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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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Copyright Status: Not copyrighted in the United States. If you live elsewhere check the laws of your country before downloading this ebook. See comments about copyright issues at end of book.

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       *       *       *       *       *









       *       *       *       *       *


Selected And Adapted



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
All rights reserved

Printed in the United States of America

Copyright 1916
By the Macmillan Company

Set up and electrotyped. Published September, 1916.

Ferris Printing Company
New York City


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

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.


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


   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


     VIII INDEX NUMBERS                                           115

       IX BANKING OPERATIONS AND ACCOUNTS                         121

          IN THE UNITED STATES                                    150

          AND GENERAL PRICES                                      159

      XII THE GOLD EXCHANGE STANDARD                              213

     XIII A PLAN FOR A COMPENSATED DOLLAR                         229



      XVI SAVINGS BANKS                                           270

     XVII DOMESTIC EXCHANGE                                       290

    XVIII FOREIGN EXCHANGE                                        305

      XIX CLEARING HOUSES                                         355

          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



     XXIX CRISES                                                  627


     XXXI THE FEDERAL RESERVE SYSTEM                              723

          BANKING AND FINANCE                                     797

          APPENDICES                                              830




[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

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.


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

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



[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.


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."


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

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.


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.


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.


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 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....


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



[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.


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

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.


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.


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.


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.


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


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.


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....


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



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

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

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

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.


[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.




[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.


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.


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.



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.


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.



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


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.


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.


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


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.


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

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



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

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

     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.


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

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 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


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


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

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.


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

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

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


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 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

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.


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.


[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.


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

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 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

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

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

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.


[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.



[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

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

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

    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

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


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



[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.


[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

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.


[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

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.


[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.


[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....


[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.


[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.


[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.


[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....


[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.



[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

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 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

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


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

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.


[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

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.


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.


[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.



[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

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

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."


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



[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

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

      _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:


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


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

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:


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


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                 }

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

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:


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


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

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:


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

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

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:


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


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



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


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

[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:


Cash                    $100,000
Notes                    100,000


Capital Stock           $100,000
Deposits                 100,000

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:


Cash                        $100,000
Notes (Loans and Discounts)


Capital Stock               $100,000
Deposits                     666,666

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.


Cash (original)    $100,000
Loans and Discounts 666,666
Cash (new)          (85,000
L & D (new)         566,666


Capital Stock      $100,000
Deposits            666,666
Deposits (new)     (100,000

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


[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

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

                                            _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

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

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

                     _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

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'


[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

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....


[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,

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

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....


[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

[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.



[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

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

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

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

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

(c) The third evidence is found in the growth of the number of small
banks, especially in the country districts....

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

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

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

... 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

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


[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.]



     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

    $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

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

    _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]


[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


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.

(c) Knowledge of the technique of production.

(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.

(c) Character of monetary and banking systems.

(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

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.

(c) As to the use of checks.

2. _Systems of payments in the community._

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

(b) As to regularity of receipts and disbursements.

(c) As to correspondence between times and amounts of receipts and

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

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

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

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

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....


[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

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

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,

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

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

       *       *       *       *       *

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

       *       *       *       *       *

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

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

       *       *       *       *       *

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

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

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

       *       *       *       *       *

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´_.


[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?


[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.

[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.

[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

[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.

[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.



     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

[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.


[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.


[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.



[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

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

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

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

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

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

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

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

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

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

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


[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.




[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

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,


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

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

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....


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

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.


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 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 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 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's coinage system duplicates that of France, and her Federal
Bank is very similar to the Bank of France....


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 ... 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


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, 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....


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.


... 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.


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 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 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, 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....


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.


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 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 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._...


[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:

                 |       |            |       |        | 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
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.



[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

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:


A trust company is preferable to individual trustees, because it
possesses every quality of desirability which the individual lacks, to

     (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

     (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

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


The banking functions of trust companies may include any or all of the

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.


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

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

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.


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

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.


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

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

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


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.


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


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.


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.


[91] Adapted from Kirkbride and Sterrett, _The Modern Trust Company_,
pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company.

[92] Thomas L. Greene, _Corporation Finance_, p. 59.



[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

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_.


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.


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."


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.


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.


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.


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

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 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

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.


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

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.



[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

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


[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

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.


     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

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

... 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

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.)


[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.



[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

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.


[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

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

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]


[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....


[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

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

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

... 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

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....


[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....


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

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.


[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.

[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.




[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

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.


[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.


[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

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.


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

     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

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

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

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.


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

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

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

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

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.


[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


[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

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

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

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.


[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.


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

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

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.


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_....


[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

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.


[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.


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.


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.


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

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


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

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.


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.


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.


[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

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

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

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.


[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

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.


[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.


[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....


[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

[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.



     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.



[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.


[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

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


[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


[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.


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

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


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.


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

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.


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

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

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


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

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.



[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

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

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.


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.


[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

[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



[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.


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

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.


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.


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

The States and Territories may be divided roughly into two groups
according to the amount of the smallest permissible capital for state

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.


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

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


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

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.


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.


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.


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

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.


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

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.


[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


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,

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

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 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

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.


[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

[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.

[146] Annual Report of the Superintendent of Banks of the State of New
York, Jan. 6, 1915, p. 33.



[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.


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.


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.


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


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.


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.


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


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 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.


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


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


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.


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

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.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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


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


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.


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.


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.


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.


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 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.



                                              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


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.


[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.




[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,

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

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

     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....


[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

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:


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


[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

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

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 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

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.


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 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

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 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.


[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

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

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

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.


[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

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 charge