that under the wholly unusual
circumstances prevailing, the recovery was so prompt and effective. What
share in this early improvement is to be assigned to the organization of
the new banking system and to the effectiveness with which the Treasury
Department co-operated in meeting the needs of the country cannot
accurately be stated, and will probably afford grounds for difference of
opinion. That it was great cannot be denied....

NATIONAL BANK FAILURES AND SUSPENSIONS--1914 COMPARED WITH 1893 AND
1907[317]

A comparison of the failures and suspensions of national banks during
the past year with failures and suspensions in the panic periods of 1893
and 1907 may be interesting at this time.

The figures show that for the 12 months ended October 31, 1914, 26
national banks, with aggregate capital stock of $2,510,000, failed or
suspended payment. The total liabilities of these banks (in the case of
receiverships claims proved) amounted to $14,177,408. In the case of six
recent failures, the figures of total liabilities, less capital,
surplus, and undivided profits, are used in lieu of the "claims proved,"
no report of the latter having yet been received as to these six banks.

For the 12 months ending October 31, 1893, 158 national banks suspended,
with capital of $30,350,000. Sixty-five banks, with total capital stock
of $10,935,000, were insolvent and required the appointment of
receivers; 86, with capital stock aggregating $18,205,000, were able to
resume business; and 7, with capital stock of $1,210,000, were placed in
charge of examiners in the expectation of resumption. The total
liabilities of failed and suspended banks for the period mentioned was
$83,042,347--in the case of failed banks, "claims proved" being
considered as "total liabilities."

During the six-months period from October 1, 1907, to April 1, 1908,
there were 22 national bank failures and suspensions, and the total
liabilities (in the case of receiverships these being "claims proved")
were $32,443,978; the total capital stock, $6,540,000. Of these banks,
however, 7, with capital stock of $1,440,000 and liabilities of
$22,124,662, resumed business.

It is worthy of special note that in the crisis of 1914, unlike the
panics of 1893 and 1907, there was no suspension of currency payments on
the part of the banks of this country, either in the large cities or in
the smaller towns. In the panics of 1893 and 1907, in addition to
clearing-house checks, many artificial methods of supplying a temporary
currency were resorted to, while actual currency commanded a premium of
from 3 per cent. to 5 per cent.--$100 in currency costing anywhere from
$103 to $105, or more, in certified bank checks.

In 1914 the banks of the country were enabled, as a result of the
instant and active co-operation of the Treasury Department, and through
the operations of the act of May 30, 1908, as amended by the Federal
Reserve Act, to supply actual currency, even during the period of
greatest stringency, to their customers and correspondents, both over
the counter and in response to requests for shipments. Whenever any
indications were seen of an attempt or disposition on the part of any
solvent bank or banks to withhold or suspend cash payments, the subject
was taken up immediately by the Treasury Department, and payments of
currency over the counter and shipments by the banks upon demand, from
the centers to the nearby and far-off districts, and vice versa, have
been maintained practically without interruption throughout this crisis.

THE EFFECTS OF THE WAR WITH SPECIAL REFERENCE TO THE CENTRAL BANKS OF
FRANCE, GERMANY, AND ENGLAND

[318]In France the gold held by the Bank of France (February, 1916) is,
in actual quantity, larger by about 25 per cent. than that held in
normal times before the war. Instead of former gold reserves of about
$800,000,000, they are now well over $1,000,000,000. The percentage of
gold to the notes--the main demand liability--has, of course, fallen
from about 65 to 35 per cent. because of the increase of notes from
about $1,200,000,000 to $2,800,000,000.

This increased supply of gold has come from hoardings and private
holdings which have been placed at the disposal of the bank in return
for bank-notes. There has been no reduction of this gold fund through
demands from note-holders, since the bank was freed from redemption in
gold at the very beginning of the war. That is, notes of the Bank of
France are inconvertible. As contrasted with the dollar of the United
States, when expressed in bills of exchange between New York and Paris,
the Bank of France note has depreciated nearly 14 per cent. Any paper
money not having immediate redemption will depreciate. As regards the
future it is a question of ultimate redemption.

With so large an available gold supply, there can be little question as
to the future intention or probability of redeeming the notes in gold.
It looks very much as if the same policy adopted in the war of 1871-3
had been consciously followed. Then, also, the _cours forcee_ was
declared, and the gold carefully retained in the vaults of the bank. The
presence of a large gold fund was an assurance of the ability to return
to specie payments after the close of the war. The war was short, and
the notes were not seriously depreciated, bearing a discount as compared
with gold of 1-1/2 to 4 per cent. In the present war, the same steps
have been taken; but this war is extending over a much longer time than
the former one, and the depreciation has already become much greater.

It is equally clear, however, that if the gold were now to be paid out
for redemption uses, it would become scattered, exported, and might even
pass through Holland or Switzerland into Germany. The increase and
preservation of this large fund of gold is the strongest evidence of the
ability of the bank to resume the gold redemption of its notes soon
after the close of the war. The actual time, however will depend upon
the rapidity with which the Government can repay some of its large loans
from the bank, since the excessive note issues have been largely due to
loans to the State.

In Germany, likewise, every effort has been made to accumulate gold,
even though the notes of the Reichsbank were made inconvertible at the
beginning of the war. Not only was the requirement to redeem the notes
in coin removed, but the regulations regarding a tax upon all notes
uncovered by a specie beyond a specified _Kontingent_ were suspended.
Thus, restrictions on the limit of note issues do not exist; and they
have risen from about $500,000,000 before the war to about
$1,500,000,000 (February, 1916), while the stock of coin and bullion has
changed from about $300,000,000 to over $600,000,000. That is, the coin,
which is mostly gold, is about 40 per cent. of the notes. Here, again
there is an obvious tendency to increase and maintain the gold reserves
so that Germany may have the means of resuming gold payments at no great
time after the close of the war.

The campaign to collect gold from the public and from hoards was
remarkable. It was successfully made a test of patriotism to hand in
gold in return for Reichsbank notes, and a house-to-house canvass in
many places resulted in providing the gold which so signally increased
the reserves behind the notes. Of course, the usual international
operations for obtaining gold were denied to Germany. It was this
campaign which was imitated by France. At the present time, certainly,
no thought has ever occurred to Germans that they would not go back to a
gold basis.

Nevertheless, Germany has clearly fallen into the same confusion of mind
which characterized our own policy in regard to the issue of greenbacks
in the Civil War. We confused the monetary with the fiscal functions of
the Treasury. So has Germany. Thinking the war would be short and
decisive, to be followed by large indemnities levied on her enemies, she
had expected to finance her expenditure by temporary expedients. That
is, the Government was led into the policy of borrowing through the
increase of monetary forms.

It does not change the principle that this increase of paper money was
not made solely by Imperial Treasury notes, but by a very large addition
to the circulation in the form of Reichsbank notes and _Darlehnskassen_
notes. It was the loans by the Reichsbank to the Government which
undoubtedly caused the main increase in the notes of this bank (just as
was true of the Bank of France), and the reduction of these issues, and
their redemption in gold, will depend directly on the power and
readiness of the Government to pay off its obligations to the Reichsbank
after the war.

The amount of borrowing by processes which led to an increase of the
circulation was necessarily limited; and very soon borrowing through
issues of paper money had to be followed by regular fiscal operations in
the form of long- or short-term bonds which would not affect the
quantity of the circulation. Expenses could not well be met to any
extent by current taxation, because taxes were already high, and in the
few years before the war, no doubt in anticipation of it, some four or
five hundred million dollars in taxes over and above normal taxation had
already been levied. In 1913 a non-recurring tax of $250,000,000 had
been imposed on the wealthier classes.

In addition a bonded debt, since the war, has been floated to the amount
of $10,000,000,000 over and above the existing public debt before the
war of about $1,200,000,000. But all these fiscal operations should be,
for our present purposes, separated from monetary operations. The
carrying of these heavy government debts is a question of the future
production of goods, of commerce, and of saving.

Whatever the burden of debts, the gold question is concerned with the
mechanism of exchange by which taxes, subscriptions to loans, payments
by the Government for munitions and supplies, current purchases of goods
by the public, payments to and by banks, are made. At present this
medium is paper money depreciated, as in the case of the Reichsbank
notes, by nearly 30 per cent. Of course, the Darlehnskassen issues would
follow the value set by the notes of the Reichsbank.

It is interesting to mention that the increase of paper money has not
been in answer to any need of the public for additional media of
exchange; for ordinary business transactions have decreased, and would
require a less quantity of money. It was an error not to separate
borrowing entirely from monetary issues.

Moreover, as bearing on the maintenance of the gold standard after the
war, it is worth noting that the rule requiring the Reichsbank to keep
one-third of its note issues covered by gold has not been violated. At
last reports (February, 1916) the gold item stood at $613,750,000, as
against $1,612,500,000 notes, or about 38.1 per cent. That is, the
greatest efforts have been made to concentrate the gold holdings of the
nation, including the "war chest" of about $30,000,000, in the reserves
of the Reichsbank.

At the same time no gold is paid out in redemption of notes, nor is it
allowed to be exported. Some sums have been sent to Holland in a vain
attempt to support German exchange in that country; but the difficulty
in exchange rates lies deeper than the relative supply of and demand for
bills, since the depreciation of German paper money determines the
general level about which the fluctuations of exchange due to demand and
supply range. In fact, wherever gold is not freely moved in
international exchange there are no shipping points, and hence no limits
to which exchange can fall short of the discount of the paper in terms
of gold.

III

As regards Great Britain, the gold standard is yet preserved for all
practical purposes. To her credit be it said that she has not fallen
into the error of borrowing by excessive issues of paper money; so far
she has not confused the fiscal with the monetary functions of the
Treasury. She resorted at once to fiscal operations in the form of heavy
taxation and loans in the form of short-time Treasury bills and
longer-term bonds. The issue of government paper money is, indeed, a new
departure; but its purpose has been more distinctly monetary than
fiscal.

The currency notes are emergency notes, issued under the act of August
6, 1914, directly by the Treasury, and not by the Bank of England,
although authorized by the same act which suspended the Bank Act in
regard to additional issues of bank notes not covered by gold. In other
crises the act of 1844 has been suspended to allow more notes based on
consols than permitted by the act (_i. e._, above the £18,750,000). In
August, 1914, such a suspension was in the future made legal, if
authorized by the Treasury, thus avoiding the old resort to a bill of
indemnity by Parliament.

But in spite of the usual suspension of the Bank Act, no use was made of
it. That is, a demand for more currency in the hands of the public could
have been supplied by the bank, but was not. In truth, the Lloyd George
currency notes need not have been issued. Nevertheless, when once
issued, they made unnecessary any resort to additional Bank of England
notes. There was no need of both. But in one respect the currency notes
helped to maintain the country's gold standard. By issuing them in small
denominations of one pound, and ten shillings, they replaced the gold in
general use for these denominations, and allowed it to be used as
reserves. Yet, it must be remembered that sound policy required a gold
reserve (which has been generally kept at about 40 per cent.) behind
these currency notes, so that the whole amount of gold replaced was not,
in fact, a gain.

As all know, the question of gold for Great Britain pivots on the
reserves of the Bank of England, which is the agent for the Government,
receiving its taxes and paying out its expenses, as well as the holder
of reserves for other banks--being thus a bankers' bank, as well as a
national agent. Moreover, the reserves mentioned, and which are of prime
importance, are those of the banking department--and these are chiefly
Bank of England notes (not gold). The percentage of reserves to
deposits, which marks the safety line for England, refers to the items
in the banking department. These notes, however, are protected (except
the bottom layer of £18,750,000 covered by consols), pound for pound, by
gold in the issue department. Hence, they can be turned into gold at any
moment.

Then, to what do these facts lead us? Simply that gold has increased
just in proportion to the issue of bank notes. In addition, the currency
notes of the Government served in the place _pro tanto_ of the Bank of
England notes. Hence, at the end of the war, the provision for
redemption of Bank of England notes will work automatically. Nor can
there be any question as to the gold being there to redeem them; for
they cannot get out without a previous deposit of gold. Indeed, the
questions of difficulty cannot arise regarding the basic currency of
Great Britain; they will arise, if at all, in connection with the assets
in the loan item of the banking department, since they will determine
the safety of the deposits chiefly created as the result of loans. The
bank discounted large sums of pre-moratorium acceptances and paper; and
yet even in these assets it is protected by the guarantee of the
Government.

DARLEHNSKASSEN AND OTHER FINANCIAL NOVELTIES IN GERMANY

[319]Germany, at the outbreak of the war, removed the limit of notes
issuable by the Reichsbank without tax; created about 1,800
Darlehnskassen (loan banks), located throughout the Empire, wherever the
Reichsbank maintained a branch; they were started without capital, in
lieu of which they issued _Darlehnskassen Scheine_ (Imperial Loan Bank
notes) in denominations of one mark and upwards, the aggregate amount
being limited to 1,500,000,000 marks; these banks made loans against
stocks, shares, produce, any personal property of a non-perishable
character, as collateral, and issued certificates, having the quality of
bank notes, to the borrowers; the loans ran for three and sometimes six
months; the minimum loan was 100 marks; a very wide margin of safety was
required, making the loans good beyond question; these certificates were
receivable for public dues and by the Reichsbank; the smaller
denominations circulated as money, the Reichsbank received the larger,
giving its notes in exchange; these certificates were not legal tender,
but were given the quality of gold and "may be considered by the
Reichsbank as gold cover, which means that against 100 marks of these
Scheine in its vault the Reichsbank is allowed to issue 300 marks of its
own notes." (I. De Bruyn.)[320]...

Sir Edward H. Holden, president of the London City and Midland Bank, in
a speech to his board of directors, January 29, 1915, said:

Germany proceeded to establish War Loan Banks, War Credit
Banks and War Aid Banks under the patronage of corporations,
municipalities and private financiers, and to make use of
the Mortgage Banks already established....

The Mortgage Banks are under the control of Chambers of
Commerce and municipalities, and they make advances on the
mortgage of properties by an issue of notes....

Germany made greater use (than of the Darlehnskassen) of the
Mortgage Banks, the notes of which are identical in power
and use with the notes of the Darlehnskassen. Another part
of their scheme was to relieve the pressure on insurance
companies (life), by forming an insurance bank, which
advanced 40 per cent. on the value of policies. These
advances were paid on notes which were exchanged for
Reichsbank notes in the same way as the notes of the
Darlehnskassen and Mortgage Banks.

Germany, with characteristic system and detail, provided different kinds
of banks to deal with different phases of the situation. War credit
banks were designed to aid Germans whose credits became unavailable,
owing to the exigencies of the war, as for instance those who had sold
and shipped goods abroad (the enemy's country), whose accounts would be
temporarily uncollectible, and those who might be otherwise embarrassed
in their foreign trade because of the interruption of business caused by
the war. War credit banks were more general in their dealings than war
loan banks. In Germany, business is largely done upon credit, and
especially so by small concerns and individuals, who possess no extended
bank credit nor available collateral, and hence are not in position to
make use of the Reichsbank or other commercial banks, or the
Darlehnskassen.

A German banker says: "It was deemed advisable to create an institution
of an intermediary character which would bear the greater share of the
risks involved. The so-called war credit banks are designed to serve
this purpose. They were established throughout the country, have their
own capital, and the obligations undertaken by them are guaranteed, and
losses, if any, refunded by the respective municipalities and
commercial associations. The war credit bank of Greater Berlin, for
instance, was established with a capital of 18 millions of marks, of
which 25 per cent. are fully paid in. In addition thereto, there is a
liability of 11.5 million marks by official bodies of commercial
organizations."

Still another kind of war credit bank was created on the co-operative
plan to assist the middle and lower classes.

Through the instrumentality of these institutions, a large amount of
credit instruments, possessing a currency function, was brought into
existence in Germany....

THE WAR AND THE WORLD'S FINANCIAL CENTRE

[321]With the end of the moratorium on November 4, it may be said that
the crisis produced by the outbreak of war was over. When peace comes
and prices [of securities] adapt themselves to the new price of capital
that the present destruction of some eight to ten millions of it a day
will bring about, and creditors begin to try to collect debts from
impoverished debtors in war-wasted countries, then there will be a new
set of problems, the acuteness of which will largely depend on the
length of the war and the extent to which the fighters are worn out.
These problems will exercise all the ingenuity and strength that Lombard
Street can muster. For the present it is enough to see how we stand at
the end of the opening period of the war, and what have been the effects
of the financial tornado with which its beginning was heralded....

The crisis of last August was the greatest evidence of London's strength
as a financial centre that it could have desired or dreamt of. It was so
strong that it did not know how strong it was. Consequently, being a
little flustered by the suddenness of the outbreak of war, on a scale
that mankind had never seen before, it made the mistake of asking its
debtors to repay it, not the thousands of millions that it had lent in
the form of permanent investment, but the comparatively trifling
amount--perhaps 150 or 200 millions--that it had lent in the shape of
bills of exchange drawn on it, and other forms of short credits.
Thereby it put the rest of the economically civilized world, for the
time being, into the bankruptcy court, and so, finding that none of its
debtors could pay, it thought itself obliged to ask for time from its
own creditors at home. Foreign creditors it had none, except Paris. It
sent gold to Paris as fast as it could be shipped and insured, and so
seems to have liquidated its debt. For when a market in exchange
reopened after the first shock of war, the Paris cheque soon steadied
itself at a more or less normal level, above the point at which gold
could be sent to France as an exchange operation. It is possible,
however, that London was still in debt to Paris, and that Paris
preferred for obvious reasons to leave its money on this side of the
Channel.

Of the three possible rivals to London as a financial centre, Paris was
the only one that gave any evidence of real financial strength. Behind
Paris stands the enormous power of the thrifty French investor, who
probably accumulates a greater proportion of his income than anybody in
the world, except, perhaps, some classes of Scotsmen. This accumulating
power of the French gives the Paris money market a position of
first-rate importance in the financial world, because capital has to be
saved, and a saving people has capital to lend. The advantage that
London holds in its more elastic credit system is partly balanced by the
advantage given to Paris by the thrifty habits of the French people. If
Paris adopted a more businesslike policy with regard to her huge store
of gold, which she has hitherto seemed to regard as a precious asset to
be sat on and protected by the charge of a premium to audacious people
who want to withdraw a bit of it, she might, in normal times, be a much
more dangerous rival to London than she is. But it need hardly be said
that Paris, as a financial centre, was soon wrapped in the cloud of war
and invasion, and had no chance of making any effort to oust London from
her pride of chief place.

Berlin was equally cut off from competition, for Berlin had to devote
herself to the task of financing war for Germany. Moreover, the rapid
depreciation in the value of the mark that took place before the war
began showed that Germany was still a debtor country in the short-loan
market. The Berlin exchange, while war was as yet only a dreaded
possibility, rose from 20 m. 50 pf. to 20 m. 60 pf. Germany invests
money abroad, but she seems to borrow as much, and more, in the discount
markets of London and Paris. So it came to pass that, in spite of the
big sales of securities that she had thrown on the markets of New York
and London, she still had to pay when the big day of settlement came,
and to pay so fast that she had not a bill on London left to pay with.

It was the chance of a century for New York. American ambition has long
ago informed the world that the United States, having been the world's
granary, is now the world's most progressive manufacturer, and means
soon to be the world's banker. This may happen some day, and might have
happened already if American policy in currency, financial and fiscal
matters had been more enlightened, and if her people had been more
thrifty. But they have tied their credit system in the bonds of narrow
banking laws and their trade in those of a cramping tariff. These bonds
they have just begun to shake off, and if the crisis had happened a few
years later they might perhaps have made a bid for London's place as
world banker. But it is hardly likely, for the development of the
enormous resources of the country still craves for much more capital
than its people can provide. The United States is still a debtor to the
world at large and seems likely to be so for some time to come, and it
is doubtful whether even New York, with all its skill in the jugglery of
finance, can make itself a great banking centre as long as its heavy
balance of indebtedness is always waiting to turn the world's exchanges
against it, whenever the monetary sky is overcast.

It was the chance of a century, but New York could not take it. When
London called in its credits from other countries, any centre that could
have said to these countries, "We will give you the credit that London
has cut off, and lend you the money to pay London," would have stepped
straight on to London's financial throne and set London a very difficult
task to regain it after the war was over. In spite of the large amounts
of gold taken from America to Europe before the war, the United States
had still a huge store within its borders--some estimates of it ranged
up to 400 millions sterling. If the United States had had the courage
to use this mountain of metal and let other countries draw on it, London
would have had more gold than it knew what to do with, and New York
would have had a big slice of London's business. The United States were
at peace, and, with all the chief countries of this antiquated
hemisphere engaged in the mediæval business of killing one another's
citizens and destroying one another's property, the United States might
have been expected to leap into the position of economic leadership. But
America feared to use its gold, and held on to it as tightly as it
could, fearful of internal trouble and a run on its banks if too much of
the metal went abroad. In New York, as in most other centres, the
question of the moment was, not to take London's business, but to pay
what she owed to London and to buy bills on London at skyrocket prices
wherever they could be found. The strength of the fat old money-lender,
whom the Australian papers, angry with him because he did not lend fast
enough, used to call John Bull Cohen, was never more wonderfully made
manifest. Strength in money bags is not everything--very far from
it--but at least J. B. Cohen can claim that he has made good use of it.
He has peopled and fertilized the uttermost ends of the earth with his
sons and his capital, and he alone among the nations has had the courage
and the homely wit to throw his ports open to all and to tell all the
peoples of the world to send their stuff along if it is worth buying.
Moreover, he has lately shown that, in spite of all his alleged
decadence, he can still tuck up his sleeves on occasion and fight at
least as well as anybody else.

So far was New York from being able to supplant London that, as we have
seen, the United States had to make special arrangements to tide over
the difficulty which London's claims on her had produced....

The American Government found it necessary to ask officials of the
British Treasury to come over and help it to find ways and means for
meeting part of the debt of the United States to England, without
shipping any more American gold. This could only be done by England's
giving America some sort of credit to take the place of the finance
bills and other forms of accommodation which Lombard Street had
withdrawn.

At the same time there is no doubt that New York did some of the
business for herself that London had formerly done for her. If she was
not in a position to finance other countries, she did make a beginning
in financing her own imports. Exporters of goods from South America to
the United States who had formerly taken payment by drawing bills on
London, and were no longer able to do so, drew on financial institutions
in New York instead. Some of these bills were used to make
three-cornered payments from South America to London, and a very costly
means of payment they were to the debtor, owing to the high rate of
discount in New York, and the depreciation of the American dollar as
compared with the pound sterling....

It seems likely that this business of financing American trade New York
will keep in her own hands to a greater extent than she did before.
Probably she would have taken more of it to herself even if there had
been no war. Her new banking legislation has included in its aim the
establishment of branches of American banks abroad, and the development
of acceptance business in New York. It could not be expected that New
York would always be content to see the greater part of America's
external trade financed with English credit. Her next step will be to
endeavor to finance other people's trade, and she is already beginning
to set about taking it, being assisted by Lombard Street's shyness in
the matter of new acceptance business. If the war should be long
continued, its appalling drain on the combatants ought to help her by
exhausting the rivals whom she hopes to drive out of the field.

So far, then, from the late crisis having given any evidence of weakness
on the part of London, or of any likelihood that she will lose her
supremacy as the world's banker, the commanding strength of her portion
has been made abundantly manifest. The only weak point was not in her
armor but in that of her foreign customers. The question arises whether
she was wise in lending so much to debtors who showed such unanimous
inability to pay on the due dates. I have heard it contended by a
disinterested and well-qualified critic, that the risk run by Lombard
Street in allowing bills to be drawn on her from all parts of the world
against goods shipped from one country to another, has been shown by the
late crisis to be too great to be worth the candle. Bills drawn against
goods coming to England are safe enough, for as long as the goods come
to port and can be sold for them, the acceptor is sure of his money. But
when the goods go from China to Peru, and Peru finds that it cannot
remit to meet the bill, the acceptor is inconvenienced, and the bank or
bill broker who holds the bill finds that he has got a security which
was not quite as gilt-edged as he thought it. This is all quite true,
but contrariwise it may be argued that this sort of world crisis is not
going to happen again very soon, and that if all finance had to be
arranged on the theory that it was likely to recur frequently, there
would be very little finance of any kind. These bills drawn against
international shipments of goods do much to make the bill on London
popular all over the world, and if they are to be frowned on there will
be a considerable restriction of international commerce, which will
react unpleasantly on England. In ordinary times these bills are safe
enough, if due precautions are taken. If mistakes are made they happen
rarely and the resources of the accepting houses are easily able to
repair the damage.

As to finance bills, it has already been admitted that much credit was
given by their means which was used for purposes with which bills of
exchange ought not to be associated. The essence of a bill of exchange
is that it has to be met at its due date, and so it should only be drawn
to finance some commercial operation that will mature before the bill
falls due, or to provide means of remittance when they are scarce, owing
to seasonal causes which will have passed before the bill's maturity.
When rolling credits, as they are called, are established, which go on
from year to year, each bill being met by drawing another, and the money
so raised in the borrowing country is put into bricks and mortar or
machinery or other forms of fixed capital, the uses of the bill of
exchange are being strained. When a jolt comes to the machinery and the
rolling credit stops rolling, it is not possible to sell the factory or
plant to provide a means of remittance. But there is no doubt that for a
time, at least, this kind of finance bill is likely to be scarcer than
it was; in fact, as we have seen, it was the excessive suddenness of the
fit of virtue that seized Lombard Street on this subject that made the
crisis more acute than it need have been, by reducing the means of
remittance and so keeping the exchanges at an abnormal point.

Lombard Street has thus shown that it has fully learnt the only lesson
that the external side of the crisis had to teach it. Too many finance
bills of the wrong kind were out, and Lombard Street saw the fact so
clearly that for some weeks it rang with the cry that there must never
be any more finance bills of any kind at all. This exaggerated view is
already discredited, and there is good reason to hope that opinion will
settle down to a sensible midway path, taking the finance bill as a
quite legitimate and necessary convenience, dangerous only when abused
and distorted....

MR. WITHERS A GOOD ENGLISHMAN

[322]Mr. Withers is a very good Englishman indeed and points out with
pardonable pride how the London market stood the shock which rocked the
rest of the financial world to its very foundations. What would have
been his attitude had the book been written a little later, however,
when the pound sterling had fallen to a discount of over 2 per cent. as
compared with the dollar, is an interesting subject of speculation.
London financing the world is, from the Englishman's point of view, an
inspiring sight, but the pound sterling obtainable in New York for $4.76
... is something which it would be interesting to hear Mr. Withers
explain. _War and Lombard Street_ treats only with the beginning of a
very big subject. It is sincerely to be hoped that a little later we
shall have a continuation of the work from Mr. Withers' pen.

AMERICA'S CHANCE OF HOLDING WORLD PURSE-STRINGS[323]

Since the outbreak of the war New York has assumed a position of
leadership in international banking. Will this position be permanent or
will its duration be limited practically to the period of the war? Is
the mantle of world financial leadership about to pass from London to
New York, as it passed after the Napoleonic Wars from Amsterdam to
London? These are questions which many are asking, but which no one can
answer positively, because so much depends upon those incalculable
items--the duration of the war and the financial strength of the
belligerents at its close....

At the end of 1913 our provincial banking system was overhauled by the
Federal Reserve Act, and put in shape to meet the needs of our growing
trade, both domestic and foreign. By this act American commercial paper,
which previously had been essentially local paper, was given an
opportunity to assume a national, or even international, character,
through the provisions for bank acceptances, rediscount, and "open
market operations." An open discount market began to develop on American
soil; and slowly, but surely, short-time paper of an international
character and standing began to appear....

By the beginning of 1914, therefore, it may be said, that the way was
opened for our financial metropolis, New York, to play an increasingly
important rôle in the international money market, and that there was
already a movement in that direction.

To this movement the European war gave a strong impetus, and to-day New
York clearly holds the premier position in the field of international
finance, although at a time when national finance in the leading
countries of Europe has assumed proportions never before dreamed of. The
European exchange markets have been demoralized, and specie payments
among the belligerent countries of Europe have become little more than a
name. On the other hand, "dollar exchange" is now quoted in the
principal cities of Latin America, the Orient, and Australia; and the
American trade with those sections, which was formerly financed chiefly
through London, is now being financed directly, and in dollars....

The United States has brought back home from a billion to two billion
dollars' worth of the six billion dollars' worth of its securities
estimated to have been held abroad, and is preparing to take more,
either by purchase or as security for loans. It has loaned upwards of a
billion dollars to the belligerent countries, and has had a net
importation of gold during the year just closed greater than that of any
five years of its history. Our banks are carrying heavy surplus
reserves, those of the New York Clearing House banks alone on December
31 having amounted to $143,000,000, and the gold reserve against net
liabilities of the twelve federal reserve banks on December 23 having
amounted to 86 per cent.; and this, at a time when the large gold
reserves of the European banks are strained to the breaking point by the
tremendous liabilities placed upon them.

Our export trade has reached unprecedented heights, and for the year
1915 was approximately equal to twice that of 1906....

This war is likely to leave her [England] still with a secure position,
a great and loyal colonial empire, an efficient banking system, and the
control of the seas. Her position as a creditor nation will lie greatly
weakened, and she may even become a heavy debtor nation, but her foreign
trade connections have been so long and so well established that it does
not seem likely that they will be permanently impaired in any large
degree by the readjustments necessitated by the war. If she disposes of
her Latin-American and Asiatic investments to the United States she will
doubtless greatly weaken her trade position in those countries, but the
present evidence is that these will be about the last foreign
investments she will dispose of.

So far we have not made great progress in securing Europe's
Latin-American trade. Europe discontinued financing Latin America at the
same time that she discontinued her normal trading with Latin America.
For us to take her place it became necessary for us to loan before we
could sell and buy. But loaning to European belligerents and selling war
supplies offered larger immediate profits; and so our chief efforts have
been turned eastward rather than southward. An analysis of our large
export trade of last year shows that much of it was of a very abnormal
character, and gives promise of being but temporary. The following
figures comparing the exports of a few selected commodities for the ten
months ended October, 1915, with those for the same period of 1914 will
make this point clear:

_Ten Months Ended Oct. 31_
_Commodities. 1914. 1915._

Breadstuffs $212,025,814 $461,074,547
Iron and steel and mfrs. thereof, incl. wire 109,232,270 294,822,223
Meat products 110,180,785 214,212,955
Animals (notable horses and mules) 6,668,121 107,201,175
Explosives 6,439,693 103,527,382
Cars, carriages, etc. 36,844,923 117,366,359
Leather and mfrs. thereof 47,123,910 135,847,788

A glance at these articles will show that most of them were intended
chiefly for military uses, and that their heavy exportation presumably
will be but temporary.

It is interesting to note that some other articles of customary export
showed large declines in 1915 as compared with 1914. During the same ten
months' period, for example, our exports of agricultural implements (and
parts) declined from $21,028,588 in 1914 to $11,162,609 in 1915; of wood
and manufactures thereof, from $68,904,895 to $45,325,146; of
fertilizers, from $7,735,613 to $3,758,598; and of sewing machines, from
$7,757,421 to $4,902,594.

Viewed from the standpoint of the destination of the articles exported,
the significant fact is that the increase in exports was chiefly to
Europe, and not to Central and South America and Asia--the places in
which we have been strenuously endeavoring in recent years to build up a
permanent export trade....

... After the war is over Europe will presumably discontinue, or greatly
reduce, her importations from the United States of most of the articles
which figured so largely in the great increase of 1915. As her needs
tend to become normal again she will immediately endeavor to resume her
old-time trade connections, both import and export, at least in so far
as the trading centres are in countries that were friendly or neutral
during the war. In seeking to re-establish these connections the
merchants of the belligerent countries will be strongly backed by their
Governments, which the war will have made more socialistic and more
aggressive. They will have a great advantage in the fact of
long-established business relations, and in the fact that the war trade
will have been to such a large extent abnormal, both as regards the
products dealt in and the parties to the trade.

Europe's banking machinery in South and Central America, although it may
not be very actively functioning in these trying times, still exists,
and will be ready to resume its former activities as soon as peace is
declared....

On the basis of London Stock Exchange listings British investments in
Latin America early in 1914 were computed at nearly $6,000,000,000.
Germany also has a large number of banking establishments in South
America and heavy investments.... United States investments in South
America are very small as compared with those of England and Germany,
while only one American bank has established branches on that continent.
These branches are only five in number, and the oldest of them is but a
little over a year old.

The conclusion seems clear that the war will need to be very long and
very disastrous to England; and American merchants, bankers, and
investors will need to be much more active and far-sighted in their
exploitation of South American opportunities than they have been in the
past, if London is to yield to New York her financial premiership for
South America.

Other obstacles to New York's becoming permanently the world's financial
centre are its great distance from the financial markets of Europe,
America's small merchant marine, its provincial protective tariff
policy, the absence of an adequate supply of men possessing the
necessary training both in foreign languages and in commerce and
international finance to go into these foreign fields and to "tie them
up" commercially and financially with the United States, and the
slowness with which our recently reorganized banking system and our
American discount market must grow, as regards international business,
if it is to have roots that are strong and grow deep.

The United States has before it a great opportunity. Much depends upon
the foresight with which Americans prepare themselves to meet the
tremendous readjustments that will be demanded at the close of the war.
That will be the supreme test. Now is the time to build for the future,
and to avoid paying too much attention to immediate profits. New York
can hardly be expected to succeed to London's position as the world's
financial centre, at least for some time to come; dollar exchange will
not at once take permanent rank ahead of sterling, or even alongside it;
none the less, if the United States refuses to be blinded by the glamour
of large immediate profits from a type of trade that is necessarily
abnormal and temporary, and if she seriously turns her attention to the
opportunities now open to her in Latin America, she will make a long
step forward in the direction of financial leadership.

FOOTNOTES:

[313] H. Parker Willis, _American Finance and the European War_, _The
Journal of Political Economy_, Vol. 23, No. 2. February, 1915, pp.
144-165.

[314] A fuller account of the gold fund and cotton loan plans will be
found in the _First Annual Report of the Federal Reserve Board_,
Washington, January 15, 1915.

[315] _Report of Secretary of the Treasury_, December 7, 1914.

[316] _First Annual Report of the Federal Reserve Board_, p. 16.

[317] _Report of the Comptroller of the Currency_, 1914, pp. 15, 16.

[318] J. Laurence Laughlin, _Will the Gold Basis Survive in Europe?_,
_The Annalist_, Vol. 7, No. 162, Feb. 21, 1916, pp. 244, 252.

[319] A. Barton Hepburn, _A History of Currency in the United States_,
pp. 463-466. The Macmillan Company. New York. 1915.

[320] Of Boissevain Co.

[321] Hartley Withers, _War and Lombard Street_, pp. 98-111. E. P.
Dutton and Company. 1915.

[322] Franklin Escher, Review of _War and Lombard Street_, _The American
Economic Review_, Vol. 5, No. 3, September, 1915, pp. 624-5.

[323] E. W. Kemmerer, _America's Chance of Holding World Purse-Strings_,
_The Annalist_, Vol. 7, No. 158, Jan. 24, 1916, pp. 119-121, 144.

APPENDIX A

AN APPROXIMATE FORMULA FOR DETERMINING THE VELOCITY OF THE CIRCULATION
OF MONEY

[324]For the purpose of tracing the circulation of money, and measuring
it by bank records,[325] we may classify the persons who use money in
purchase of goods into three groups:

1. Commercial depositors, _i. e._, all engaged in business--firms,
companies, and others--who have bank deposits mainly or wholly apart
from personal accounts.

2. All other depositors, chiefly private persons.

3. All who, like most wage earners, are not depositors at all.

These three classes we shall distinguish as "Commercial depositors,"
"Other depositors," and "Nondepositors," or C, O, and N. The money in
the possession of "Commercial depositors" we shall call "till money,"
and the rest "pocket money."

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 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....

... 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."...

... "Nondepositors" consist chiefly of those who are classed in
statistics as wage earners. While there are some wage earners who are
depositors,[326] 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 recognised in practice....

We may now picture concretely the main currents of the monetary flow,
including the circulation of money in exchange for goods.... [The figure
here given] illustrates the three principal types.

[Illustration]

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 B_{o} represents the
annual withdrawals from banks by "other depositors," O_{c} the spending
of this withdrawn money by "other depositors" among "commercial
depositors," and C_{b} the return of the money from the "commercial
depositors" to the banks. This circuit (B_{o} O_{c} C_{b}) of three
links is very common. A second type of circuit is represented by a chain
of four arrows (B_{o} O_{n} N_{c} C_{b}). It is illustrated by private
depositors drawing money (B_{o}), and paying wages (O_{n}) to servants
who in turn spend the money (N_{c}) among tradesmen who finally deposit
it (C_{b}). A third type of circuit, also fourfold, is represented by
the arrows B_{c} C_{n} N_{c} C_{b}. It is illustrated by commercial
firms cashing their checks at banks (B_{c}) for pay rolls, with the cash
so obtained paying wages (C_{n}) to workmen who spend it (N_{c}) among
other tradesmen who redeposit it in banks (C_{b}). These three types are
not the only ones, but they are so much more important than any others
that they merit out undivided attention before a completer study is
undertaken.... [The accompanying figure] 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: O_{c} payments of money from "other depositors" to
"commercial depositors" in the purchase of goods; O_{o} payments from
"other depositors" to "nondepositors," as when a housewife pays wages;
C_{n} payments from "commercial depositors" to "nondepositors," as when
a firm pays wages; and N_{c} payments from "nondepositors" to
"commercial depositors," as when a wage earner buys goods of a merchant.

There 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, O_{c}, is contained within the circuit B_{o} O_{c}
C_{b} and, since no "nondepositors" intervene, represents money changing
hands once between its withdrawal from bank and its redeposit there. The
remaining types (O_{n}, C_{n}, and N_{c}) are contained within the two
other circuits (B_{o} O_{n} N_{c} C_{b} and B_{c} C_{n} N_{c} C_{b}),
and, owing to the fact that "nondepositors" intervene, represent money
circulating twice between withdrawal and redeposit.

In short, one of the three circuits (B_{o} O_{c} C_{b}) 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....

FOOTNOTES:

[324] Irving Fisher, _Purchasing Power of Money_, Appendix XII. pp.
448-454. _The Macmillan Company. New York. 1911._

[325] For a complete formula for determining the velocity of the
circulation of money see pages 448-460, of the Purchasing Power of
Money.

[326] The term "depositors," as here used, does not, of course, include
savings bank depositors. A savings bank is not a true bank of deposit,
providing circulating credit.

APPENDIX B

SOME REGULATIONS OF THE FEDERAL RESERVE BOARD

FEDERAL RESERVE BOARD

WASHINGTON, January 12, 1915.

ACCEPTANCE OF STATEMENTS IN LIEU OF CERTIFICATES AS TO CHARACTER OF
COMMERCIAL PAPER

Whenever a member bank shall offer for rediscount any note, draft, or
bill of exchange bearing the indorsement of such member bank, with
waiver of demand notice and protest, the directors or executive
committee of the federal reserve bank may, until July 15, 1915, accept
as evidence that the proceeds of such note, draft, or bill of exchange
were or are to be used for agricultural, industrial, or commercial
purposes (and that such notes, drafts, or bills of exchange in other
respects comply with the regulations of the board), a written statement
from the officer of the applying bank that of his own knowledge and
belief the original loan was made for one of the purposes mentioned, and
that the provisions of the act and regulations issued by the board have
been complied with.

CHARLES S. HAMLIN,
Governor.

H. PARKER WILLIS,
Secretary.

FEDERAL RESERVE BOARD

WASHINGTON, April 2, 1915.

BANKERS' ACCEPTANCES

DEFINITION

In this regulation the term "acceptance" is defined as a draft or bill
of exchange drawn to order, having a definite maturity, and payable in
dollars, in the United States, the obligation to pay which has been
accepted by an acknowledgment written or stamped and signed across the
face of the instrument by the party on whom it is drawn; such agreement
to be to the effect that the acceptor will pay at maturity according to
the tenor of such draft or bill without qualifying conditions.

STATUTORY REQUIREMENTS UNDER SECTIONS 13 AND 14

Section 13 of the Federal Reserve Act as amended provides
that:

(a) Any federal reserve bank may discount acceptances:

(1) Which are based on the importation or exportation of
goods;

(2) Which have a maturity at time of discount of not more
than three months; and

(3) Which are indorsed by at least one member bank.

(b) The amount of acceptances so discounted shall at no time
exceed one-half the paid-up capital stock and surplus of the
bank for which the rediscounts are made, except by authority
of the Federal Reserve Board and of such general regulations
as said board may prescribe, but not to exceed the capital
stock and surplus of such bank.

(c) The aggregate of notes and bills bearing the signature
or indorsement of any one person, company, firm, or
corporation rediscounted for any one bank shall at no time
exceed 10 per centum of the unimpaired capital and surplus
of said bank; but this restriction shall not apply to the
discount of bills of exchange drawn in good faith against
actually existing values.

Section 14 of the Federal Reserve Act permits federal reserve banks,
under regulations to be prescribed by the Federal Reserve Board, to
purchase and sell in the open market bankers' acceptances, with or
without the indorsement of member bank.

III

RULING

The Federal Reserve Board, exercising its power of regulation with
reference to paragraph II (b) hereof, rules as follows:

Any federal reserve bank shall be permitted to discount for any member
bank "bankers' acceptances" as hereinafter defined up to an amount not
to exceed the capital stock and surplus of the bank for which the
rediscounts are made.

ELIGIBILITY

The Federal Reserve Board has determined that, until further order, to
be eligible for discount under section 13, by federal reserve banks, at
the rates to be established for bankers' acceptances:

(a) Acceptances must comply with the provisions of paragraph II (a),
(b), (c) hereof;

(b) Acceptances must have been made by a member bank, non-member bank,
trust company, or by some private banking firm, person, company, or
corporation engaged in the business of accepting or discounting. Such
acceptances will hereafter be referred to as "bankers'"
acceptances;[327]

(c) A banker's acceptance must be drawn by a commercial, industrial, or
agricultural concern (that is some person, firm, company, or
corporation) directly connected with the importation or exportation of
the goods involved in the transaction in which the acceptance
originated, or by a "banker." In the latter case the goods, the
importation or exportation of which is to be financed by the acceptance,
must be clearly specified in the agreement with or the letter of advice
to the acceptor. The bill must not be drawn or renewed after the goods
have been surrendered to the purchaser or consignee.

(d) A banker's acceptance must bear on its face or be accompanied by
evidence in form satisfactory to a federal reserve bank that it
originated in an actual _bona fide_ sale or consignment involving the
importation or exportation of goods. Such evidence may consist of a
certificate on or accompanying the acceptance to the following effect:

This acceptance is based upon a transaction involving the importation or
exportation of goods. Reference No. ----. Name of acceptor ----.

(e) Bankers' acceptances, other than those of member banks, shall be
eligible only after the acceptors shall have agreed in writing to
furnish to the federal reserve banks of their respective districts, upon
request, information concerning the nature of the transactions against
which acceptances (certified or bearing evidence under IV (d) hereof)
have been made.

(f) A bill of exchange accepted by a "banker" may be considered as drawn
in good faith against "actually existing values," under II (c) hereof,
when the acceptor is secured by a lien on or by transfer of title to the
goods to be transported; or, in case of release of the goods before
payment of the acceptance, by the substitution of other adequate
security;

(g) Except in so far as they may be secured by a lien on or by transfer
of the title to the goods to be transported, as under (f), the bills of
any person, firm, company, or corporation, drawn on and accepted by any
private banking firm, person, company, or corporation (other than a bank
or trust company) engaged in the business of discounting and accepting,
and discounted by a federal reserve bank, shall at no time exceed in the
aggregate a sum equal to 5 per centum of the paid-in capital of such
federal reserve bank;

(h) The aggregate of acceptances of any private banking firm, person,
company, or corporation (other than a bank or trust company) engaged in
the business of discounting or accepting, discounted or purchased by a
federal reserve bank, shall at no time exceed a sum equal to 25 per
centum of the paid-in capital of such federal reserve bank.

To be eligible for purchase by federal reserve banks under section 14,
bankers' acceptances must comply with all requirements and be subject to
all limitations hereinbefore stated, except that they need not be
indorsed by a member bank: _Provided, however_, That no federal reserve
bank shall purchase the acceptance of a "banker" other than a member
bank which does not bear the indorsement of a member bank, unless a
federal reserve bank has first secured a satisfactory statement of the
financial condition of the acceptor in form to be approved by the
Federal Reserve Board.

POLICY AS TO PURCHASES

While it would appear impracticable to fix a maximum sum or percentage
up to which federal reserve banks may invest in bankers' acceptances,
both under section 13 and section 14, it will be necessary to watch
carefully the aggregate amount to be held from time to time. In framing
their policy with respect to transactions in acceptances, federal
reserve banks will have to consider not only the local demands to be
expected from their own members, but also requirements to be met in
other districts. The plan to be followed must in each case adapt itself
to the constantly varying needs of the country.

CHARLES S. HAMLIN,
Governor.

H. PARKER WILLIS,
Secretary.

FEDERAL RESERVE BOARD

WASHINGTON, April 2, 1915.

ACCEPTANCE BY MEMBER BANKS

By act of Congress approved March 3, 1915, section 13 (paragraphs 3, 4,
and 5 of the Federal Reserve Act) was amended and re-enacted so as to
read as follows:

Any federal reserve bank may discount acceptances which are based on
the importation or exportation of goods and which have a maturity at
time of discount of not more than three months and indorsed by at least
one member bank. The amount of acceptances so discounted shall at no
time exceed one-half the paid-up and unimpaired capital stock and
surplus of the bank for which the rediscounts are made, except by
authority of the Federal Reserve Board, under such general regulations
as said board may prescribe, but not to exceed the capital stock and
surplus of such bank.

The aggregate of such notes and bills bearing the signature or
indorsement of any one such person, company, firm, or corporation
rediscounted for any one bank shall at no time exceed 10 per centum of
the unimpaired capital and surplus of said bank; but this restriction
shall not apply to the discount of bills of exchange drawn in good faith
against actually existing values.

Any member bank may accept drafts or bills of exchange drawn upon it and
growing out of transactions involving the importation of exportation of
goods having not more than six months' sight to run; but no bank shall
accept such bills to an amount equal at any time in the aggregate to
more than one-half of its paid-up and unimpaired capital stock and
surplus, except by authority of the Federal Reserve Board, under such
general regulations as said board may prescribe, but not to exceed the
capital stock and surplus of such bank, and such regulations shall apply
to all banks alike, regardless of the amount of capital stock and
surplus.

In order to give effect to the above amendment of the law, the Federal
Reserve Board issues the appended Regulation K, series of 1915, stating
the conditions under which member banks may accept, up to 100 per cent.
of their capital and surplus, drafts or bills of exchange growing out of
transactions involving the importation or exportation of goods and
having not more than six months' sight to run.

CHARLES S. HAMLIN,
Governor.

H. PARKER WILLIS,
Secretary.

FEDERAL RESERVE BOARD

WASHINGTON, May 8, 1915.

CLEARINGS BETWEEN FEDERAL RESERVE BANKS

STATUTORY PROVISIONS UNDER SECTION 16

"The Federal Reserve Board shall make and promulgate from time to time
regulations governing the transfer of funds and charges therefore among
federal reserve banks and their branches, and may at its discretion
exercise the functions of a clearing house for such federal reserve
banks, or may designate a federal reserve bank to exercise such
functions, and may also require each such bank to exercise the functions
of a clearing house for its member banks."

GENERAL PROVISIONS

In the exercise of the functions of the clearing house authorised under
the provisions of section 16, quoted above, the Federal Reserve Board
and the federal reserve banks will be governed by and subject to the
following regulations and the Federal Reserve Board will be the
custodian of the funds hereinafter termed the gold settlement fund. The
board will appoint a settling agent who shall keep the necessary records
and accounts.

III

DEPOSITS IN THE GOLD SETTLEMENT FUND

(a) Each federal reserve bank shall, not later than May 24, 1915,
forward to the Treasury or the nearest Sub-Treasury, for credit to the
account of the gold settlement fund $1,000,000 in gold, gold
certificates or gold order certificates, and, in addition, an amount at
least equal to its net indebtedness due to all federal reserve banks.

(b) The Treasurer of the United States or Assistant Treasurer will, in
accordance with arrangements made with the Treasury Department, advise
the Federal Reserve Board, by mail or telegraph, of the receipt of all
funds deposited on account of the gold settlement fund, and the
Treasurer will issue and deliver to the Federal Reserve Board gold order
certificates made "payable to the order of the Federal Reserve Board"
covering the sum so deposited.

(d) Excess balances may, at the convenience of each federal reserve
bank, remain deposited with the gold settlement fund.

CUSTODY OF FUNDS

(a) A safe in the Treasury vault will be set apart for the exclusive use
of the Federal Reserve Board.

(b) To open the Treasury vault, the presence of two persons designated
by the Secretary of the Treasury is required. The combination of the
safe set apart for the use of the board will be controlled by two
persons designated by the board.

(c) A vault record shall be kept, giving a memorandum of all entrances
to the safe, by whom made, for what purpose, and the certificates
deposited or withdrawn. Each entry on the vault record book shall be
signed by the persons having access to the safe.

ACCOUNTS

In its relations with other federal reserve banks each federal reserve
bank shall keep an account showing balances "due to" other federal
reserve banks representing the proceeds of items which it has actually
collected, and payments and transfers which have been made to it for the
account of such other federal reserve banks; and an account showing
balances "due from" other federal reserve banks representing the
proceeds of items which it has sent to such other federal reserve banks,
and payments and transfer which have been made to such other federal
reserve banks for its account.

PROCEDURE

(a) At the close of business each Wednesday night, each federal reserve
bank shall telegraph to the Federal Reserve Board, confirming such
telegram by mail, the amounts in even thousands due to each other
federal reserve bank as of that date, as indicated by its "due to"
account provided for in Rule V. If Wednesday is a holiday in the State
in which a federal reserve bank is located, then such bank shall
telegraph as herein provided on Tuesday, at the close of business.

(b) The settling agent shall, on each Thursday, make the proper debits
and credits in the accounts of each federal reserve bank with the gold
settlement fund, and shall telegraph to each bank the amounts, in even
thousands, of credits to its settlement account, giving the name of each
federal reserve bank from which each of its credits was received and
also its net debit or credit balance in the weekly settlement.

(c) Each federal reserve bank shall, on receipt of the telegram from the
settling agent, debit the "due to" federal reserve banks' accounts, and
shall credit the gold settlement fund; and shall credit the "due from"
federal reserve banks' accounts and charge the gold settlement fund. The
difference between the total debits and credits shall equal the net
debit or credit to the gold settlement fund, as advised in the telegram
from the settling agent.

VII

DEFICITS

(a) Should the debit settlement balance of any federal reserve bank be
in excess of the amount of its credit in the gold settlement fund, such
deficit must be immediately covered either by the deposit of gold, gold
certificates, or gold order certificates in the Treasury or nearest
Sub-Treasury, or by credit operations with other federal reserve banks
which have an excess balance with the gold settlement fund. Any delay in
covering such deficit shall be subject to such charge as the Federal
Reserve Board may impose.

(b) As required in III (c) of this regulation, each federal reserve bank
shall maintain a balance in the gold settlement fund of not less than
$1,000,000. Should the credit balance of any federal reserve bank in
such fund fall below $1,000,000, such bank shall restore its balance to
that amount in either manner indicated under VII (a) of this regulation
on or before Tuesday of the following week.

VIII

EXCESS BALANCES

Any excess balance shall, on request, either by telegraph or letter, of
the federal reserve bank to which it is due, be refunded by the return
to the reserve bank of the gold order certificates held by the gold
settlement fund properly indorsed; or by the indorsement and delivery to
the Treasurer of a like amount of such certificates for which he will
give in exchange bearer gold certificates, which the Federal Reserve
Board may send by registered mail, insured, to the banks, if they want
funds other than gold order certificates, or in lieu of such payment,
the Treasurer may by wire or mail direct payment to be made by a
Sub-Treasury office through the medium of the general account, provided
funds are held in such office available for the purpose. Gold order
certificates will, when presented at the office of the Treasurer of the
United States or any Sub-Treasury, bearing the signatures of duly
authorised officers of the federal reserve bank, be payable in gold or
gold certificates. If the Treasury finds it necessary to ship from one
point to another in order to have the gold or gold certificates
available at the Sub-Treasury to which such gold order certificates are
presented, the Federal Reserve Board will, for the account of the gold
settlement fund, refund any expense incurred by the Treasury in making
such shipments.

RESERVE

Each federal reserve bank shall count as a part of its legal reserve the
funds standing to the credit of its account on the books of the gold
settlement fund.

EXPENSES

Cost of operation of and shipment of currency by the gold settlement
fund shall be apportioned by a semi-annual accounting among the 12
federal reserve banks on a basis to be hereafter determined by the board
after consultations with the federal reserve banks.

AUDIT

At least once in each three months an audit shall be made of the gold
settlement fund by a representative of the Federal Reserve Board and
representative appointed by the federal reserve banks.

XII

The Federal Reserve Board reserves the right to add to, alter, or amend
these regulations.

CHARLES S. HAMLIN,
Governor.

H. PARKER WILLIS,
Secretary.

FEDERAL RESERVE BOARD

WASHINGTON, June 7, 1915.

MEMBERSHIP OF STATE BANKS

STATUTORY REQUIREMENTS

Specific provisions of the Federal Reserve Act applicable to State banks
and trust companies which become member banks are quoted at the end of
this regulation.

BANKS ELIGIBLE FOR MEMBERSHIP

A State bank or a trust company to be eligible for membership in a
federal reserve bank must comply with the following conditions:

(1) It must have been incorporated under a special or general law of the
State or district in which it is located.

(2) It must have a minimum paid-up unimpaired capital stock as follows:

In cities or towns not exceeding 3,000 inhabitants, $25,000.

In cities or towns exceeding 3,000 but not exceeding 6,000 inhabitants,
$50,000.

In cities or towns exceeding 6,000 but not exceeding 50,000 inhabitants,
$100,000.

In cities exceeding 50,000 inhabitants, $200,000.

III

APPLICATION FOR MEMBERSHIP

Any eligible State bank or trust company may make application on Form
83, made a part of this regulation, to the federal reserve agent of its
district for an amount of capital stock in the federal reserve bank of
such district equal to 6 per cent. of the paid-up capital stock and
surplus of such State bank or trust company.[328]

Upon receipt of such application the federal reserve agent shall submit
the same to a committee composed of the federal reserve agent, the
governor of the federal reserve bank, and at least one other member of
the board of directors of such bank, to be appointed by such board, but
no Class A director whose bank is in the same city or town as the
applying bank or trust company shall be a member of such committee. This
committee shall, after receiving the report of such examination as may
be required by the federal reserve bank in pursuance of directions from
the Federal Reserve Board, consider the application and transmit it to
the Federal Reserve Board with its report and recommendations.

APPROVAL OF APPLICATION

In passing upon an application the Federal Reserve Board will consider
especially:

(1) The financial condition of the applying bank or trust company and
the general character of its management.

(2) Whether the nature of the powers exercised by the said bank or trust
company and its charter provisions are consistent with the proper
conduct of the business of banking and with membership in the federal
reserve bank.

(3) Whether the laws of the State or district in which the applying bank
or trust company is located contain provisions likely to interfere with
the proper regulation and supervision of member banks.

If, in the judgment of the Federal Reserve Board, an applying bank or
trust company conforms to all the requirements of the Federal Reserve
Act and these regulations, and is otherwise qualified for membership,
the board will issue a certificate of approval. Whenever the board may
deem it necessary, it will impose such conditions as will insure
compliance with the act and these regulations. When the certificate of
approval and any conditions contained therein have been accepted by the
applying bank or trust company, stock in the federal reserve bank of the
district in which the applying bank or trust company is located shall be
issued and paid for under the regulations of the Federal Reserve Act
provided for national banks which become stockholders in the federal
reserve banks.

POWERS AND RESTRICTIONS

Every State bank or trust company while a member of the federal reserve
system:

(1) Shall retain its full charter and statutory rights as a State bank
or trust company, and may continue to exercise the same functions as
before admission, except as provided in the Federal Reserve Act and the
regulations of the Federal Reserve Board, including any conditions
embodied in the certificate of approval.

(2) Shall invest only in loans on real estate or mortgages of a
character and to an extent which, considering the nature of its
liabilities, will not impair its liquid condition.

(3) Shall adjust, to conform with the requirements of the Federal
Reserve Act and these regulations, within such reasonable time as may be
determined by the board in each case, any loans it may have at the time
of its admission to membership which are secured by its own stock, or
any loans to one person, firm, or corporation aggregating more than 10
per cent. of its capital and surplus or more than 30 per cent. of its
capital, or any real estate loans which, in the judgment of the Federal
Reserve board, impair its liquid condition.

(4) Shall maintain such improvements and changes in its banking practice
as may have been specifically required of it by the Federal Reserve
Board as a condition of its admission, and shall not lower the standard
of banking then required of it: and

(5) Shall enjoy all the privileges an observe all those requirements of
the Federal Reserve Act and of the regulations of the Federal Reserve
Board applicable to State banks and trust companies which have become
member banks.

WITHDRAWALS

Any State bank or trust company desiring to withdraw from membership in
a federal reserve bank may do so twelve months after written notice of
its intention to withdraw shall have been filed with the Federal Reserve
Board. The board will immediately notify the federal reserve bank of the
receipt of such notice. At the expiration of said twelve months, such
bank or trust company shall surrender all of its holdings of capital
stock in the federal reserve bank, which stock shall then be cancelled
and the withdrawing bank or trust company shall thereupon be released
from its stock subscription not previously called. Such bank or trust
company shall, immediately upon the cancellation of its stock, cease to
be a member of the federal reserve bank, and the federal reserve bank
shall then refund to such bank or trust company a sum equal to the
cash-paid subscription on the shares surrendered, with interest at the
rate of one-half of one per centum per month computed from the last
dividend, if earned, not to exceed the book value thereof, and the
reserve deposits, less any liability of such member to the federal
reserve bank: _Provided_, That no federal reserve bank shall, except by
the specific authority of the Federal Reserve Board, cancel within the
same calendar year more than 10 per cent. of its capital stock for the
purpose of effecting voluntary withdrawals during that year. All
applications, including therein any on which action may have been
deferred because in excess of the aforesaid 10 per cent. limitation,
will be dealt with in the order in which they were originally filed with
the board.

Any State bank or trust company desiring to withdraw from membership at
the expiration of the twelve months' notice, notwithstanding the fact
that the federal reserve bank has previously cancelled 10 per cent. of
its stock during the same calendar year, may do so. In such case,
however, the federal reserve bank shall not be required to repay to the
withdrawing bank or trust company the sums due as above, until such time
as its stock would have been cancelled had it not exercised this option.
The federal reserve bank shall, however, give a receipt for the stock
surrendered.

VII

EXAMINATIONS

Every State bank or trust company, while a member of the Federal Reserve
system, shall be subject to such examinations as may be prescribed by
the Federal Reserve Board in pursuance to the provisions of the Federal
Reserve Act.

In order to avoid duplication, the board will exercise the broad
discretion vested in it by the act in accepting examinations of State
banks and trust companies made by State authorities wherever these are
satisfactory to the board and are found to be of the same standard of
thoroughness as national bank examinations, and where in addition
satisfactory arrangements for co-operation in the matter of examination
between the designated examiners of the Board and those of the States
already exist or can be effected with State authorities. Examiners from
the staff of the board or of the federal reserve banks will, whenever
desirable, be designated by the board to act with the examination staff
of the State in order that uniformity in the standard of examination may
be assured.

VIII

FUTURE REGULATIONS

The Federal Reserve Board reserves the right to make such amendments and
adopt and issue, from time to time, such further regulations authorised
by the act as it may deem necessary, but no amendment of section VI of
these regulations, relating to voluntary withdrawals, shall take effect
until six months after its adoption and issue by the board.

CHARLES S. HAMLIN,
Governor.

H. PARKER WILLIS,
Secretary.

FOOTNOTES:

[327] Drafts and bills of exchange eligible for rediscount under section
13, other than "bankers'" acceptances, have been dealt with by
Regulation B, series of 1915.

[328] Three per cent. has already been called from national and other
member banks, but the remainder of the subscription or any part of it
shall be subject to call if deemed necessary by the Federal Reserve
Board.

*** End of this LibraryBlog Digital Book "Readings in Money and Banking - Selected and Adapted" ***

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