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diff --git a/35120-8.txt b/35120-8.txt new file mode 100644 index 0000000..0a2bfe9 --- /dev/null +++ b/35120-8.txt @@ -0,0 +1,33493 @@ +The Project Gutenberg eBook, Readings in Money and Banking, by Chester +Arthur Phillips + + +This eBook is for the use of anyone anywhere at no cost and with +almost no restrictions whatsoever. You may copy it, give it away or +re-use it under the terms of the Project Gutenberg License included +with this eBook or online at www.gutenberg.org + + + + + +Title: Readings in Money and Banking + Selected and Adapted + + +Author: Chester Arthur Phillips + + + +Release Date: January 30, 2011 [eBook #35120] + +Language: English + +Character set encoding: ISO-8859-1 + + +***START OF THE PROJECT GUTENBERG EBOOK READINGS IN MONEY AND BANKING*** + + +E-text prepared by Jonathan Ingram, Josephine Paolucci, and the Online +Distributed Proofreading Team (http://www.pgdp.net) from page images +generously made available by Internet Archive/Canadian Libraries +(http://www.archive.org/details/toronto) + + + +Note: Project Gutenberg also has an HTML version of this + file which includes the original illustrations. + See 35120-h.htm or 35120-h.zip: + (http://www.gutenberg.org/files/35120/35120-h/35120-h.htm) + or + (http://www.gutenberg.org/files/35120/35120-h.zip) + + + Images of the original pages are available through + Internet Archive/Canadian Libraries. See + http://www.archive.org/details/readingsnimoney00philuoft + + +Transcriber's note: + + Text enclosed by tilde characters is in bold face (~bold~). + + Text enclosed by underscores is in italics (_italics_). + + An underscore followed by a letter enclosed in curly braces + indicates that the enclosed letter is a subscript. (Example: + C_{b} indicates that the "b" is a subscript). + + + + + +READINGS IN MONEY AND BANKING + + * * * * * + +THE MACMILLAN COMPANY + +NEW YORK · BOSTON · CHICAGO · DALLAS + +ATLANTA · SAN FRANCISCO + +MACMILLAN & CO. LIMITED + +LONDON · BOMBAY · CALCUTTA + +MELBOURNE + +THE MACMILLAN CO. OF CANADA. LTD. + +TORONTO + + * * * * * + + +READINGS IN MONEY AND BANKING + +Selected And Adapted + +by + +CHESTER ARTHUR PHILLIPS + +Assistant Professor of Economics in Dartmouth College +and Assistant Professor of Banking in the Amos +Tuck School of Administration and Finance + + + + + + + +New York +The Macmillan Company +1921 +All rights reserved + +Printed in the United States of America + +Copyright 1916 +By the Macmillan Company + +Set up and electrotyped. Published September, 1916. + +Ferris Printing Company +New York City + + + + + +PREFACE + + +Designed mainly for class room use in connection with one of the +introductory manuals on the subject of Money and Banking or of Money and +Currency, this volume, _in itself_, lays no claim to completeness. Where +its use is contemplated the problems of emphasis and proportion are, +accordingly, to be solved by the selection of one or another of the +available texts, or by the choice of supplementary lecture topics and +materials. The contents of the introductory manuals are so divergent in +character as to render possible combinations of text and readings that +will include, it is hoped, matter of such range and variety as may be +desired. + +Fullness of treatment has been attempted, however, in the chapters +dealing with the important recent developments in the "mechanism of +exchange," and my aim has been throughout to select and, in many +instances, to adapt with a view to meeting the wants of those who are +interested chiefly in the modern phases of the subject. + +For valuable suggestions in the preparation of the volume I am greatly +indebted to Professors F. H. Dixon and G. R. Wicker and Mr. J. M. +Shortliffe of Dartmouth, Professor Hastings Lyon of Columbia, Professor +E. E. Day of Harvard, and to my former teacher, Professor F. R. +Fairchild of Yale. I desire also to mention my great obligation to +authors and publishers who alike have generously permitted the +reproduction of copyrighted material. + +CHESTER ARTHUR PHILLIPS. + +Dartmouth College, +Hanover, N. H., July, 1916. + + + + +TABLE OF CONTENTS + + + CHAPTER PAGE + + I THE ORIGIN AND FUNCTIONS OF MONEY 1 + + II THE EARLY HISTORY OF MONEY 10 + + III QUALITIES OF THE MATERIAL OF MONEY 18 + + IV LEGAL TENDER 26 + + V THE GREENBACK ISSUES 33 + + VI INTERNATIONAL BIMETALLISM 71 + + VII THE SILVER QUESTION IN THE UNITED STATES 82 + + VIII INDEX NUMBERS 115 + + IX BANKING OPERATIONS AND ACCOUNTS 121 + + X THE USE OF CREDIT INSTRUMENTS IN PAYMENTS + IN THE UNITED STATES 150 + + XI A SYMPOSIUM ON THE RELATION BETWEEN MONEY + AND GENERAL PRICES 159 + + XII THE GOLD EXCHANGE STANDARD 213 + + XIII A PLAN FOR A COMPENSATED DOLLAR 229 + + XIV MONETARY SYSTEMS OF FOREIGN COUNTRIES 246 + + XV THE NATURE AND FUNCTIONS OF TRUST COMPANIES 256 + + XVI SAVINGS BANKS 270 + + XVII DOMESTIC EXCHANGE 290 + + XVIII FOREIGN EXCHANGE 305 + + XIX CLEARING HOUSES 355 + + XX STATE BANKS AND TRUST COMPANIES SINCE THE PASSAGE + OF THE NATIONAL BANK ACT 381 + + XXI THE CANADIAN BANKING SYSTEM 406 + + XXII THE ENGLISH BANKING SYSTEM 435 + + XXIII THE SCOTCH BANKS 474 + + XXIV THE FRENCH BANKING SYSTEM 488 + + XXV THE GERMAN BANKING SYSTEM 526 + + XXVI BANKING IN SOUTH AMERICA 559 + + XXVII AGRICULTURAL CREDIT IN THE UNITED STATES 575 + + XXVIII THE CONCENTRATION OF CONTROL OF MONEY AND CREDIT 606 + + XXIX CRISES 627 + + XXX THE WEAKNESSES OF OUR BANKING SYSTEM PRIOR TO + THE ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 672 + + XXXI THE FEDERAL RESERVE SYSTEM 723 + + XXXII THE EUROPEAN WAR IN RELATION TO MONEY, + BANKING AND FINANCE 797 + + APPENDICES 830 + + + + +READINGS IN MONEY AND BANKING + + + + +CHAPTER I + +THE ORIGIN AND FUNCTIONS OF MONEY + +[1]In order to understand the manifold functions of a Circulating +Medium, there is no better way than to consider what are the principal +inconveniences which we should experience if we had not such a medium. +The first and most obvious would be the want of a common measure for +values of different sorts. If a tailor had only coats, and wanted to buy +bread or a horse, it would be very troublesome to ascertain how much +bread he ought to obtain for a coat, or how many coats he should give +for a horse. The calculation must be recommenced on different data, +every time he bartered his coats for a different kind of article; and +there could be no current price, or regular quotations of value. Whereas +now each thing has a current price in money, and he gets over all +difficulties by reckoning his coat at £4 or £5, and a four-pound loaf at +6_d._ or 7_d_. As it is much easier to compare different lengths by +expressing them in a common language of feet and inches, so it is much +easier to compare values by means of a common language of pounds, +shillings, and pence. In no other way can values be arranged one above +another in a scale: in no other can a person conveniently calculate the +sum of his possessions; and it is easier to ascertain and remember the +relations of many things to one thing, than their innumerable cross +relations with one another. This advantage of having a common language +in which values may be expressed, is, even by itself, so important, that +some such mode of expressing and computing them would probably be used +even if a pound or a shilling did not express any real thing, but a mere +unit of calculation. It is said that there are African tribes in which +this somewhat artificial contrivance actually prevails. They calculate +the value of things in a sort of money of account, called macutes. They +say, one thing is worth ten macutes, another fifteen, another twenty. +There is no real thing called a macute: it is a conventional unit, for +the more convenient comparison of things with one another. + +This advantage, however, forms but an inconsiderable part of the +economical benefits derived from the use of money. The inconveniences of +barter are so great, that without some more commodious means of +effecting exchanges, the division of employments could hardly have been +carried to any considerable extent. A tailor, who had nothing but coats, +might starve before he could find any person having bread to sell who +wanted a coat: besides, he would not want as much bread at a time as +would be worth a coat, and the coat could not be divided. Every person, +therefore, would at all times hasten to dispose of his commodity in +exchange for anything which, though it might not be fitted to his own +immediate wants, was in great and general demand, and easily divisible, +so that he might be sure of being able to purchase with it, whatever was +offered for sale. The primary necessaries of life possess these +properties in a high degree. Bread is extremely divisible, and an object +of universal desire. Still, this is not the sort of thing required: for, +of food, unless in expectation of a scarcity, no one wishes to possess +more at once than is wanted for immediate consumption; so that a person +is never sure of finding an immediate purchaser for articles of food; +and unless soon disposed of, most of them perish. The thing which people +would select to keep by them for making purchases, must be one which, +besides being divisible, and generally desired, does not deteriorate by +keeping. This reduces the choice to a small number of articles. + +By a tacit concurrence, almost all nations, at a very early period, +fixed upon certain metals, and especially gold and silver, to serve this +purpose. No other substances unite the necessary qualities in so great a +degree, with so many subordinate advantages. Next to food and clothing, +and in some climates even before clothing, the strongest inclination in +a rude state of society is for personal ornament, and for the kind of +distinction which is obtained by rarity or costliness in such ornaments. +After the immediate necessities of life were satisfied, every one was +eager to accumulate as great a store as possible of things at once +costly and ornamental; which were chiefly gold, silver, and jewels. +These were the things which it most pleased every one to possess, and +which there was most certainty of finding others willing to receive in +exchange for any kind of produce. They were among the most imperishable +of all substances. They were also portable, and containing great value +in small bulk, were easily hid; a consideration of much importance in an +age of insecurity. Jewels are inferior to gold and silver in the quality +of divisibility; and are of very various qualities, not to be accurately +discriminated without great trouble. Gold and silver are eminently +divisible, and when pure, always of the same quality; and their purity +may be ascertained and certified by a public authority. + +Accordingly, though furs have been employed as money in some countries, +cattle in others, in Chinese Tartary cubes of tea closely pressed +together, the shells called cowries on the coast of Western Africa, and +in Abyssinia at this day blocks of rock salt; though even of metals, the +less costly have sometimes been chosen, as iron in Lacedæmon from +ascetic policy, copper in the early Roman republic from the poverty of +the people; gold and silver have been generally preferred by nations +which were able to obtain them, either by industry, commerce, or +conquest. To the qualities which originally recommended them, another +came to be added, the importance of which only unfolded itself by +degrees. Of all commodities, they are among the least influenced by any +of the causes which produce fluctuations of value. They fluctuate less +than almost any other things in their cost of production. And from their +durability, the total quantity in existence is at all times so great in +proportion to the annual supply, that the effect on value even of a +change in the cost of production is not sudden: a very long time being +required to diminish materially the quantity in existence, and even to +increase it very greatly not being a rapid process. Gold and silver, +therefore, are more fit than any other commodity to be the subject of +engagements for receiving or paying a given quantity at some distant +period. If the engagement were made in corn, a failure of crops might +increase the burthen of the payment in one year to fourfold what was +intended, or an exuberant harvest sink it in another to one-fourth. If +stipulated in cloth, some manufacturing invention might permanently +reduce the payment to a tenth of its original value. Such things have +occurred even in the case of payments stipulated in gold and silver; but +the great fall of their value after the discovery of America, is, as +yet, the only authenticated instance; and in this case the change was +extremely gradual, being spread over a period of many years. + +When gold and silver had become virtually a medium of exchange, by +becoming the things for which people generally sold, and with which they +generally bought, whatever they had to sell or to buy; the contrivance +of coining obviously suggested itself. By this process the metal was +divided into convenient portions, of any degree of smallness, and +bearing a recognized proportion to one another; and the trouble was +saved of weighing and assaying at every change of possessors, an +inconvenience which on the occasion of small purchases would soon have +become insupportable. Governments found it their interest to take the +operation into their own hands, and to interdict all coining by private +persons; indeed, their guarantee was often the only one which would have +been relied on, a reliance however which very often it ill deserved; +profligate governments having until a very modern period seldom +scrupled, for the sake of robbing their creditors, to confer on all +other debtors a licence to rob theirs, by the shallow and impudent +artifice of lowering the standard; that least covert of all modes of +knavery, which consists in calling a shilling a pound, that a debt of a +hundred pounds may be cancelled by the payment of a hundred shillings. +It would have been as simple a plan, and would have answered the purpose +as well, to have enacted that "a hundred" should always be interpreted +to mean five, which would have effected the same reduction in all +pecuniary contracts, and would not have been at all more shameless. Such +strokes of policy have not wholly ceased to be recommended, but they +have ceased to be practised; except occasionally through the medium of +paper money, in which case the character of the transaction, from the +greater obscurity of the subject, is a little less barefaced. + +Money, when its use has grown habitual, is the medium through which the +incomes of the different members of the community are distributed to +them, and the measure by which they estimate their possessions. As it is +always by means of money that people provide for their different +necessities, there grows up in their minds a powerful association +leading them to regard money as wealth in a more peculiar sense than any +other article; and even those who pass their lives in the production of +the most useful objects, acquire the habit of regarding those objects as +chiefly important by their capacity of being exchanged for money. A +person who parts with money to obtain commodities, unless he intends to +sell them, appears to the imagination to be making a worse bargain than +a person who parts with commodities to get money; the one seems to be +spending his means, the other adding to them. Illusions which, though +now in some measure dispelled, were long powerful enough to overmaster +the mind of every politician, both speculative and practical, in Europe. + +It must be evident, however, that the mere introduction of a particular +mode of exchanging things for one another, by first exchanging a thing +for money, and then exchanging the money for something else, makes no +difference in the essential character of transactions. It is not with +money that things are really purchased. Nobody's income (except that of +the gold or silver miner) is derived from the precious metals. The +pounds or shillings which a person receives weekly or yearly, are not +what constitutes his income; they are a sort of tickets or orders which +he can present for payment at any shop he pleases, and which entitle him +to receive a certain value of any commodity that he makes choice of. The +farmer pays his laborers and his landlord in these tickets, as the most +convenient plan for himself and them; but their real income is their +share of his corn, cattle, and hay, and it makes no essential difference +whether he distributes it to them directly or sells it for them and +gives them the price; but as they would have to sell it for money if he +did not, and he is a seller at any rate, it best suits the purposes of +all, that he should sell their share along with his own, and leave the +laborers more leisure for work and the landlord for being idle. The +capitalists, except those who are producers of the precious metals, +derive no part of their income from those metals, since they only get +them by buying them with their own produce: while all other persons have +their incomes paid to them by the capitalists, or by those who have +received payment from the capitalists, and as the capitalists have +nothing, from the first, except their produce, it is that and nothing +else which supplies all incomes furnished by them. There cannot, in +short, be intrinsically a more insignificant thing, in the economy of +society, than money; except in the character of a contrivance for +sparing time and labor. It is a machine for doing quickly and +commodiously, what would be done, though less quickly and commodiously, +without it: and like many other kinds of machinery, it only exerts a +distinct and independent influence of its own when it gets out of order. + +The introduction of money does not interfere with the operation of any +of the Laws of Value.... The reasons which make the temporary or market +value of things depend on the demand and supply, and their average and +permanent values upon their cost of production, are as applicable to a +money system as to a system of barter. Things which by barter would +exchange for one another, will, if sold for money, sell for an equal +amount of it, and so will exchange for one another still, though the +process of exchanging them will consist of two operations instead of +only one. The relations of commodities to one another remain unaltered +by money: the only new relation introduced, is their relation to money +itself; how much or how little money they will exchange for; in other +words, how the Exchange Value of money itself is determined. And this is +not a question of any difficulty, when the illusion is dispelled, which +caused money to be looked upon as a peculiar thing, not governed by the +same laws as other things. Money is a commodity, and its value is +determined like that of other commodities, temporarily by demand and +supply, permanently and on the average by cost of production. + +In the foregoing,[2] attention has been directed mainly to the two +functions of money known (1) as the Standard or Common Denominator of +Value, and (2) as the Medium of Exchange. Concerning transactions begun +and ended on the spot nothing more need be said; but the fact of +contracts over a period of time introduces an important element--the +time element. Whenever a contract is made covering a period of time, +within which serious changes in the economic world may take place, then +difficulties may arise as to what is a just standard of payments. +Various articles might serve equally well as a standard for exchanges +performed on the spot, but it is not so when any one article is chosen +as a standard for deferred payments. Without much regard to theory, the +world has in fact used the same standard for transactions whether +settled on the spot, or whether extending over a period of time. + +In order to work with perfection as a standard for deferred payments, +the article chosen as that standard should place both debtors and +creditors in exactly the same absolute, and the same relative, position +to each other at the end of a contract that they occupied at its +beginning; this implies that the chosen article should maintain the same +exchange value in relation to goods, rents, and the wages of labour at +the end as at the beginning of the contract, and it implies that the +borrower and lender should preserve the same relative position as +regards their fellow producers and consumers at the later as at the +earlier point of time, and that they have not changed this relation, one +at the loss of the other. This makes demands which any article that can +be suggested as a standard cannot satisfy. And yet it is a practical +necessity of society that some one article should in fact be selected as +the standard. The business world has thus been forced to find some +commodity which--while admittedly never capable of perfection--provides +more nearly than anything else all the essentials of a desirable +standard. + +The causes which may bring about changes in the relations between goods +and labor, on the one side, and the standard, on the other, are +various. We may, for instance, compare wheat with the existing gold +standard. The quantity of gold for which the wheat will exchange is its +price. As wheat falls in value relatively to gold, it exchanges for less +gold, that is, its price falls; or, _vice versa_, gold exchanges for +more wheat, and relatively to wheat gold has risen. As one goes up, the +other term in the ratio necessarily goes down; just as certainly as a +rise in one end of a plank balanced on a log necessitates a fall in the +other end of the plank. Therefore, changes in prices can be caused by +forces affecting either the gold side or the wheat side of the ratio; by +forces affecting either the money standard or the goods compared with +that standard. Consequences of importance follow from this explanation. +First suppose that commodities and labor remain unchanged in their +production and reward, respectively; then, anything affecting the supply +of and demand for gold will affect in general the value of gold in +comparison with goods and labor. Or, second, if we suppose an +equilibrium between the demand for and supply of gold, then, prices and +wages can be affected also by anything affecting the cost of obtaining +goods or labor. It is one-sided to look for changes in prices solely +from causes touching gold, or one term of the price ratio. If, however, +it should be desired that prices should remain stationary, then this can +be brought about only by finding for the standard an article that would +automatically move in extent, and in the proper compensating direction, +so as to meet any changes in value arising not only from causes +affecting itself, but also from causes affecting labor and the vast +number of goods that may be quoted in price. No commodity ever existed +which could thus move in value. + +During long periods of time--within which gains in mechanical skill and +invention, revolutions in political and social habits, changes in taste +or fashion, settlement of new countries, opening of new markets, may +take place--great alterations in the value of the standard may occur +wholly from natural causes affecting the commodity side of the price +ratio. And yet, in default of a perfect standard, persons who borrow and +lend create debts and obligations expressed in terms of that article +which has been adopted as the standard by the concurring habits of the +commercial community of which they form a part. It should be understood, +whenever men enter into obligations reaching over a period of time, that +a necessary part of the risks involved in this undertaking is the +possibility of an alteration in the exchange values of goods, on the one +hand, and in the standard metal on the other, due to industrial changes +and natural causes. This is one of the risks which belong to individual +enterprise, differing in no way from other possibilities of gain and +loss. For instance, prices rose, as indicated by an index number of 100 +in 1860 to an index number of 216 in 1865. Therefore, in the United +States, in this period of rising prices the creditor lost and the debtor +gained. On the other hand, from 1865 to 1878, prices fell from 216 to +101, and in this period of falling prices the creditor gained and the +debtor lost. It is to be observed, however, that these figures refer to +actual quotations of prices during the fluctuations of our paper money. +But it is evident in such movements as these, that parties to a +time-contract must take their own chances of changes; and indeed it is +much more wholesome that they should do so. + +It should be kept well in mind that it is not a proper function of +government to step in and save men from the ordinary risks of trade and +industry. It goes without saying that if changes in the value of the +standard due to natural causes take place during the continuance of a +contract, it is not the business of government to indemnify either party +to the contract. This is a matter on which every individual who enters +into time obligations must bear his own responsibility. + +FOOTNOTES: + +[1] John Stuart Mill, _Principles of Political Economy_, Vol. II, pp. +17-23. + +[2] Adapted from _The Report of the Commission of the Indianapolis +Convention_, pp. 92, 93, 103, 104. The University of Chicago Press, +1898. + + + + +CHAPTER II + +THE EARLY HISTORY OF MONEY + +[3]Living in civilized communities, and accustomed to the use of coined +metallic money, we learn to identify money with gold and silver; hence +spring hurtful and insidious fallacies. It is always useful, therefore, +to be reminded of the truth, so well stated by Turgot, that every kind +of merchandise has the two properties of measuring value and +transferring value. It is entirely a question of degree what commodities +will in any given state of society form the most convenient currency, +and this truth will be best impressed upon us by a brief consideration +of the very numerous things which have at one time or other been +employed as money. Though there are many numismatists and many political +economists, the natural history of money is almost a virgin subject, +upon which I should like to dilate; but the narrow limits of my space +forbid me from attempting more than a brief sketch of the many +interesting facts which may be collected. + + +CURRENCY IN THE HUNTING STATE + +Perhaps the most rudimentary state of industry is that in which +subsistence is gained by hunting wild animals. The proceeds of the chase +would, in such a state, be the property of most generally recognized +value. The meat of the animals captured would, indeed, be too perishable +in nature to be hoarded or often exchanged; but it is otherwise with the +skins, which, being preserved and valued for clothing, became one of the +earliest materials of currency. Accordingly, there is abundant evidence +that furs or skins were employed as money in many ancient nations. They +serve this purpose to the present day in some parts of the world. + +In the book of Job (ii, 4) we read, "Skin for skin, yea, all that a man +hath will he give for his life"; a statement clearly implying that skins +were taken as the representative of value among the ancient Oriental +nations. Etymological research shows that the same may be said of the +northern nations from the earliest times. In the Esthonian language the +word _râha_ generally signifies money, but its equivalent in the kindred +Lappish tongue has not yet altogether lost the original meaning of skin +or fur. Leather money is said to have circulated in Russia as late as +the reign of Peter the Great, and it is worthy of notice, that classical +writers have recorded traditions to the effect that the earliest +currency used at Rome, Lacedæmon, and Carthage, was formed of leather. + +We need not go back, however, to such early times to study the use of +rude currencies. In the traffic of the Hudson's Bay Company with the +North American Indians, furs, in spite of their differences of quality +and size, long formed the medium of exchange. It is very instructive, +and corroborative of the previous evidence to find that even after the +use of coin had become common among the Indians the skin was still +commonly used as the money of account. Thus Whymper says, "a gun, +nominally worth about forty shillings, bought twenty 'skins.' This term +is the old one employed by the company. One skin (beaver) is supposed to +be worth two shillings, and it represents two marten, and so on. You +heard a great deal about 'skins' at Fort Yukon, as the workmen were also +charged for clothing, etc., in this way." + + +CURRENCY IN THE PASTORAL STATE + +In the next higher stage of civilization, the pastoral state, sheep and +cattle naturally form the most valuable and negotiable kind of property. +They are easily transferable, convey themselves about, and can be kept +for many years, so that they readily perform some of the functions of +money. + +We have abundance of evidence, traditional, written, and etymological, +to show this. In the Homeric poems oxen are distinctly and repeatedly +mentioned as the commodity in terms of which other objects are valued. +The arms of Diomed are stated to be worth nine oxen, and are compared +with those of Glaucos, worth one hundred. The tripod, the first prize +for wrestlers in the 23rd Iliad, was valued at twelve oxen, and a woman +captive, skilled in industry, at four. It is peculiarly interesting to +find oxen thus used as the common measure of value, because from other +passages it is probable, as already mentioned, that the precious metals, +though as yet uncoined, were used as a store of value, and occasionally +as a medium of exchange. The several functions of money were thus +clearly performed by different commodities at this early period. + +In several languages the name for money is identical with that of some +kind of cattle or domesticated animal. It is generally allowed that +_pecunia_, the Latin word for money, is derived from _pecus_, cattle. +From the Agamemnon of Æschylus we learn that the figure of an ox was the +sign first impressed upon coins, and the same is said to have been the +case with the earliest issues of the Roman _As_. Numismatic researches +fail to bear out these traditions, which were probably invented to +explain the connection between the name of the coin and the animal. A +corresponding connection between these notions may be detected in much +more modern languages. Our common expression for the payment of a sum of +money is _fee_, which is nothing but the Anglo-Saxon _feoh_, meaning +alike money and cattle, a word cognate with the German _vieh_, which +still bears only the original meaning of cattle. + +In the ancient German codes of law, fines and penalties are actually +defined in terms of live-stock. In the Zend Avesta, as Professor +Theodores ... informs me, the scale of rewards to be paid to physicians +is carefully stated, and in every case the fee consists in some sort of +cattle. The fifth and sixth lectures in Sir H. S. Maine's most +interesting work on _The Early History of Institutions_, which has just +been published, are full of curious information showing the importance +of live-stock in a primitive state of society. Being counted by the +head, the kine was called capitale, whence the economical term capital, +the law term chattel, and our common name cattle. + +In countries where slaves form one of the most common and valuable +possessions, it is quite natural that they should serve as the medium +of exchange like cattle. Pausanias mentions their use in this way, and +in Central Africa and some other places where slavery still flourishes, +they are the medium of exchange along with cattle and ivory tusks. +According to Earl's account of New Guinea, there is in that island a +large traffic in slaves, and a slave forms the unit of value. Even in +England slaves are believed to have been exchanged at one time in the +manner of money. + + +ARTICLES OF ORNAMENT AS CURRENCY + +A passion for personal adornment is one of the most primitive and +powerful instincts of the human race, and as articles used for such +purposes would be durable, universally esteemed, and easily +transferable, it is natural that they should be circulated as money. The +_wampumpeag_ of the North American Indians is a case in point, as it +certainly served as jewellery. It consisted of beads made of the ends of +black and white shells, rubbed down and polished, and then strung into +belts or necklaces, which were valued according to their length, and +also according to their color and luster, a foot of black _peag_ being +worth two feet of white _peag_. It was so well established as currency +among the natives that the Court of Massachusetts ordered in 1649, that +it should be received in the payment of debts among settlers to the +amount of forty shillings. It is curious to learn, too, that just as +European misers hoard up gold and silver coins, the richer Indian chiefs +secrete piles of wampum beads, having no better means of investing their +superfluous wealth. + +Exactly analogous to this North American currency, is that of the cowry +shells, which, under one name or another--_chamgos_, _zimbis_, _bouges_, +_porcelanes_, etc.--have long been used in the East Indies as small +money. In British India, Siam, the West Coast of Africa, and elsewhere +on the tropical coasts, they are still used as small change, being +collected on the shores of the Maldive and Laccadive Islands, and +exported for the purpose. Their value varies somewhat, according to the +abundance of the yield, but in India the current rate used to be about +five thousand shells for one rupee, at which rate each shell is worth +about the two-hundredth part of a penny. Among our interesting +fellow-subjects, the Fijians, whale's teeth served in the place of +cowries, and white teeth were exchanged for red teeth somewhat in the +ratio of shillings to sovereigns. + +Among other articles of ornament or of special value used as currency, +may be mentioned yellow amber, engraved stones, such as the Egyptian +scarabæi, and tusks of ivory. + + +CURRENCY IN THE AGRICULTURAL STATE + +Many vegetable productions are at least as well suited for circulation +as some of the articles which have been mentioned. It is not surprising +to find, then, that among a people supporting themselves by agriculture, +the more durable products were thus used. Corn has been the medium of +exchange in remote parts of Europe from the time of the ancient Greeks +to the present day. In Norway corn is even deposited in banks, and lent +and borrowed. What wheat, barley, and oats are to Europe, such is maize +in parts of Central America, especially Mexico, where it formerly +circulated. In many of the countries surrounding the Mediterranean, +olive oil is one of the commonest articles of produce and consumption; +being, moreover, pretty uniform in quality, durable, and easily +divisible, it has long served as currency in the Ionian Islands, +Mytilene, some towns of Asia Minor, and elsewhere in the Levant. + +Just as cowries circulate in the East Indies, so cacao nuts, in Central +America and Yucatan, form a perfectly recognized and probably an ancient +fractional money. Travellers have published many distinct statements as +to their value, but it is impossible to reconcile these statements +without supposing great changes of value either in the nuts or in the +coins with which they are compared. In 1521, at Caracas, about thirty +cacao nuts were worth one penny English, whereas recently ten beans +would go to a penny, according to Squier's statements. In the European +countries, where almonds are commonly grown, they have circulated to +some extent like the cacao nuts, but are variable in value, according to +the success of the harvest. + +It is not only, however, as a minor currency that vegetable products +have been used in modern times. In the American settlements and the West +India Islands, in former days, specie used to become inconveniently +scarce, and the legislators fell back upon the device of obliging +creditors to receive payment in produce at stated rates. In 1618, the +Governor of the Plantations of Virginia ordered that tobacco should be +received at the rate of three shillings for the pound weight, under the +penalty of three years' hard labor. We are told that, when the Virginia +Company imported young women as wives for the settlers, the price per +head was one hundred pounds of tobacco, subsequently raised to one +hundred and fifty. As late as 1732, the legislature of Maryland made +tobacco and Indian corn legal tenders; and in 1641 there were similar +laws concerning corn in Massachusetts. The governments of some of the +West India Islands seem to have made attempts to imitate these peculiar +currency laws, and it was provided that the successful plaintiff in a +lawsuit should be obliged to accept various kinds of raw produce, such +as sugar, rum, molasses, ginger, indigo, or tobacco.... + +The perishable nature of most kinds of animal food prevents them from +being much used as money; but eggs are said to have circulated in the +Alpine villages of Switzerland, and dried codfish have certainly acted +as currency in the colony of Newfoundland. + + +MANUFACTURED AND MISCELLANEOUS ARTICLES AS CURRENCY + +The enumeration of articles which have served as money may already seem +long enough for the purposes in view. I will, therefore, only add +briefly that a great number of manufactured commodities have been used +as a medium of exchange in various times and places. Such are the pieces +of cotton cloth, called _Guinea pieces_, used for traffic upon the banks +of the Senegal, or the somewhat similar pieces circulated in Abyssinia, +the Soulou Archipelago, Sumatra, Mexico, Peru, Siberia, and among the +Veddahs. It is less easy to understand the origin of the curious straw +money which circulated until 1694 in the Portuguese possessions in +Angola, and which consisted of small mats, called _libongos_, woven out +of rice straw, and worth about 1-1/2_d._ each. These mats must have had, +at least originally, some purpose apart from their use as currency, and +were perhaps analogous to the fine woven mats so much valued by the +Samoans, and also treated by them as a medium of exchange. + +Salt has been circulated not only in Abyssinia, but in Sumatra, Mexico, +and elsewhere. Cubes of benzoin gum or beeswax in Sumatra, red feathers +in the Islands of the Pacific Ocean, cubes of tea in Tartary, iron +shovels or hoes among the Malagasy, are other peculiar forms of +currency. The remarks of Adam Smith concerning the use of hand-made +nails as money in some Scotch villages will be remembered by many +readers, and need not be repeated. M. Chevalier has adduced an exactly +corresponding case from one of the French coalfields. + +Were space available it would be interesting to discuss the not +improbable suggestion of Boucher de Perthes, that, perhaps, after all, +the finely worked stone implements now so frequently discovered were +among the earliest mediums of exchange. Some of them are certainly made +of jade, nephrite, or other hard stones, only found in distant +countries, so that an active traffic in such implements must have +existed in times of which we have no records whatever. + +There are some obscure allusions in classical authors to a wooden money +circulating among the Byzantines, and to a wooden talent used at Antioch +and Alexandria, but in the absence of fuller information as to their +nature, it is impossible to do more than mention them.... + + +THE INVENTION OF COINING + +The date of the invention of coining can be assigned with some degree of +probability. Coined money was clearly unknown in the Homeric times, and +it was known in the time of Lycurgus. We might therefore assume, with +various authorities, that it was invented in the mean time, or about 900 +B. C. There is tradition, moreover, that Pheidon, King of Argos, first +struck silver money in the island of Ægina about 895 B. C., and the +tradition is supported by the existence of small stamped ingots of +silver, which have been found in Ægina. Later inquiries, however, lead +to the conclusion that Pheidon lived in the middle of the eighth century + B. C., and Grote has shown good reasons for believing that what he did +accomplish was done in Argos, and not in Ægina. + +The mode in which the invention happened is sufficiently evident. Seals +were familiarly employed in very early times, as we learn from the +Egyptian paintings or the stamped bricks of Nineveh. Being employed to +signify possession, or to ratify contracts, they came to indicate +authority. When a ruler first undertook to certify the weights of pieces +of metal, he naturally employed his seal to make the fact known, just +as, at Goldsmiths' Hall, a small punch is used to certify the fineness +of plate. In the earliest forms of coinage there were no attempts at so +fashioning the metal that its weight could not be altered without +destroying the stamp or design. The earliest coins struck, both in Lydia +and in the Peloponnesus, were stamped on one side only.... + +FOOTNOTES: + +[3] W. Stanley Jevons, _Money and the Mechanism of Exchange_, D. +Appleton and Company, New York, 1902, pp. 19-28, 54, 55. + + + + +CHAPTER III + +QUALITIES OF THE MATERIAL OF MONEY + +[4]Many recent writers, such as Huskisson, MacCulloch, James Mill, +Garnier, Chevalier, and Walras, have satisfactorily described the +qualities which should be possessed by the material of money. Earlier +writers seem, however, to have understood the subject almost as well.... +Of all writers, M. Chevalier ... probably gives the most accurate and +full account of the properties which money should possess, and I shall +in many points follow his views. + +The prevailing defect in the treatment of the subject is the failure to +observe that money requires different properties as regards different +functions. To decide upon the best material for money is thus a problem +of great complexity, because we must take into account at once the +relative importance of the several functions of money, the degree in +which money is employed for each function, and the importance of each of +the physical qualities of the substance with respect to each function. +In a simple state of industry money is chiefly required to pass about +between buyers and sellers. It should, then, be conveniently portable, +divisible into pieces of various size, so that any sum may readily be +made up, and easily distinguishable by its appearance, or by the design +impressed upon it. When money, however, comes to serve, as it will at +some future time, almost exclusively as a measure and standard of value, +the system of exchange, being one of perfected barter, such properties +become a matter of comparative indifference, and stability of value, +joined perhaps to portability, is the most important quality. Before +venturing, however, to discuss such complex questions, we must proceed +to a preliminary discussion of the properties in question, which may +thus perhaps be enumerated in the order of their importance: + + 1. Utility and value. + 2. Portability. + 3. Indestructibility. + 4. Homogeneity. + 5. Divisibility. + 6. Stability of value. + 7. Cognisability. + + +1. UTILITY AND VALUE + +Since money has to be exchanged for valuable goods, it should itself +possess value and it must therefore have utility as the basis of value. +Money, when once in full currency, is only received in order to be +passed on, so that if all people could be induced to take worthless bits +of material at a fixed rate of valuation, it might seem that money does +not really require to have substantial value. Something like this does +frequently happen in the history of currencies, and apparently valueless +shells, bits of leather, or scraps of paper are actually received in +exchange for costly commodities. This strange phenomenon is, however, in +most cases capable of easy explanation, and if we were acquainted with +the history of every kind of money the like explanation would no doubt +be possible in other cases. The essential point is that people should be +induced to receive money, and pass it on freely at steady ratios of +exchange for other objects; but there must always be some sufficient +reason first inducing people to accept the money. The force of habit, +convention, or legal enactment may do much to maintain money in +circulation when once it is afloat, but it is doubtful whether the most +powerful government could oblige its subjects to accept and circulate as +money a worthless substance which they had no other motive for +receiving. + +Certainly, in the early stages of society, the use of money was not +based on legal regulations, so that the utility of the substance for +other purposes must have been the prior condition of its employment as +money. Thus the singular _peag_ currency, or _wampumpeag_, which was +found in circulation among the North American Indians by the early +explorers, was esteemed for the purpose of adornment, as already +mentioned.... The cowry shells, so widely used as a small currency in +the East, are valued for ornamental purposes on the West Coast of +Africa, and were in all probability employed as ornaments before they +were employed as money. All the other articles [previously] mentioned +... such as oxen, corn, skins, tobacco, salt, cacao nuts, tea, olive +oil, etc., which have performed the functions of money in one place or +another, possessed independent utility and value. If there are any +apparent exceptions at all to this rule, they would doubtless admit of +explanation by fuller knowledge. We may, therefore, agree with Storch +when he says: "It is impossible that a substance which has no direct +value should be introduced as money, however suitable it may be in other +respects for this use." + +When once a substance is widely employed as money, it is conceivable +that its utility will come to depend mainly upon the services which it +thus confers upon the community. Gold, for instance, is far more +important as the material of money than in the production of plate, +jewellery, watches, gold-leaf, etc. A substance originally used for many +purposes may eventually serve only as money, and yet, by the demand for +currency and the force of habit, may maintain its value. The cowry +circulation of the Indian coasts is probably a case in point. The +importance of habit, personal or hereditary, is at least as great in +monetary science as it is, according to Mr. Herbert Spencer, in morals +and sociological phenomena generally. + +There is, however, no reason to suppose that the value of gold and +silver is at present due solely to their conventional use as money. +These metals are endowed with such singularly useful properties that, if +we could only get them in sufficient abundance, they would supplant all +the other metals in the manufacture of household utensils, ornaments, +fittings of all kinds, and an infinite multitude of small articles, +which are now made of brass, copper, bronze, pewter, German silver, or +other inferior metals and alloys. + +In order that money may perform some of its functions efficiently, +especially those of a medium of exchange and a store of value, to be +carried about, it is important that it should be made of a substance +valued highly in all parts of the world, and, if possible, almost +equally esteemed by all peoples. There is reason to think that gold and +silver have been admired and valued by all tribes which have been lucky +enough to procure them. The beautiful lustre of these metals must have +drawn attention and excited admiration as much in the earliest as in the +present times. + + +2. PORTABILITY + +The material of money must not only be valuable, but the value must be +so related to the weight and bulk of the material, that the money shall +not be inconveniently heavy on the one hand, nor inconveniently minute +on the other. There was a tradition in Greece that Lycurgus obliged the +Lacedæmonians to use iron money, in order that its weight might deter +them from overmuch trading. However this may be, it is certain that iron +money could not be used in cash payments at the present day, since a +penny would weigh about a pound, and instead of a five-pound note, we +should have to deliver a ton of iron. During the last century copper was +actually used as the chief medium of exchange in Sweden; and merchants +had to take a wheelbarrow with them when they went to receive payments +in copper _dalers_. Many of the substances used as currency in former +times must have been sadly wanting in portability. Oxen and sheep, +indeed, would transport themselves on their own legs; but corn, skins, +oil, nuts, almonds, etc., though in several respects forming fair +currency, would be intolerably bulky and troublesome to transfer. + +The portability of money is an important quality not merely because it +enables the owner to carry small sums in the pocket without trouble, but +because large sums can be transferred from place to place, or from +continent to continent, at little cost. The result is to secure an +approximate uniformity in the value of money in all parts of the world. +A substance which is very heavy and bulky in proportion to value, like +corn or coal, may be very scarce in one place and over-abundant in +another; yet the supply and demand cannot be equalised without great +expense in carriage. The cost of conveying gold or silver from London to +Paris, including insurance, is only about four-tenths of one per cent.; +and between the most distant parts of the world it does not exceed from +2 to 3 per cent. + +Substances may be too valuable as well as too cheap, so that for +ordinary transactions it would be necessary to call in the aid of the +microscope and the chemical balance. Diamonds, apart from other +objections, would be far too valuable for small transactions. The value +of such stones is said to vary as the square of the weight, so that we +cannot institute any exact comparison with metals of which the value is +simply proportional to the weight. But taking a one-carat diamond (four +grains) as worth £15, we find it is, weight for weight, 460 times as +valuable as gold. There are several rare metals, such as iridium and +osmium, which would likewise be far too valuable to circulate. Even gold +and silver are too costly for small currency. A silver penny now weighs +7-1/4 grains, and a gold penny would weigh only half a grain. The pretty +octagonal quarter-dollar tokens circulated in California are the +smallest gold coins I have seen, weighing less than four grains each, +and are so thin that they can almost be blown away. + + +3. INDESTRUCTIBILITY + +If it is to be passed about in trade, and kept in reserve, money must +not be subject to easy deterioration or loss. It must not evaporate like +alcohol, nor putrefy like animal substances, nor decay like wood, nor +rust like iron. Destructible articles, such as eggs, dried codfish, +cattle, or oil, have certainly been used as currency; but what is +treated as money one day must soon afterwards be eaten up. Thus a large +stock of such perishable commodities cannot be kept on hand, and their +value must be very variable. The several kinds of corn are less subject +to this objection, since, when well dried at first, they suffer no +appreciable deterioration for several years. + + +4. HOMOGENEITY + +All portions of specimens of the substance used as money should be +homogeneous, that is, of the same quality, so that equal weights will +have exactly the same value. In order that we may correctly count in +terms of any unit, the units must be equal and similar, so that twice +two will always make four. If we were to count in precious stones, it +would seldom happen that four stones would be just twice as valuable as +two stones. Even the precious metals, as found in the native state, are +not perfectly homogeneous, being mixed together in almost all +proportions; but this produces little inconvenience, because the assayer +readily determines the quantity of each pure metal present in any ingot. +In the processes of refining and coining, the metals are afterwards +reduced to almost exactly uniform degrees of fineness, so that equal +weights are then of exactly equal value. + + +5. DIVISIBILITY + +Closely connected with the last property is that of divisibility. Every +material is, indeed, mechanically divisible, almost without limit. The +hardest gems can be broken, and steel can be cut by harder steel. But +the material of money should be not merely capable of division, but the +aggregate value of the mass after division should be almost exactly the +same as before division. If we cut up a skin or fur the pieces will, as +a general rule, be far less valuable than the whole skin or fur, except +for a special intended purpose; and the same is the case with timber, +stone, and most other materials in which reunion is impossible. But +portions of metal can be melted together again whenever it is desirable, +and the cost of doing this, including the metal lost, is in the case of +precious metals very inconsiderable, varying from 1/4_d._ to 1/2_d._ per +ounce. Thus, approximately speaking, the value of any piece of gold or +silver is simply proportional to the weight of fine metal which it +contains. + + +6. STABILITY OF VALUE + +It is evidently desirable that the currency should not be subject to +fluctuations of value. The ratios in which money exchanges for other +commodities should be maintained as nearly as possible invariable on the +average. This would be a matter of comparatively minor importance were +money used only as a measure of values at any one moment, and as a +medium of exchange. If all prices were altered in like proportion as +soon as money varied in value, no one would lose or gain, except as +regards the coin which he happened to have in his pocket, safe, or bank +balance. But, practically speaking, as we have seen, people do employ +money as a standard of value for long contracts, and they often maintain +payments at the same variable rate, by custom or law, even when the real +value of the payment is much altered. Hence every change in the value of +money does some injury to society. + +It might be plausibly said, indeed, that the debtor gains as much as the +creditor loses, or vice versa, so that on the whole the community is as +rich as before; but this is not really true. A mathematical analysis of +the subject shows that to take any sum of money from one and give it to +another will, on the average of cases, injure the loser more than it +benefits the receiver. A person with an income of one hundred pounds a +year would suffer more by losing ten pounds than he would gain by an +addition of ten pounds, because the degree of utility of money to him is +considerably higher at ninety pounds than it is at one hundred and ten. +On the same principle, all gaming, betting, pure speculation, or other +accidental modes of transferring property involve, on the average, a +dead loss of utility. The whole incitement to industry and commerce and +the accumulation of capital depends upon the expectation of enjoyment +thence arising, and every variation of the currency tends in some degree +to frustrate such expectation and to lessen the motives for exertion. + + +7. COGNISABILITY + +By this name we may denote the capability of a substance for being +easily recognised and distinguished from all other substances. As a +medium of exchange, money has to be continually handed about, and it +will occasion great trouble if every person receiving currency has to +scrutinize, weigh, and test it. If it requires any skill to discriminate +good money from bad, poor ignorant people are sure to be imposed upon. +Hence the medium of exchange should have certain distinct marks which +nobody can mistake. Precious stones, even if in other respects good as +money, could not be so used, because only a skilled lapidary can surely +distinguish between true and imitation gems. + +Under cognisability we may properly include what has been aptly called +_impressibility_, namely, the capability of a substance to receive such +an impression, seal, or design, as shall establish its character as +current money of certain value. We might more simply say, that the +material of money should be coinable, so that a portion, being once +issued according to proper regulations with the impress of the state, +may be known to all as good and legal currency, equal in weight, size, +and value to all similarly marked currency.... + +FOOTNOTES: + +[4] W. Stanley Jevons, _Money and the Mechanism of Exchange_, pp. 29-39. +D. Appleton & Company, New York, 1902. + + + + +CHAPTER IV + +LEGAL TENDER[5] + + +The essential idea of "legal tender" is that quality given to money by +law which obliges the creditor to receive it in full satisfaction of a +past debt when expressed in general terms of the money of a country. A +debt is a sum of money due by contract, express or implied. When our +laws, for instance, declare that United States notes are legal +tender--and this is the only complete designation of a legal-tender +money--for "all debts public and private," it must be understood that +this provision does not cover any operations not arising from contract. +Current buying and selling do not make a situation calling for legal +tender; a purchaser cannot compel the delivery of goods over a counter +by offering legal-tender money for them, because, as yet, no debt has +been created.[6] + +Contracts made in general terms of the money units of the country must +necessarily often be interpreted by the courts. The existence of +contracts calling for a given sum of dollars and the necessity of +adjudicating and enforcing such contracts, require that there should be +an accurate legal interpretation of what a dollar is. As every one +knows, the name, or unit of account, is affixed to a given number of +grains of a specified fineness of a certain metal. This being the +standard, and this having been chosen by the concurring habits of the +business world, it is fit that the law should designate that, when only +dollars are mentioned in a contract, it should be satisfied only by the +payment of that which is the standard money of the community. + +Since prices and contracts are expressed in terms of the standard +article, it is clear that the legal-tender quality should not be equally +affixed to different articles having different values, but called by the +same name. This method would be sure to bring confusion, uncertainty, +and injustice into trade and industry. No one who had made a contract +would know in what he was to be paid. The legal-tender quality, then, +should be confined to that which is the sole standard. And it is also +obvious that when a standard is satisfactorily determined upon, and when +various effective media of exchange, like bank notes, checks, or bills +of exchange, have sprung up, the legal-tender quality should not be +given to these instruments of convenience. They are themselves expressed +in, and are resolvable into, the standard metal; so the power to satisfy +debts should be given not to the shadow, but to the substance, not to +the devices drawn in terms of the standard, but only to the standard +itself, even though, as a matter of fact, nine-tenths of the debts and +contracts are actually settled by means of these devices. So long as +these instruments are convertible into, and thus made fully equal to, +the standard in terms of which they are drawn, they will be used by the +business community for the settlement of debts without being made a +legal tender. And whenever they are worth less than the standard they +certainly should not be made a legal tender, because of the injustice +which in such a case they would work. + +Having shown that the legal-tender quality is only a necessary legal +complement of the choice of a standard, it will not be difficult to see +that the state properly chooses an article fit to have the legal-tender +attribute for exactly the reasons that governed the selection of the +same article as a standard. The whole history of money shows that the +standard article was the one which had utility to the community using +it. As the evolution of the money commodity went on from cattle to +silver and gold, so the legal-tender provisions naturally followed this +course. + +A state may select a valueless commodity as a standard, but that will +not make it of value to those who would already give nothing for it; and +so, it may give the legal-tender quality to a thing which has become +valueless, but that will not of itself insure the maintenance of its +former value. This proposition may, at first, appear to be opposed to a +widely-spread belief; but its soundness can be fully supported. It +should be learned that a commodity, or a standard, holds its value for +reasons quite independent of the fact that it is given legal +recognition. It has happened that legal recognition has been given to it +because it possessed qualities that gave it value to the commercial +world, and not that it came to have these qualities and this value +because it was made a legal tender. + +A good illustration of this truth is to be found in international trade. +Money which is not dependent on artificial influences for its value, and +which is not redeemable in something else, is good the world over at its +actual commercial value, not at its value as fixed by any legal-tender +laws. It is not the legal-tender stamp that gives a coin its value in +international payments. A sovereign, an eagle, a napoleon, is constantly +given and received in international trade not because of the stamp it +bears, but because of the number of grains of a given fineness of gold +which it contains--the value of which is determined in the markets of +the world. And an enormous trade among the great commercial countries +goes on easily and effectively without regard to the legal-tender laws +of the particular country whose coins are used. + +By imposing the attribute of legal tender, however, upon a given metal +or money, it may be believed that thereby a new demand is created for +that metal, and that its value is thus controlled. And in theory there +is some basis for this belief. It is, of course, true that, in so far as +giving to money a legal-tender power creates a new demand for it (which +without that power would not have existed) an effect upon its value can +be produced. But this effect is undoubtedly much less than is usually +supposed. It must be remembered that the value of gold, for instance, is +affected by world influences; that its value is determined by the demand +of the whole world as compared with the whole existing supply in the +world. In order to affect the value of gold in any one country, a demand +created by a legal-tender enactment must be sufficient to affect the +world-value of gold. Evidently the effect will be only in the proportion +that the new demand bears to the whole stock in the world. It is like +the addition of a barrel of water to a pond; theoretically the surface +level is raised, but not to any appreciable extent. + +It may now be permissible to examine into the extent to which a demand +is created by legal-tender laws. If the article endowed with a +legal-tender power is already used as the standard and as a medium of +exchange, it is given no value which it did not have before. The customs +and business habits of a country alone determine how much of the +standard coin will be carried about and used in hand-to-hand purchases, +and how much of the business will be performed by other media of +exchange, such as checks or drafts. The decision of a country to adopt +gold--when it had only paper before, as was the case in Italy--would +create a demand for gold to an extent determined by the monetary habits +of that country; and this demand has an effect, as was said, only in the +proportion of this amount to the total supply in the world. This +operation arises from choosing gold as the standard of prices and as the +medium of exchange. To give this standard a legal-tender power in +addition does not increase the demand for it, because the stamp on the +coin does not in any way alter the existing habits of the community as +to the quantity of money it will use. + +But in case an equal power to pay debts is given to fixed quantities of +two metals, while each quantity so fixed has a different metallic value +but the same denomination in the coinage, Gresham's law is set in +operation with the result that the cheaper metal becomes the standard. +After this change has been accomplished, the legal tender has no +value-giving force. When the cheaper metal has become the standard, its +legal-tender quality does not raise the value of the coin beyond the +value of its content. This cheaper standard, in international trade, +would be worth no more in the purchase of goods because it bore the +stamp of any one country. Prices must necessarily be adjusted between +the relative values of goods and the standard with which they are +compared. If the standard is cheaper, prices will be higher, +irrespective of legal-tender acts. Where two metals are concerned, then, +the only effect of a legal-tender clause is an injurious one, in that +the metal which is overvalued drives out that which is under-valued. + +The example of an inconvertible paper, such as our United States notes +(greenbacks) in 1862-1879, is still more conclusive. Although a full +legal tender for all debts public and private, their value steadily sank +until they were at one time worth only 35 cents in gold. In California, +moreover, these notes, although legal-tender, were even kept out of +circulation by public opinion. In short, the value of inconvertible +paper can be but little affected by legal-tender powers. Its value is +more directly governed, as in the case of token coins, by the +probabilities of redemption.[7] As bearing on the point that the value +of the paper was more influenced by the chances of redemption than by +legal-tender laws, we may cite the sudden fluctuations in the value of +our United States notes during the Civil War. With no change in the +legal-tender quality and no change in the indebtedness which might be +paid with such notes, their value frequently rose or fell many per cent. +in a single day owing to reports of Federal successes or defeats in +battle, which had a tendency to affect one way or the other the public +estimate of the probabilities of an early resumption of specie payments. +The fact that they were legal tender evidently had no effect whatever in +maintaining their value. + +In view of the evident fact that legal-tender acts do not preserve the +value of money, it is clear that the demand created by such legislation +must be insignificant. And this must be so in principle as well as in +fact. + +There is but one thing which the legal-tender quality enables money to +do which it could not equally well do without being a legal tender; that +is, to pay past debts. An examination, however, shows that this use of +money is very small compared with its other uses. The amount of past +debts coming due and which might be paid in any year, month or day is +insignificant when compared with the total transactions of that year, +month or day--so very small as to lose all measurable value-giving +power. In other words, the one thing which legal-tender money can surely +do in spite of the habits, wishes or prejudices of the business +community in which it exists, namely, cancel past debt, is +infinitesimally small when compared with those other things which man +wishes money to do for him. It is for this reason that it ceases to give +value, and this is why history has shown so many instances where money +endowed with legal-tender power has become utterly valueless. The +legal-tender money is no longer money if it will not secure for man the +things which are most important for his welfare, if it will not buy +food, clothes and shelter; for it performs none of the functions of +money except the subsidiary one of cancelling past debts. + +Moreover, the obligatory uses of legal-tender money are in fact very +inconsiderable. A law requiring a past debt to be satisfied with money +of a certain kind has for its essence only the payment of something of a +definite value, or its equivalent; in practice, it does not even bring +about the actual use of a legal money, since the monetary habits of the +community will not necessarily require the debt to be paid in such +money. Take the extreme case of a judgment by a court against a +defendant for fulfilment of a contract; in such an example, of all +others, it would be supposed that legal money would be exacted. But even +here, the judgment would most probably be satisfied by the attorney's +check, or at most by a certified check. If such media of exchange are of +common usage in the community they will be resorted to in practice even +for legal-tender payments. + +The necessity of paying that which would be mutually satisfactory to +payer and payee also makes clear why the existence of a legal-tender +money does not necessarily cause its actual use in payments. The +business habits of the community are stronger than legislative powers. +Business men will not as a rule take advantage of a legal-tender act to +pay debts in a cheaper money, if they look forward to remaining in +business. For, if, by taking advantage of legal devices they defraud the +creditor, they cannot expect credit again from the same source; and +since loans are a necessity of legitimate modern trade, such action +would ruin their credit and cut them off from business activity in the +future. Gold was not driven out of circulation by paper money during the +years 1862-1879 in California, because the sentiment of the business +public was against the use of our depreciated greenback currency; and a +discrimination was made against merchants who resorted to the use of +paper. + +Explanation has been given of the principles according to which +legal-tender laws should be applied, if at all. It is not wholly clear +that there is any reason for their existence. It may now be well to +indicate briefly the origin of legal-tender provisions. It can scarcely +be doubted that their use arose from the desire of defaulting monarchs +to ease their indebtedness by forcing upon creditors a debased coinage. +Having possession of the mints, the right of coinage vesting in the +lord, the rulers of previous centuries have covered the pages of history +with the records of successive debasements of the money of account. The +legal-tender enactment was the instrument by which the full payment of +debts was evaded. There would have been no reason for debasing coins, if +they could not be forced upon unwilling creditors. It is, therefore, +strange indeed that, in imitation of monarchical morals of a past day, +republican countries should have thought it a wise policy to clothe +depreciated money with a nominal value for paying debts. Although the +people are now sovereign, they should not embrace the vices of mediæval +sovereignty for their own dishonest gain in scaling debts. + +FOOTNOTES: + +[5] _Report of the Monetary Commission of the Indianapolis Convention_, +pp. 131-7. The Hollenbeck Press, Indianapolis, 1900. + +[6] "A contract payable in money generally is, undoubtedly, payable in +any kind of money made by law legal tender, at the option of the debtor +at the time of payment. He contracts simply to pay so much money, and +creates a debt pure and simple; and by paying what the law says is money +his contract is performed. But, if he agrees to pay in gold coin, it is +not an agreement to pay money simply, but to pay or deliver a specific +kind of money and nothing else; and the payment in any other is not a +fulfilment of the contract according to its terms or the intention of +the parties." 25 California 564, Carpenter _vs._ Atherton. + +[7] For a contrary view, see Joseph French Johnson, _Money and +Currency_, Chapter 13.--EDITOR. + + + + +CHAPTER V + +THE GREENBACKS + + +THE GREENBACK ISSUES + +[8]The greenbacks were an outgrowth of the Civil War. Soon after the +opening of the struggle the Secretary of the Treasury negotiated a loan +of $150,000,000 with Eastern banks. Partly because of Confederate +successes and partly because of the failure of Secretary Chase to adopt +a firm policy of loans supported by taxation, public credit greatly +declined, and Government bonds became almost unsaleable. The outlook +became alarming and depositors withdrew gold from the New York banks in +such large amounts that specie payments were suspended, December 30, +1861. In February, 1862, Congress provided for the issue of $150,000,000 +in United States notes or greenbacks. Bond sales proceeded slowly and a +second issue of $150,000,000 of notes was authorised in July of the same +year. As a result of "military necessity" a third issue of $100,000,000 +was authorised January 17, 1863, and temporarily increased March 3 to +$150,000,000. Provision was made for the reissue of the greenbacks and +$400,000,000 were outstanding at the close of the war. + + +THE FLUCTUATING PREMIUM ON GOLD + +Depreciation of the greenbacks occurred at once and the value of gold as +expressed in greenbacks was subject to almost constant change. During +the year 1862 the premium varied from 2 to 32; in 1863 from 25 to 60; +and in 1864 from 55 to 185. Among the most important political and +economic factors which caused these fluctuations may be mentioned: + +(1) The increase in the amount of the greenbacks. Each new issue was +reflected in a rise in the premium. + +(2) The condition of the treasury. The annual reports of the Secretary +of the Treasury were anxiously awaited and their appearance caused a +rise or fall of the premium according as the condition of the finances +seemed gloomy or hopeful. + +(3) Ability of the Government to borrow. The fate of a loan indicated +public confidence or distrust. + +(4) Changes in the officials of the treasury department. Secretary +Chase's resignation, July 1, 1864, depressed the currency decidedly. + +(5) War news. Every victory raised the price of currency and every +defeat depressed it. + +From 1862 to 1865 the premium on gold and the median of relative prices +correspond so well that one cannot resist the conclusion that these +changes were mainly due to a common cause, which can hardly be other +than the varying esteem in which the notes of the Government that +constituted the standard money of the country were held. If this +conclusion be accepted, it follows that the suspension of specie +payments and the legal-tender acts must be held almost entirely +responsible for all the far-reaching economic disturbances following +from the price upheaval which it is our task now to trace in detail. + + +THE EFFECTS OF GREENBACKS UPON WAGES + +Statistical evidence supports unequivocally the common theory that +persons whose incomes are derived from wages suffer seriously from a +depreciation of the currency. The confirmation seems particularly +striking when the conditions other than monetary affecting the labour +market are taken into consideration. American workingmen are intelligent +and keenly alive to their interests. There are probably few districts +where custom plays a smaller and competition a larger rôle in +determining wages than in the Northern States. While labor organisations +had not yet attained their present power, manual laborers did not fail +to avail themselves of the help of concerted action in the attempt to +secure more pay. Strikes were frequent. All these facts favored a speedy +readjustment of money wages to correspond with changed prices. But more +than all else, a very considerable part of the labor supply was +withdrawn from the market into the army and navy. In 1864 and 1865 about +one million of men seem to have been enrolled. About one-seventh of the +labor supply withdrew from the market. But despite all these favoring +circumstances, the men who stayed at home did not succeed in obtaining +an advance in pay at all commensurate with the increase in living +expenses. Women on the whole succeeded less well than men in the +struggle to readjust money wages to the increased cost of living. + +It is sometimes argued that the withdrawal of laborers from industrial +life was the chief cause of the price disturbances of the war period. +This withdrawal, it is said, caused the advance of wages, and greater +cost of labor led to the rise of prices. The baselessness of this view +is shown by two well established facts--first, that the advance of wages +was later than the advance of prices, and second, that wages continued +to rise in 1866 after the volunteer armies had been disbanded and the +men gone back to work. + +Wage-earners, however, seem to have been more fully employed during the +war than in common times of prosperity. Of course, the enlistment of so +many thousands of the most efficient workers made places for many who +might otherwise have found it difficult to secure work. Moreover, the +paper currency itself tended to obtain full employment for the laborer, +for the very reason that it diminished his real income. In the +distribution of what Marshall has termed the "national dividend" a +diminution of the proportion received by the laborer must have been +accompanied by an increase in the share of some one else. Nor is it +difficult to determine who this person was. The beneficiary was the +active employer, who found that the money wages, interest, and rent he +had to pay increased less rapidly than the money prices of his products. +The difference between the increase of receipts and the increase of +expenses swelled his profits. Of course, the possibility of making high +profits provided an incentive for employing as many hands as possible. + +After an examination of the change in the condition of the great mass of +wage-earners, it may seem surprising that few complaints were heard +from them of unusual privations. This silence may be due in part to the +fact that a considerable increase of money income produces in the minds +of many a fatuous feeling of prosperity, even though it be more than +offset by an increase of prices. But doubtless the chief reason is to be +found in the absorption of public interest in the events of the war. The +people both of the South and North were so vitally concerned with the +struggle that they bore without murmuring the hardships it entailed of +whatever kind. Government taxation that under other circumstances might +have been felt to be intolerable was submitted to with cheerfulness. The +paper currency imposed upon wage-earners a heavier tax--amounting to +confiscation of perhaps a fifth or a sixth of real incomes. But the +workingmen of the North were receiving considerably more than a bare +subsistence minimum before the war, and reduction of consumption was +possible without producing serious want. Accordingly the currency tax, +like the tariff and the internal revenue duties, was accepted as a +necessary sacrifice to the common cause and paid without protest by +severe retrenchment. + + +RENT + + +URBAN RENTS + +In studying the influence of depreciation upon rent, it is necessary to +use that term in its popular rather than in its scientific sense. This +fact is less to be lamented, because the theorist himself admits that +the distinction becomes sadly blurred when he attempts to deal with +short intervals of time. Capital once invested in improvements can +seldom be withdrawn rapidly. In "the short run," therefore, it is +practically a part of the land, and the return to it follows the analogy +of rent rather than of interest. + +The renting landlord found that the degree in which he was affected by +the fluctuations in the value of the paper money depended largely upon +the terms of the contract into which he had entered. It is clear from a +careful examination that the landlord who before suspension had leased +his property for a considerable period without opportunity for +revaluation must have suffered severely if paid in greenbacks. The +number of "dollars" received as rental might be the same in 1865 as in +1860, but their purchasing power was less than one-half as great. +Somewhat less hard was the situation of the landlord who had let his +property for but one or two years. At the expiration of the leases he +had opportunities to make new contracts with the tenants. + +In his capacity as special commissioner of the revenue, Mr. David A. +Wells devoted some attention to the rise of rent. His report for +December, 1866, says: + + The average advance in the rents of houses occupied by + mechanics and laborers in the great manufacturing centres of + the country is estimated to have been about 90 per cent.; in + some sections, however, a much greater advance has been + experienced, as for example, at Pittsburgh, where 200 per + cent. and upward is reported. In many of the rural + districts, on the other hand, the advance has been much + less. Mr. Wells later modified this estimate somewhat. + +The advance in rents was greater in cities than in minor towns. In some +cities--_e. g._, Cincinnati and Louisville--owners of workingmen's +tenements appear to have been able to increase their money incomes +rather more rapidly than prices advanced, but in Boston, Philadelphia, +St. Louis, and in smaller towns, their money incomes appear to have +increased more slowly than living expenses. These conclusions rest, +however, on a narrow statistical basis. + + +FARM RENTS + +The rural landowner suffered serious injury from the paper currency when +he let his land for a money rent. But renting farms for a fixed sum of +money has always been less common in the United States than renting for +a definite share of the products. It is probable that at the time of the +Civil War more than three-quarters of the rented farms were let "on +shares." Inasmuch as no money payments entered into such arrangements, +the pecuniary relations of landlord and tenant were not directly +affected by the change in the monetary standard. Farm owners who had let +their places on these conditions escaped the direct losses that weighed +so heavily on the recipients of money rents. But even they did not avoid +all loss. For the price of agricultural products for the greater part +of the war period lagged considerably behind the price of other goods. +This difference, of course, meant loss to men whose incomes were paid in +bushels of grain. + + +INTEREST AND LOAN CAPITAL + + +THE PROBLEM OF LENDERS AND BORROWERS OF CAPITAL + +The task of ascertaining the effect of the greenback issues upon the +situation of lenders and borrowers of capital is in one respect more +simple and in another respect more complex than the task of dealing with +wage-earners. It is simpler in that there are not different grades of +capital to be considered like the different grades of labor. But it is +more complex in that the capitalist must be considered not only as the +recipient of a money income, as is the laborer, but also as the +possessor of certain property that may be affected by changes in the +standard money. + +The problem is further complicated by the fact that the relative +importance of these two items--rate of interest and value of +principal--is not the same in all cases. Whether a lender is affected +more by the one item or the other depends upon what he intends to do +with his property at the expiration of existing contracts. A widow left +in 1860 with an estate of say $10,000, who expected to keep this sum +constantly at interest and to find new borrowers as soon as the old +loans were paid, could neglect everything but the net rate of interest +received. On the other hand, if this estate had been left to a youth of +twenty who intended to invest his property in some business after a few +years, the rate of interest would be of relatively less importance to +him than the purchasing power of the principal when the time came to set +up for himself. + +Of course, the same difference exists in the case of different +borrowers. Those borrowers who expected to renew old loans on maturity +would have to consider little beyond the interest demanded by lenders, +while borrowers who expected to pay off the loans out of the proceeds of +their ventures would be interested primarily in the amount of goods that +would sell for sufficient money to make up the principal. + +Although these two classes of cases are by no means independent of each +other, the following discussion will be rendered clearer by observing +the broad difference between them. Accordingly, attention will first be +directed to the effect of the price fluctuations upon the purchasing +power of the principal of loans, and afterward to changes in the rate of +interest. + + +PURCHASING POWER OF THE PRINCIPAL OF LOANS + +Most persons who made loans in the earlier part of the Civil War and +were repaid in greenbacks must have suffered heavy losses from the +smaller purchasing power of the principal when it was returned to them. +But while this general fact is clear, it is difficult to make a +quantitative statement of the degree of the loss that will be even +tolerably satisfactory. + +In the case of almost all loans made before the middle of 1864 and +repaid prior to 1866, the creditor found that the sum returned to him +had a purchasing power much less than the purchasing power that had been +transferred to the borrower when the loan was made. This decline varied +from 1 to more than 50 per cent. On loans made in the middle of 1864 or +later, on the contrary, the creditor gained as a rule. In the case of +loans made in January, 1865, and repaid six months later, the increase +in purchasing power was over 40 per cent. + + +THE RATE OF INTEREST + +In turning to study the fortunes of men who have no thought of employing +their capital for themselves, but expect to seek new borrowers as +rapidly as old loans are repaid, one finds it necessary to distinguish +between cases where loans have been made for short and for long terms; +between the cases, that is, where there is and where there is not an +opportunity to make a new contract regarding the rate of interest. The +latter cases may be dismissed with a word. The capitalist who lent +$10,000 for five years in April, 1862, at 6 per cent. interest, would be +in relatively the same position as the workingman who received no +advance in money wages; while his money income remained the same, the +rise of prices would decrease his real income in 1864 and 1865 by about +one-half. Of course, this loss to the creditor is a gain to the debtor; +for to the business man using borrowed capital the advance of prices +means that he can raise his interest money by selling a smaller +proportion of his output. + +More interesting is the case of loans maturing and made afresh during +the period under examination. The important question is: How far did the +lender secure compensation for the diminished purchasing power of the +money in which he was paid by contracting for a higher rate of interest? + +The advance in the rate of interest was comparatively small--much too +small to compensate for the increased cost of living. While prices rose +approximately 85 per cent. and money wages somewhat less than 60 per +cent. during the years 1860-65, rates of interest on call and time loans +increased less than 15 per cent. during the same period. + +The conclusion is not only that persons who derived their income from +capital lent at interest for short terms were injured by the issues of +the greenbacks, but also that their injuries were more serious than +those suffered by wage-earners. + +To explain this state of affairs is not easy. The first reason that +suggests itself to the mind considering the problem is that both lenders +and borrowers failed to foresee the changes that would take place in the +purchasing power of money between the dates when loans were made and +repaid. No doubt there is much force in this explanation. If, for +instance, men arranging for loans in April, 1862, to be repaid a year +later, had known that in the meantime the purchasing power of money +would decline 30 per cent., they would have agreed upon a very high rate +of interest. Men able to discern the future course of prices would not +have lent money at the ordinary rates, and if the rates prevailing in +the New York market throughout all 1862 and 1863 were less than 7 per +cent., it must have been because the extraordinary rise of prices was +not foreseen by borrowers and lenders. + +Nor is it surprising that business men failed to see what was coming; +for the course of prices depended chiefly upon the valuation set upon +the greenbacks, and this valuation, in turn, depended chiefly upon the +state of the finances and the fortunes of war--matters that no one could +foresee with certainty. Indeed, there was much of the time a very +general disposition to take an unwarrantedly optimistic view of the +military situation and the chances of an early peace. Many members of +the business community seem to have felt that the premium on gold was +artificial and must soon drop, that prices were inflated and must +collapse. To the extent that such views prevailed borrowers would be +cautious about making engagements to repay money in a future that might +well present a lower range of prices, and lenders would expect a gain +instead of a loss from the changes in the purchasing power of money. + +But the full explanation of the slight advance in interest cannot be +found in this inability to foresee the future--at least not without +further analysis of what consequences such inability entailed. +Workingmen are commonly credited with less foresight than capitalists, +and nevertheless they seem, according to the figures, to have succeeded +better in making bargains with employers of labour than did lenders with +employers of capital. The explanation of this less success seems to be +found in the difference between the way in which depreciation affected +what the capitalist and the laborer had to offer in return for interest +and wages. There is no reason for assuming that an artisan who changed +employers during the war would render less efficient service in his new +than in his old position, or that a landlord who changed tenants had +less advantages to put at the disposal of the incoming lessee. In both +these cases the good offered to the active business man remained +substantially the same, and it may safely be assumed that, other things +being equal, this business man could afford to give quite as much for +the labor and the land after as before suspension. From the business +man's point of view, therefore, there seems to have been room for a +doubling of money wages and rent when the purchasing power of money had +fallen one-half. But in the case of the borrower of capital the like was +not true. The thousand dollars which Mr. A offered him in 1865 was not, +like the labour of John Smith or the farm of Mr. B, as efficient for his +purposes as it would have been five years before. For, with the thousand +dollars he could not purchase anything like the same amount of +machinery, material, or labor. And since the same nominal amount of +capital was of less efficiency in the hands of the borrower, he could +not without loss to himself increase the interest which he paid for new +loans in proportion to the decline in the purchasing power of money, as +he could increase the wages of laborers or the rent for land. + +It should also be pointed out that on one important class of loans +capitalists suffered comparatively little even during the war. Interest +on many forms of Government bonds was paid in gold. Capitalists who +invested their means in these securities consequently received an income +of almost unvarying specie value. If the person who made these +investments were an American, he would be able to sell his gold-interest +money at a high premium, but he would also have to pay correspondingly +high prices for commodities, so that upon the whole his position would +not be greatly different from that of the foreign investor. That such +opportunities for investment as these securities offered should exist +when men were most of the time loaning money for short terms at 7 per +cent. or less, is perhaps the most emphatic proof that could be offered +of the inability of the public to foresee what the future had in store. + + +PROFITS + +Laborers, landlords, and lending capitalists are all alike in that the +amount of remuneration received by them for the aid which they render to +production is commonly fixed in advance by agreement, and is not +immediately affected by the profitableness or unprofitableness of the +undertaking. It remains to examine the economic fortunes of those men +whose money incomes are made up by the sums left over in any business +after all the stipulated expenses have been met. + +A very important part of the solution of the problem of profits has +already been contributed by the preceding studies of wages, rent, and +interest. The evidence has been found to support the conclusion that in +almost all cases the sums of money wages, rent, and interest received by +laborers, landlords, and capitalists increased much less rapidly than +did the general price level. If the wording of this conclusion be +reversed--the prices of products rose more rapidly than wages, rent, or +interest--we come at once to the proposition that as a rule profits +must have increased more rapidly than prices. For, if the sums paid to +all the other co-operating parties were increased in just the same ratio +as the prices of the articles sold, it would follow that, other things +remaining the same, money profits also would increase in the same ratio. +But if, while prices doubled, the payments to labourers, landlords, and +capitalists increased in any ratio less than 100 per cent., the sums of +money left for the residual claimants must have more than doubled. In +other words, the effect of the depreciation of the paper currency upon +the distribution of wealth may be summed up in the proposition: The +shares of wage-earners, landowners, and lenders in the national dividend +were diminished and the share of residual claimants was increased. + +Two other general propositions respecting profits are suggested. First, +other things being equal, profits varied inversely as the average wage +per day paid to employees. This conclusion follows directly from the +fact that the money wages of men earning $1-$1.49 per day before the +perturbation of prices increased in higher ratio than those of men +earning $1.50-$1.99; that the wages of the latter class increased more +than the wages of men in the next higher wage class, etc. Second, other +things being equal, profits varied directly as the complexity of the +business organization. By this proposition is meant, for example, that a +farmer who paid money rent, used borrowed capital, and employed hired +labourers, made a higher percentage of profits than a farmer of whom any +one of these suppositions did not hold true. If, as has been argued, the +increase of profits was made at the expense of laborers, landlords, and +capitalists, it follows that that _entrepreneur_ fared best whose +contracts enabled him to exploit the largest number of these other +persons. + + +PROFITS IN AGRICULTURE + +The farmers of the loyal states were among the unfortunate producers +whose products rose in price less than the majority of other articles, +and from this standpoint they were losers rather than gainers by the +paper currency. Of course, it is possible that the farmer's loss from +this inequality of price fluctuations might be more than offset by his +gains at the expense of labourers, landlord, and lending capitalist. +But there is good reason for believing that the increase of the +_entrepreneur's_ profits in the latter fashion was less in farming than +in any other important industry. This conclusion seems to follow from +the proposition that, other things being equal, profits varied directly +as the complexity of business organization. The American farmers of the +Civil War were in a large proportion of cases their own landlords, +capitalists, and laborers. So far as this was true, they had few +important pecuniary contracts with other persons of which they could +take advantage by paying in depreciated dollars. Of those farmers who +hired labor very many paid wages partly in board and lodging--an +arrangement which threw a considerable part of the increased cost of +living upon them instead of upon their employees. Finally, the renting +farmer probably gained less on the average from the contract with his +landlord than tenants of any other class, because in a majority of cases +the rent was not a sum of money, but a share of the produce. While, +then, the general effect of the paper standard was in the direction of +increasing profits, it seems very doubtful whether farmers as a whole +did not lose more than they gained because of the price disturbances. + + +STATISTICAL EVIDENCE REGARDING PROFITS + +It would be highly desirable to test our general conclusions by means of +direct information regarding profits made in various branches of trade, +but the data available for such a purpose are very meager. What scraps +of information are available, however, support the view that profits +were uncommonly large. Mr. David A. Wells, for example, in his reports +as special commissioner of the revenue, has stories of "most anomalous +and extraordinary" profits that were realized in the paper, woolen, +pig-iron, and salt industries. A more general indication of the +profitableness of business is afforded by the remark in the annual +circular of Dun's Mercantile Agency for 1864, that "it is generally +conceded that the average profits on trade range from 12 to 15 per +cent." + +But the most important piece of evidence is found in the statistics of +failures compiled by the same agency. The following table shows Dun's +report of the number of bankruptcies and the amount of liabilities in +the loyal States from the panic year 1857 to the end of the war: + + _Year_ _Number_ _Liabilities_ + + 1857 4,257 $265,500,000 + 1858 3,113 73,600,000 + 1859 2,959 51,300,000 + 1860 2,733 61,700,000 + 1861 5,935 $178,600,000 + 1862 1,652 23,000,000 + 1863 495 7,900,000 + 1864 510 8,600,000 + 1865 500 17,600,000 + +The very great decrease both in the number and the liabilities of firms +that failed is the best proof that almost all business enterprises were +"making money." + +From one point of view the small number of failures is surprising. An +unstable currency is generally held to make business unsafe, and seldom +has the standard money of a mercantile community proven so unstable, +undergone such violent fluctuations in so short a time, as in the United +States during the Civil War. Yet, instead of being extremely hazardous, +business seems from the statistics of failures to have been more than +usually safe. + +The explanation of the anomaly seems to be that the very extremity of +the danger proved a safeguard. Business men realized that the inflation +of prices was due to the depreciation of the currency, and that when the +war was over gold would fall and prices follow. They realized very +clearly the necessity of taking precautions against being caught in a +position where a sudden decline of prices would ruin them. They did this +by curtailing credits. So long as prices continued to rise such +precautions were really not needed by the man in active business except, +in so far as he was a creditor of other men; but when prices commenced +to fall prudence had its reward. Such a sudden and violent drop of +prices as occurred between January and July, 1865, would have brought a +financial revulsion of a most serious character upon a business +community under ordinary circumstances. But so well had the change been +prepared for, that the number of failures was actually less than it had +been in the preceding year of rapidly rising prices. + +The whole situation can hardly be explained better than it was by a New +York business man writing in _Harper's Monthly Magazine_: "When the war +ended," he said, "we all knew we should have a panic. Some of us, like +Mr. Hoar, expected that greenbacks and volunteers would be disbanded +together. Others expected gold to fall to 101 or 102 in a few days. +Others saw a collapse of manufacturing industry, owing to the cessation +of Government purchases. But we all knew a 'crisis' was coming, and +having set our houses in order accordingly, the 'crisis' of course never +came." + + +THE PRODUCTION AND CONSUMPTION OF WEALTH + + +PRODUCTION + +What influence did the greenback currency have as one of the many +factors that affected the production of wealth? In the first place, the +paper standard was responsible in large measure for the feeling of +"prosperity" that seems from all the evidence to have characterized the +public's frame of mind. Almost every owner of property found that the +price of his possessions had increased, and almost every wage-earner +found that his pay was advanced. Strive as people may to emancipate +themselves from the feeling that a dollar represents a fixed quantity of +desirable things, it is very difficult for them to resist a pleasurable +sensation when the money value of their property rises or their incomes +increase. They are almost certain to feel cheerful over the larger sums +that they can spend, even though the amount of commodities the larger +sums will buy is decreased. Habit is too strong for arithmetic. + +But, more than this, "business" in the common meaning of the word was +unusually profitable during the war. The "residual claimant" is in most +enterprises the active business man, and, as has been shown, his money +income did as a rule rise more rapidly than the cost of living. In other +words, "business" was, in reality as well as in appearance, rendered +more profitable by the greenbacks. There is therefore no error in saying +that the business of the country enjoyed unwonted prosperity during the +war. And it may be added that the active business man is probably a more +potent factor in determining the community's feeling about "good times" +and "bad times" than is the workingman, the landlord, or the lending +capitalist. + +The effect of high profits, however, is not limited to producing a +cheerful frame of mind among business men. Under ordinary circumstances +one would say that when the great majority of men already in business +are "making money" with more than usual rapidity they will be inclined +to enlarge their operations, that others will be inclined to enter the +field, and that thus the production of wealth will be stimulated. But +the circumstances of the war period were not ordinary and this +conclusion cannot be accepted without serious modifications. + +1. It has been shown that business men realised the precariousness of +all operations that depended for their success upon the future course of +prices--and nearly all operations that involved any considerable time +for their consummation were thus dependent. So far did this disposition +prevail that it produced a marked curtailment in the use of credit. The +prudent man might be willing to push his business as far as possible +with the means at his own disposal, but he showed a disinclination to +borrow for the purpose. Thus the uncertainty which all men felt about +the future in a large measure counteracted the influence of high profits +in increasing production. + +2. The foregoing consideration of course weighed most heavily in the +minds of cautious men. But not all business men are cautious. Among many +the chance of winning large profits in case of success is sufficient to +induce them to undertake heavy risks of loss. On the whole, Americans +seem to display a decided propensity toward speculative ventures and are +not easily deterred by having to take chances. To men of this type it +seems that the business opportunities offered by the fluctuating +currency would make a strong appeal. But, while the force of this +observation may be admitted, it does not necessitate a reconsideration +of the conclusion that the instability of prices tended to diminish the +production of wealth. For in a time of great price fluctuations the +possibilities of making fortunes rapidly are much greater in trade than +in agriculture, mining, or manufactures. Every rise and fall in +quotations holds out an alluring promise of quick gain to the man who +believes in his shrewdness and good fortune, and who does not hesitate +to take chances. The probable profits of productive industry in the +narrower sense might be larger than common, but this would not attract +investors in large numbers if the probable profits of trading were +larger yet; and such seems clearly to have been the case during the war +when the paper currency offered such brilliant possibilities to +fortunate speculators in gold, in stocks, or in commodities. Instead, +then, of the greenbacks being credited with stimulating the production +of wealth, they must be charged with offering inducements to abandon +agriculture and manufactures for the more speculative forms of trade. + +This tendency of the times did not escape observation. On the contrary, +it was often remarked and lamented in terms that seem exaggerated. Hugh +McCulloch, for instance, in his report as Secretary of the Treasury for +1865, said: + + There are no indications of real and permanent prosperity + ... in the splendid fortunes reported to be made by skilful + manipulations at the gold room or the stock board; no + evidences of increasing wealth in the facts that railroads + and steamboats are crowded with passengers, and hotels with + guests; that cities are full to overflowing, and rents and + the necessities of life, as well as luxuries, are daily + advancing. All these things prove rather ... that the number + of non-producers is increasing, and that productive industry + is being diminished. + +In one of his reports as special commissioner of the revenue, Mr. Wells +said: + + During the last few years large numbers of our population, + under the influence and example of high profits realized in + trading during the period of monetary expansion, have + abandoned employments directly productive of national + wealth, and sought employments connected with commerce, + trading, or speculation. As a consequence we everywhere find + large additions to the population of our commercial cities, + an increase in the number and cost of the buildings devoted + to banking, brokerage, insurance, commission business, and + agencies of all kinds, the spirit of trading and speculating + pervading the whole community, as distinguished from the + spirit of production. + +Within the period under review, then, it seems very doubtful whether the +high profits had their usual effect of leading to a larger production +of raw materials or to an increase in manufactures. The prudent man +hesitated to expand his undertakings because of the instability of the +inflated level of prices; the man with a turn for speculative ventures +found more alluring opportunities in trade. + + +CONSUMPTION + +No one can read contemporary comments on American social life of the +later years of the war without being impressed by the charges of +extravagance made against the people of the North. Newspapers and +pulpits were at one in denouncing the sinful waste that, they declared, +was increasing at a most alarming rate. The "shoddy aristocracy" with +its ostentatious display of wealth became a stock subject for +cartoonists at home, and earned a well-merited reputation for vulgarity +abroad. + +In trying to account for this unpleasant phase of social development, +men usually laid the blame upon the paper standard. High prices were +said to make every one feel suddenly richer and so to tempt every one to +adopt a more lavish style of living than his former wont. Thus the view +gained general credence that the greenbacks were ultimately responsible +for a great increase in the consumption of wealth. + +However, such a view regarding the consumption of wealth can be but +partially true. The enormous profits of _entrepreneurs_ made possible +the rapid accumulation of an unusual number of fortunes, and the +families thus lifted into sudden affluence enjoyed spending their money +in the ostentatious fashion characteristic of the newly rich. It is +therefore true that the monetary situation was largely responsible for +the appearance of a considerable class of persons--of whom the fortunate +speculator and the army contractor are typical--who plunged into the +recklessly extravagant habits that called down upon their heads the +condemnation of the popular moralist. + +But if the greenbacks were in the last resort a chief cause of the +increased consumption of articles of luxury by families whom they had +aided in enriching, they were not less truly a cause of restricted +consumption by a much larger class of humbler folk. The laboring man +whose money wages increased but one-half, while the cost of living +doubled, could not continue to provide for his family's wants so fully +as before. He was forced to practise economies--to wear his old clothing +longer, to use less coffee and less sugar, to substitute cheaper for +better qualities in every line of expenditure where possible. Similar +retrenchment of living expenses must have been practised by the families +of many owners of land and lenders of capital. In other words, the war +time fortunes resulted in a very large measure from the mere transfer of +wealth from a wide circle of persons to the relatively small number of +residual claimants to the proceeds of business enterprises. The enlarged +consumption of wealth which the paper currency made possible for the +fortunate few was therefore contrasted with a diminished consumption on +the part of the unfortunate many on whose slender means the greenbacks +levied contributions for the benefit of their employers. + +That the diminished consumption of wealth by large numbers of poor +people escaped general notice, while the extravagance of the newly rich +attracted so much attention, need not shake one's confidence in the +validity of these conclusions. The purchase of a fast trotting-horse by +a Government contractor, and the elaborateness of his wife's gowns and +jewelry, are much more conspicuous facts than the petty economies +practised by his employees. The same trait that leads fortunate people +to flaunt their material prosperity in the eyes of the world leads the +unfortunate to conceal their small privations. Even an attentive +observer may fail to notice that the wives of workingmen are still +wearing their last year's dresses and that the children are running +barefoot longer than usual. + +But though the newspapers were not full of comments on the enforced +economies of the mass of the population, wholesale dealers in staple +articles of food and clothing noticed a decrease in sales. In reviewing +the trade situation in September, 1864. when real wages were near their +lowest ebb, Hunt's _Merchants' Magazine_ remarked that "the rise in the +prices of commodities has ... outrun the power of consumption and the +fall trade has been almost at a stand. Those articles such as coffee, +sugar, low grade goods, which form the staple products of the great mass +of the people in moderate circumstances, have reached such high rates +that the decline in consumption is very marked, amounting almost to a +stagnation of the fall trade." The consumption of many articles of +luxury increased very greatly, while the consumption of many staple +articles declined. + + +THE GREENBACKS AND THE COST OF THE CIVIL WAR + +The reader who goes back to the debates upon the legal-tender bills will +find that most of the unfortunate consequences that followed their +enactment were foretold in Congress--the decline of real wages, the +injury done creditors, the uncertainty of prices that hampered +legitimate business and fostered speculation. But a majority of this +Congress were ready to subject the community to such ills because they +believed that the relief of the treasury from its embarrassments was of +more importance than the maintenance of a relatively stable monetary +standard. + + +GREENBACKS AND EXPENDITURES + +What effect had the greenbacks upon the amount of expenditures incurred? +Few questions raised by the legal-tender acts have attracted more +attention than this. Even while the first legal-tender bill was being +considered its critics declared that if made a law it would increase the +cost of waging the war by causing an advance in the prices of articles +that the Government had to buy. As the war went on the soundness of this +view became apparent. + +When the war was over and the divers reasons that had deterred many men +from criticizing the financial policy of the government were removed, +competent writers began to express similar views with freedom. For +example, Mr. C. P. Williams put the increase of debt at one-third to +two-fifths; S. T. Spear, at a billion dollars; L. H. Courtney, an +English critic, at nearly $900,000,000. Of later discussions that of H. +C. Adams has attracted the most attention. He estimated that of the +gross receipts from debts created between January 1, 1862, and +September 30, 1865, amounting to $2,565,000,000 the gold value was but +$1,695,000,000--a difference of $870,000,000 between value received and +obligations incurred. + +A detailed consideration of the elements that enter the problem would +seem to warrant a reduction of the estimates given to $791,000,000. It +is hardly necessary to insist strenuously that this is but a very rough +estimate. + + +THE GREENBACKS AND RECEIPTS + +The total increase of receipts was approximately $174,000,000, as shown +in the following table: + + (In millions of dollars) + + _1862_ _Fiscal Year_ _1866_ + _(Six Months) 1863 1864 1865 (Two Months)_ + +Current receipts: +From customs 33.5 69.1 102.3 84.9 31.3 +From sales of public lands .1 .2 .6 1.0 .1 +From direct tax 1.8 1.5 .5 1.2 .0 +From miscellaneous sources .5 3.0 47.5 33.0 12.3 +From internal revenue ... 37.6 109.7 209.5 64.4 + ---- ----- ----- ----- ----- + 35.9 111.4 260.6 329.6 108.1 +Estimated actual increase 0 10 39 106 19 + +The caution is hardly necessary that the above results are to be +accepted subject also to a wide margin of error. + +There were other financial consequences of the shift from the specie to +the paper standard, however, that were not unimportant, though they were +indirect and difficult to gauge. Two of the most prominent must be +indicated. + +1. It is probable that not a little of the lavishness with which public +funds were appropriated by Congress during the war can be traced to the +paper-money policy. + +2. If the paper currency tempted the Government to reckless +expenditures, it also predisposed the people to submit more willingly to +heavy taxation. It has been remarked several times that the advance of +money wages and of money prices made most people feel wealthier, and, +feeling wealthier, they were less inclined to grumble over the taxes. + +While these indirect effects of the paper currency on expenditures and +receipts could not by any system of bookkeeping be brought to definite +quantitative statement, it is probable that their net result was +unfavorable to the treasury. + + +CONTRACTION AND INFLATION OF THE LEGAL TENDERS[9] + +The policy of a permanent currency of government legal-tender paper at +the close of the Civil War was unknown. Upwards of four hundred million +notes of the United States were, it is true, in circulation at the +return of peace. There were doubtless many individuals who approved the +continuance of exactly this form of currency. But no such proposition +had been advanced by any public man of influence or by any political +organization. That the resort to legal-tender powers was an evil +justified only by extreme emergency, and that the circulation of +government notes in any form was a purely temporary measure, were the +unanimous convictions of the statesmen who contrived the system. The +logical inference that these Government notes would be paid off and +cancelled, as soon as the war deficiency had ended, was publicly +accepted. + +Such was the theory and purpose of the public men through whom the +Legal-Tender Act was constructed and applied. Nor is the general +position of our statesmen, at the close of the Civil War, any more +obscure than their original position. The first financial resolution +adopted by Congress, in December, 1865, was an explicit promise to +retire the legal tenders. The first legislation of that Congress gave +discretionary powers to the Secretary of the Treasury for continuous +contraction. Very few legislative victories are won without at least a +temporary popular endorsement, and the votes of December, 1865, and of +March, 1866, were no exceptions. But the popular approval of contraction +in that year, exception as it was to all our subsequent legislation, is +readily enough explained. Public opinion, when the war ended, was +governed by impatience with inflated prices; inflation far beyond the +European level, and properly ascribed to the condition of the currency. +The cost of living reached during 1865 the highest point recorded in +this country's history. From 1860 to 1865, inclusive, the average of +European prices rose only 4 to 6 per cent.; average prices in the +United States advanced, in the same period, no less than 116 per cent. +With flour at $16 a barrel, butter at 55 cents a pound, coal at $10 a +ton, and wages and salaries advanced since 1860 hardly one-third as far +as prices, the demand for currency reform obtained ready endorsement +from the people. + +This popular sentiment was further strengthened by the Administration's +attitude at the opening of Lincoln's second term. Mr. McCulloch's first +official Treasury report, dated December 4, 1865, took positive ground +for the reduction of the legal-tender debt. He asked authority to issue +bonds in his discretion, at 6 per cent. or less, "for the purpose of +retiring not only the compound interest notes, but the United States +notes." + +Two weeks after the publication of this report, on December 18, 1865, +the House of Representatives resolved, by a vote of 144 to 6, + + that this house cordially concurs in the view of the + Secretary of the Treasury in relation to the necessity of a + contraction of the currency, with a view to as early a + resumption of specie payments as the business interests of + this country will permit; and we hereby pledge co-operative + action to this end as speedily as practicable. + +This resolution of 1865, however, marked the climax of the movement. +Never thereafter did the policy of retiring the legal-tender notes even +approach success. The truth is, that the inflated prices had begun +already, during the three months after the resolution of December, to +recede. This was inevitable, from the very nature of the previous +expansion; and it was a welcome movement to consumers. But it +necessarily caused some derangement in the plans of trade, and +politicians began to ask, when they had to face the fulfilment of their +pledge through a formal act of Congress, how the contraction policy +would be greeted by producers. The bill, as originally introduced, +granted full powers to the Secretary of the Treasury to issue new bonds +for the retirement both of interest-bearing and of noninterest-bearing +debt. In the spring of 1866 this measure was defeated in the House of +Representatives by a vote of 70 to 64. Reconsidered and amended so as to +restrict contraction of the legal tenders to $10,000,000 in the first +six months and to $4,000,000 per month thereafter, the compromise +measure did indeed pass the House by 83 to 53, and the Senate by 32 to +7. But a victory thus won was ominous. Mr. McCulloch himself declared +the amended act to be awkward and ineffective. Still more significant +was the character of opposition developed in the course of the debate. +It had a dozen varying grounds of argument, most of them pretty certain +to appeal to popular prejudice later on. Some Congressmen objected to +the discretionary powers as revolutionary, and, while conceding Mr. +McCulloch's ability and conservatism, pointed out that a very different +Treasury Secretary might succeed him. Others pronounced the notion of +immediate resumption of specie payments to be "Utopian in the extreme." +Much was heard of the comfortable theory that if Congress would "allow +things to go on without active interference," the "natural development +of events" would automatically bring about resumption. More than one +legislator could not understand, "when we have $450,000,000 [debt] +bearing no interest, and which need bear no interest, why it is to be +taken up and put into bonds." The excellence of a circulating medium +"that rests on the property of the whole country, and has for its +security the faith and patriotism of the greatest and freest country on +the face of the globe," played its usual part in the discussion; so did +the argument that "the amount of legal tenders now outstanding is not +too much for the present condition of the country." In short, all the +arguments which have been made familiar by the twenty subsequent years +of controversy, cut a figure in this opening discussion. + +As a matter of fact, even the restricted powers of note retirement +granted under the law of March, 1866, were revoked within two years. +Little or no progress had meantime been made towards resumption of +specie payments. The Secretary himself had officially pointed out that +two commercial influences must be removed before resumption would be +possible; the excessively high prices in the United States and the heavy +balance of foreign trade against us. But prices continued above the +European level, and, as a consequence, export of merchandise was checked +and imports greatly stimulated. The entire gold product of each year in +the United States was sent abroad. + +Contraction of the inflated currency, even if pursued under the +limitations of the Act of 1866, would in time have brought about +conditions under which resumption might have been planned. But events +outside of the United States now moved in such a way as to turn the +entire financial community against the Secretary's policy. Hardly two +months after the vote of March came a wholly unexpected crisis in the +foreign money markets. The London collapse, precipitated by the +Overend-Gurney failure of May, 1866, was in some respects as complete as +any in the history of England. It affected every nation with which Great +Britain had commercial dealings; not least of all the United States, of +whose securities it was estimated that European investors even then held +$600,000,000. During three months the Bank of England kept its minimum +discount rate at the panic figure of 10 per cent.; the consequent sudden +recall of foreign capital put a heavy strain on the American markets. + +With the familiar disposition of the trade community to lay the blame +for disordered markets on some move of public policy, the Treasury's +operations to reduce outstanding notes were made the scapegoat. +Politicians with an eye to popularity were quick to catch this drift of +public sentiment. Some of them honestly believed that McCulloch's action +in the currency was the cause of the trade distress; others, better +informed but equally politic, avoided personal declaration of opinion, +but characteristically announced that whether the theory was correct or +not, the public believed it, and that in deference to the public, +currency contraction ought to cease. The usual result ensued. Under the +previous question, and without debate, a measure revoking absolutely the +Secretary's power of contraction passed the House of Representatives in +December, 1867, by a vote of 127 to 32. In the Senate there was an able +show of opposition, but it was plainly put on the defensive, and on +January 22, 1868, the resolution passed both chambers in its original +and final shape. + +This was the end of the McCulloch plan. It was the end of all serious +debate upon resumption, for at least six years. It was also, and very +logically, the beginning of the fiat-money party. The Republicans were +forced into open defence of sound financial principles by the very +recklessness of their opponents. Helped by the great personal prestige +of its candidate, General Grant, the Republican party won a sweeping +victory. President Johnson, who was then at open odds with his party, +had produced in his Annual Message of December 7, 1868, the +extraordinary suggestion that "the 6 per cent. interest now paid by the +Government" on its debt "should be applied to the reduction of the +principal in semi-annual instalments"; in other words, that the plan of +repudiating interest obligations--since adopted, with no agreeable +results, by Turkey and Greece--should be formally approved by the United +States. This remarkable utterance was first condemned by an overwhelming +vote in both House and Senate; next, by an almost equally decisive vote, +on March 3, 1869, Congress adopted the Public Credit Act, promising coin +redemption of both notes and bonds, solemnly pledging its faith "to make +provision, at the earliest practicable period, for the redemption of the +United States notes in coin." + +The promise was as easily made as the similar pledge of December, 1865; +was still more easily broken. No such arrangement was made, nor any +serious attempt in that direction, until the matter was forced on the +party by the exigency of politics. Not only was no effort made to reduce +outstanding legal tenders, but the supply in circulation was heavily +increased; rising from $314,704,000 in the middle of 1869 to +$346,168,000 in 1872, and two years later, as a result of the Treasury's +weak experiments in the panic, to $371,421,000. + +This period was congenial to such juggling with public credit and +legislative pledges. Socially, financially, and politically, it stands +out quite apart from any other decade of the century. Moral sense for a +time seemed to have deteriorated in the whole community; it was a sorry +audience, at Washington or elsewhere, to which to address appeals for +economy, retrenchment, and rigid preservation of the public faith. The +Government's financial recklessness was readily imitated by the +community at large; debt was the order of the day in the affairs of +both. As the period approached its culmination, foreign trade reflected +the nature of the situation. Merchandise imports in the fiscal year 1871 +rose $84,000,000 over 1870; in 1872 they increased $106,000,000 over +1871. This movement was the familiar warning of an approaching crash; +but the warning fell on deaf ears, as it usually does. In 1873 the house +of cards collapsed. + +The panic of 1873 left the country's financial and commercial structure +almost a ruin. It had, however, several ulterior results so valuable +that it is not wholly unreasonable to describe the wreck of credit as a +blessing in disguise. American prices, long out of joint with the +markets of the world, and thoroughly artificial in themselves, were +certain to be eventually brought down. This very liquidating process +served a useful double purpose; it disclosed the nation's true +resources, and it placed the United States on equal footing with the +commercial world at large. With the bursting of the bubble of inflated +debt and inflated prices, the excessive importations ceased. +Simultaneously the export trade, which had halted during 1872, in spite +of the continued agricultural expansion, rose to proportions never +before approached in our commercial history. In 1874, the balance of +foreign trade turned permanently in our favor. By 1876, even the +continuous outflow of gold was checked. In short, the two conditions +fixed by Hugh McCulloch, ten years before, as indispensable to +resumption of specie payments, had now been realized. + +Congress was not by any means disposed, however, to seize the +opportunity. The first result of the money market crisis in 1873, as in +all similar years, was urgent public clamor for more currency. The +Supreme Court had decided finally, in 1871, for the constitutionality of +the legal tenders; the Secretary of the Treasury, in 1873, had so far +yielded to the prevalent excitement as to reissue legal-tender notes +already formally retired. The first response of Congress, therefore, was +an inflation measure. By a vote of 140 to 102 in the House of +Representatives, and of 29 to 24 in the Senate, a law was passed for the +permanent increase of the legal-tender currency, by $18,000,000. The +Republican party controlled Congress by unusually large majorities; but +60 per cent. of the party's vote in each chamber was cast in favor of +the bill. Only the interposition of Grant's Presidential veto prevented +this first positive backward step in the direction of fiat money. + +It is reasonable to suppose that this curious vote of the Administration +party, which occurred in April, 1874, measured the party's political +desperation. They were about to receive, in the Congressional elections, +the usual chastisement experienced by a dominant party when the people +vote in a period of hard times; the inflation act was an anchor thrown +desperately to windward. The experiment was in all respects a failure. +Even the party's own State conventions failed to say a good word for the +inflation bill, and it gained no mitigation of sentence in the November +vote. + + +PASSAGE OF THE RESUMPTION ACT[10] + +The Forty-third Congress had three months of existence left to it after +the vote of November, 1874. Already defeated overwhelmingly at the +polls, it had nothing to risk by a move in sound-money legislation, and +possibly much to gain. It used this three-months' period to enact a law +of the first importance, not only to the nation, but to the Republican +party's future history--a law which must fairly be described, however, +under the circumstances of the time, as an expression of death-bed +repentance. This was the Specie-Resumption Act, drawn up by a party +committee, and submitted to Congress, in December, 1874, by Senator John +Sherman. It fixed the date for resumption of specie payments at January +1, 1879, provided for the reduction of legal-tender notes from +$382,000,000 to $300,000,000, but made no provision for any further +retirement of the notes. It went through Congress on January 7, 1875. It +was contended by some that under the Resumption Act of 1875 there could +be no reissue of the greenbacks once received into the Treasury. +Inflationist successes of 1877-1878 settled this uncertainty, as +Congress, May 31, 1878, ordered that there be no further destruction of +greenbacks. The amount then outstanding was $346,681,000--the volume of +legal tenders still current. + + +THE STRUGGLE FOR RESUMPTION[11] + +The Resumption Act is one of the most curious laws in financial history. +It was plain in its requirement that on and after January 1, 1879, the +Treasury should "redeem in coin the United States legal-tender notes +then outstanding, on their presentation for redemption"; but it left the +Treasury to make whatever arrangements it might choose. The law, it is +true, conferred ample powers. In order "to prepare and provide for the +redemption in this Act authorized or required," it empowered the +Secretary of the Treasury "to use any surplus revenues, from time to +time, in the Treasury not otherwise appropriated, and to issue, sell, +and dispose of bonds of the United States at not less than par in coin." +This power was perpetual. + +The Law of 1875 involved the double problem of providing for resumption +at the stipulated date, and of maintaining it afterward. It is the first +of these undertakings, which we shall now sketch. There were, as we have +already seen, two influences at work in 1875, which made possible the +achievement as it would not have been in 1866. These influences--the +shifting of the foreign trade balance in favor of the United States and +the subsequent check to gold exports--were factors on which no finance +minister could have reckoned. Both in fact developed after the passage +of the Resumption Law. But even after allowing for these accidental +commercial advantages, the credit for the return to specie payments on +January 1, 1879, belongs individually and without dispute to John +Sherman. + +As one of the authors of the Resumption Act, Mr. Sherman was responsible +both for its virtues and its vices. His appointment to the Treasury, +therefore, in the Administration under which resumption must by law be +carried out, was entirely logical. Yet the practical efficiency of Mr. +Sherman, in an administrative office, could not then have been foretold. +The Secretary's previous career, though useful and industrious, had been +marred by weaknesses which did not promise well. As a legislator, he +belonged to the school of compromisers who have indirectly been +responsible, in a score of critical emergencies, for the gravest +mischief in our history. + +But Mr. Sherman was not the first of public men to show that the faults +or weakness of a legislator, whose purpose is to obtain enactment of a +policy, will sometimes disappear in the administrator, who presses +settled policies into execution. As Secretary he was unwavering in +pursuit of the resumption goal; practical, resolute, and adroit in the +means employed. It was in the face of the repudiation clamor that he +declared officially for payment of the Government bonds in gold. Equally +distinct was the Secretary's public declaration that the Act of 1875 +conferred the power to issue bonds after, as well as before, resumption; +another precedent which did invaluable service sixteen years afterward. + +To say that Secretary Sherman's management of the Treasury achieved +during his time precisely the results proposed, and achieved them +promptly, is to concede his administration's practical success. Nor were +these results attained through extravagance or waste. In his refunding +and resumption operations, Mr. Sherman placed the bonds of the United +States on better terms than any of his predecessors. + + +ARRANGEMENTS FOR RESUMPTION[12] + +The Secretary of the Treasury now put the final touches on his +arrangements for resumption. Partly by accident and partly through +stress of circumstances, the Treasury gold reserve was defined, in later +years, at a fixed and arbitrary minimum. The theory adopted by Mr. +Sherman, however, in his early operations, was different and undoubtedly +better. Following probably the practice of the Bank of England, he fixed +his reserve at 40 per cent. of outstanding notes--"the smallest +reserve," he wrote to Congress, "upon which resumption could be +prudently commenced and successfully maintained." On this basis he held +in the Treasury, on December 31, 1878, $114,193,000 gold in excess of +outstanding gold certificates, which was a trifle over 40 per cent. of +the Government notes then circulating outside the Treasury. Of this gold +reserve, $95,500,000 had been obtained through sale of bonds, part of +the coin being procured in Europe. + +There remained now to be settled only the formal machinery of exchange +between the Treasury and outside institutions. If the Treasury had left +the banks to pursue unchanged their policy of keeping special gold +deposits, the Government reserve would have been at once imperilled. If +the banks had continued to present their individual drafts for +redemption across the counter of the Sub-Treasury, any timid or +blundering banker might have started a general drain of gold. Against +these possibilities Mr. Sherman now took measures. He secured the +admission of the New York Sub-Treasury as a member of the +clearing-house. At New York and Boston the clearing-houses modified +their rules, agreed to abolish "gold deposits" after January 1st, and to +accept the legal tenders freely in discharge of balances against one +another and against the Government. At the same time, the requirement of +coin payment of customs duties was revoked, and public officers were +directed to receive coin or legal tenders at the payer's option--a move +of obvious propriety, since refusal to take notes in payment would +merely send the importer to the Treasury's redemption office to convert +them into coin. All these preliminaries had been formally and positively +settled before the close of 1878. On December 17th, the premium on gold +disappeared, for the first time since 1861; on January 1st, specie +payments were quietly resumed. + + +SHOULD THE GREENBACKS BE RETIRED? + +[13]Let us now consider for a moment an issue which twenty years ago was +urgently pertinent, was in fact the very crux of so-called "currency +reform," and which still persists as a live issue in the minds of some +of the veteran "reformers" of those days, although the conditions which +then gave it point have long since disappeared. + +In the middle nineties, when it was estimated that the total gold stock +of the entire country was only about 600 million dollars and less than +200 millions of this was in the vaults of the treasury, the +Government's fiduciary currency, consisting of 346 millions of +greenbacks and 400 millions or more of overvalued silver, presented +beyond question a serious menace to the country's monetary standard. It +meant that the treasury had outstanding currency obligations payable in +gold to the extent of three or four times its own gold holdings, and +amounting to far more than all of the gold in the country, including the +holdings of the treasury, the banks, and the general public. At that +time fluctuations in the trade balance of a single year sometimes almost +equalled the treasury's gold holdings in amount, and it was quite +conceivable, in fact not improbable, that a sudden unfavorable change in +that balance might drain the treasury of all of its gold, and leave the +country with a currency standard of depreciated silver or paper. This +was the situation which continually menaced Mr. Cleveland's second +administration, causing great financial anxiety and forcing the treasury +during those years of peace and normal expenditures to borrow 262 +million dollars in gold in order to replenish its continually dwindling +reserve. Such a situation inevitably led the advocates of monetary +legislation in the nineties to place first and foremost among their +proposals the necessity of getting rid of the precarious greenback, and +most of the plans proposed by bankers' associations, chambers of +commerce, and financial experts generally at that time emphasized the +urgency of this measure. + + +WHY RETIREMENT IS NOT IMPORTANT + +It sometimes happens that, with the lapse of time and with changed +conditions, infirmities, long left untreated, cure themselves, and so it +has been with the one-time bothersome greenback. Twenty years ago, when +the outstanding greenbacks amounted to twice the gold holdings of the +treasury and to much more than half of the country's entire gold stock, +there was abundant reason for anxiety on account of their continued +circulation. The situation is utterly different to-day. Gold has +accumulated in the treasury beyond the wildest "dreams of avarice" of +the nineties. From less than 200 millions in the middle nineties the +treasury's gold holdings have grown to approximately 1,250 millions +to-day, and the estimated gold stock of the country has increased from +600 to more than 1,800 millions, despite the fact that the Director of +the Mint in 1907 reduced the estimate for gold in circulation by 135 +millions as compared with the basis of previous years. + +The greenback has thus become each year a relatively less important +element in our currency system, an element of ever less and less potency +for harm. Doubtless the absolute amount of outstanding greenbacks has +diminished considerably through loss and destruction during fifty years, +and is to-day far less than the $346,000,000 issued during the Civil +War, which are still carried as an obligation on the Government +books.... + +The greenbacks are less menacing to-day for the further reason that they +are being rapidly transformed into small denominations which are +absorbed in the general circulation, and which could only with great +difficulty be collected in sufficiently large amounts to cause a serious +drain upon the treasury through presentation for redemption.... So great +and continuous is the demand for notes of small denominations that one +may safely predict that in another decade practically all of the +greenbacks still in existence will be in small denominations in the +pockets of the people. + +The "endless chain" with its ineffectual bond issues, the imminence of +specie suspension, and the fear of treasury bankruptcy will never again +result from the outstanding greenbacks. Their dangers, lurid and +nerve-racking though they were twenty years ago, are now only memories. + + +THE CONFEDERATE CURRENCY[14] + +The financial system adopted by the Confederate Government was +singularly simple and free from technicalities. It consisted chiefly in +the issue of treasury notes enough to meet all the expenses of the +Government, and in the present advanced state of the art of printing +there was but one difficulty incident to this process; namely, the +impossibility of having the notes signed in the Treasury Department, as +fast as they were needed. There happened, however, to be several +thousand young ladies in Richmond willing to accept light and +remunerative employment at their homes, and as it was really a matter +of small moment whose name the notes bore, they were given out in sheets +to these young ladies, who signed and returned them for a consideration. +I shall not undertake to guess how many Confederate treasury notes were +issued. Indeed, I am credibly informed by a gentleman who was high in +office in the Treasury Department, that even the Secretary himself did +not certainly know. It was clearly out of the power of the Government +ever to redeem the notes, and whatever may have been the state of +affairs within the treasury, nobody outside its precincts ever cared to +muddle his head in an attempt to get at exact figures. + +We knew only that money was astonishingly abundant. Provisions fell +short sometimes, and the supply of clothing was not always as large as +we should have liked, but nobody found it difficult to get money enough. +It was to be had almost for the asking. And to some extent the abundance +of the currency really seemed to atone for its extreme badness. Money +was so easily got, and its value was so utterly uncertain, that we were +never able to determine what was a fair price for anything. We fell into +the habit of paying whatever was asked, knowing that to-morrow we should +have to pay more. + +Speculation became the easiest and surest thing imaginable. The +speculator saw no risks of loss. Every article of merchandise rose in +value every day, and to buy anything this week and sell it next was to +make an enormous profit quite as a matter of course. So uncertain were +prices, or rather so constantly did they tend upward, that when a cargo +of cadet gray cloths was brought into Charleston once, an officer in my +battery, attending the sale, was able to secure enough of the cloth to +make two suits of clothes, without any expense whatever, merely by +speculating upon an immediate advance. Naturally enough, speculation +soon fell into very bad repute, and the epithet "speculator" came to be +considered the most opprobrious in the whole vocabulary of invective. +The feeling was universal that the speculators were fattening upon the +necessities of the country and the sufferings of the people. Nearly all +mercantile business was regarded at least with suspicion, and much of it +fell into the hands of people with no reputations to lose, a fact which +certainly did not tend to relieve the community in the matter of high +prices. + +The prices which obtained were almost fabulous, and singularly enough +there seemed to be no sort of ratio existing between the values of +different articles. I bought coffee at forty dollars and tea at thirty +dollars a pound on the same day. My dinner at a hotel cost me twenty +dollars, while five dollars gained me a seat in the dress circle of the +theatre. I paid one dollar the next morning for a copy of the +_Examiner_, but I might have got the _Whig_, _Dispatch_, _Enquirer_, or +_Sentinel_, for half that sum. For some wretched tallow candles I paid +ten dollars a pound. The utter absence of proportion between these +several prices is apparent, and I know of no way of explaining it except +upon the theory that the unstable character of the money had +superinduced a reckless disregard of all value on the part of both +buyers and sellers. A facetious friend used to say prices were so high +that nobody could see them, and that they "got mixed for want of +supervision." He held, however, that the difference between the old and +the new order of things was a trifling one. "Before the war," he said, +"I went to market with the money in my pocket, and brought back my +purchases in a basket; now I take the money in the basket, and bring the +things home in my pocket." + +As I was returning to my home after the surrender at Appomattox Court +House, a party of us stopped at the residence of a planter for supper, +and as the country was full of marauders and horse thieves, deserters +from both armies, bent upon indiscriminate plunder, our host set a +little black boy to watch our horses while we ate, with instructions to +give the alarm if anybody should approach. After supper we dealt +liberally with little Sam. Silver and gold we had none, of course, but +Confederate money was ours in great abundance, and we bestowed the crisp +notes upon the guardian of our horses, to the extent of several hundreds +of dollars. A richer person than that little negro I have never seen. +Money, even at par, never carried more of happiness with it than did +those promises of a dead government to pay. We frankly told Sam that he +could buy nothing with the notes, but the information brought no sadness +to his simple heart. + +"I don' want to buy nothin', master," he replied. "I's gwine to keep dis +always." + +I fancy his regard for the worthless paper, merely because it was called +money, was closely akin to the feeling which had made it circulate among +better-informed people than he. Everybody knew, long before the +surrender, that these notes never could be redeemed. There was little +reason to hope, during the last two years of the war, that the +"ratification of a treaty of peace between the Confederate States and +the United States," on which the payment was conditioned, would ever +come. We knew the paper was worthless, and yet it continued to +circulate. It professed to be money, and on the strength of that +profession people continued to take it in payment for goods. The amount +of it for which the owner of any article would part with his possession +was always uncertain. Prices were regulated largely by accident, and +were therefore wholly incongruous. + +In the winter of 1863-64 Congress became aware of the fact that prices +were higher than they should be under a sound currency. If Congress +suspected this at any earlier date, there is nothing in the proceedings +of that body to indicate it. Now, however, the newspapers were calling +attention to an uncommonly ugly phase of the matter, and reminding +Congress that what the Government bought with a currency depreciated to +less than one per cent. of its face, the Government must some day pay +for in gold at par. The lawgivers took the alarm and sat themselves down +to devise a remedy for the evil condition of affairs. With that +infantile simplicity which characterized nearly all the doings and quite +all the financial legislation of the Richmond Congress, it was decided +that the very best way to enhance the value of the currency was to +depreciate it still further by a declaratory statute, and then to issue +a good deal more of it. The act set a day, after which the currency +already in circulation should be worth only two-thirds of its face, at +which rate it was made convertible into notes of the new issue, which +some, at least, of the members of Congress were innocent enough to +believe would be worth very nearly their par value. This measure was +intended, of course, to compel the funding of the currency, and it had +that effect to some extent, without doubt. Much of the old currency +remained in circulation, however, even after the new notes were issued. +For a time people calculated the discount, in passing and receiving the +old paper, but as the new notes showed an undiminished tendency to still +further depreciation, there were people, not a few, who spared +themselves the trouble of making the distinction. + +I am sometimes asked at what time prices attained their highest point in +the Confederacy, and I find that memory fails to answer the question +satisfactorily. They were about as high as they could be in the fall of +1863, and I should be disposed to fix upon that as the time when the +climax was reached, but for my consciousness that the law of constant +depreciation was a fixed one throughout the war. The financial condition +got steadily worse to the end. + +The Government's course in levying a tax in kind, as the only possible +way of making the taxation amount to anything, led speedily to the +adoption of a similar plan, as far as possible, by the people. A +physician would order from his planter friend ten or twenty visits' +worth of corn, and the transaction was a perfectly intelligible one to +both. The visits would be counted at ante-war rates, and the corn +estimated by the same standard. In the early spring of 1865 I wanted a +horse, and a friend having one to spare, I sent for the animal, offering +to pay whatever the owner should ask for it. He could not fix a price, +having literally no standard of value to which he could appeal, but he +sent me the horse, writing, in reply to my note: + +"Take the horse, and when the war shall be over, if we are both alive +and you are able, give me as good a one in return. Don't send any note +or due-bill. It might complicate matters if either should die." + +A few months later I paid my debt by returning the very horse I had +bought. I give this incident merely to show how utterly without +financial compass or rudder we were. + +How did people manage to live during such a time? I am often asked; and +as I look back at the history of those years, I can hardly persuade +myself that the problem was solved at all. A large part of the people, +however, was in the army, and drew rations from the Government. The +country people raised upon their plantations all the necessaries of +life, and were generally allowed to keep enough of them to live on, the +remainder being taken by the subsistence officers for army use. + +In the cities, living was not by any means so easy as in the country. +Business was paralyzed, and abundant as money was, it seems almost +incredible that city people got enough of it to live on. Very many of +them were employed, however, in various capacities, in the arsenals, +departments, bureaus, etc., and these were allowed to buy rations at +fixed rates, after the post-office clerks in Richmond had brought +matters to a crisis by resigning their clerkships to go into the army, +because they could not support life on their salaries of nine thousand +dollars a year. For the rest, if people had anything to sell, they got +enormous prices for it, and could live a while on the proceeds. Above +all, a kindly, helpful spirit was developed by the common suffering, and +this, without doubt, kept many thousands of people from starvation. +Nobody formed any plans or laid by any money for to-morrow or next week +or next year, and indeed to most of us there really seemed to be no +future. We were not used to think of ourselves as possible survivors of +a struggle which was every day perceptibly thinning our ranks. The +coming of ultimate failure we saw clearly enough, but the future beyond +was a blank. + +The reader may find it difficult to believe that with gold at a hundred +and twenty-five for one, or 12,400 per cent. premium; when every day +made the hopelessness of the struggle more apparent; when our last man +was in the field; when the resources of the country were visibly at an +end, there were financial theorists who honestly believed that by a mere +trick of legislation the currency could be brought back to par. I heard +some of these people explain their plan during a two days' stay in +Richmond. Gold, they said, is an inconvenient currency always, and +nobody wants it, except as a basis. The Government has some +gold--several millions in fact--and if Congress will only be bold enough +to declare the treasury notes redeemable at par in coin, we shall have +no further difficulty with our finances. So long as notes are redeemable +in gold at the option of the holder, nobody wants them redeemed.... The +gold which the Government holds will suffice to satisfy a few timid +ones, and there will be an end of high prices and depreciated currency. +I am not jesting. This is, as nearly as I can repeat it, the utterance +of a member of the Confederate Congress. + +The matter of prices was frequently made a subject for jesting in +private, but for the most part it was carefully avoided in the +newspapers. As with the accounts of battles in which our arms were not +successful, necessary references to the condition of the finances were +crowded into a corner, as far out of sight as possible. The _Examiner_, +however, on one occasion denounced with some fierceness the charges +prevailing in the schools; and I quote a passage from Prof. Sidney H. +Owens's reply, which is interesting as a summary of the condition of +things in the South at that time: + +"The charges made for tuition are about five or six times as high as in +1860. Now, sir, your shoemaker, carpenter, butcher, market man, etc., +demand from twenty, to thirty, to forty times as much as in 1860. Will +you show me a civilian who is charging only six times the prices charged +in 1860, except the teacher only? As to the amassing of fortunes by +teachers, spoken of in your article, make your calculations, sir, and +you will find that to be almost an absurdity, since they pay from twenty +to forty prices for everything used, and are denounced exorbitant and +unreasonable in demanding five or six prices for their own labor and +skill!" + +There were compensations, however. When gold was at 12,000 per cent. +premium with us, we had the consolation of knowing that it was in the +neighborhood of one hundred above par in New York, and a Richmond paper +of September 22, 1864, now before me, fairly chuckles over the high +prices prevailing at the North, in a two-line paragraph which says, "Tar +is selling in New York at two dollars a pound. It used to cost eighty +cents a barrel." That paragraph doubtless made many a five-dollar +beefsteak palatable. + +FOOTNOTES: + +[8] Adapted from Wesley Clair Mitchell, _A History of the Greenbacks_, +Part II, The University of Chicago Press, 1903. + +[9] Adapted from A. D. Noyes, _Forty Years of American Finance_, pp. +7-20. G. P. Putnam's Sons, New York and London, 1909. + +[10] _Ibid._, pp. 21-22. + +[11] _Ibid._, pp. 23-31. + +[12] _Ibid._, pp. 44-47. + +[13] A. Piatt Andrew, The Essential and the Unessential in Currency +Legislation, in _Questions of Public Policy_, Addresses delivered in the +Page Lecture Series, 1913, before the Senior Class of the Sheffield +Scientific School, Yale University, pp. 55-59. Yale University Press, +New Haven, Connecticut. 1913. + +[14] Adapted from George Gary Eggleston, _A Rebel's Recollections_, pp. +78-107. Hurd and Houghton. Boston, 1875. + + + + +CHAPTER VI + +INTERNATIONAL BIMETALLISM + +[15]... There are natural and commercial causes which may operate to +produce either an incessant fluctuation in the relative value of silver +and gold, or a wide and increasing divergence, from year to year, +through a long period, from the ratio of exchange existing between the +two metals at the commencement of the period. So far are the sources and +conditions of supply of the one different from those of the other that, +notwithstanding the influence of the durableness of the metals in giving +steadiness of value to either by turns, and hence to the two in their +relation to each other, it would be in the highest degree unreasonable +to assume that the ratio of exchange between gold and silver would +remain unaltered through any considerable term of years. The annual or +monthly variations may take the form of oscillations, now on one side +and now on the other of any historical ratio, or they may be cumulative +on one side of that ratio, producing a divergence increasing from month +to month, and year to year; but variations in some degree, in some +direction, are to be expected under the unrestrained operation of causes +influencing the demand for, or the supply of, each metal. + +The conditions, natural and commercial, which determine the ratio of +exchange of the two metals being such, we have seen that government may +enter, and, by making the two indifferently legal tender for debts at a +ratio fixed by law, may, for the time, counteract the operation of any +and all forces tending to produce divergence. So long as any country +establishing such a principle holds a considerable amount of that metal +which, under the natural and commercial conditions of supply and demand +prevailing at the time, tends to become the dearer of the two, it is +impossible that the cheapened metal should there, or in any market, fall +far below that ratio. By the force of the bimetallic law, the +substitution of the cheapened for the dearer metal will at once begin; +and so long as that continues, the divergence of the market ratio from +the mint ratio can never be wide. Why should any one in London or New +York pay much more than fifteen and a half ounces of silver for an ounce +of gold, when gold can, at any time and in any amount, be obtained for +silver at the rate of fifteen and a half in Paris? + +This operation of the bimetallic system can not be denied; but there is +ground for dispute as to the degree of the advantages to result, and as +to the cost at which those advantages are to be obtained. The +monometallist, or advocate of the so-called single standard, is disposed +to disparage the benefits to be expected, and to magnify the expense of +this system. He points to the fact that the two metals do not actually +circulate in the same country, at the same time, in any considerable +degree; that it is always the one metal or the other which is used as +money, according as the market ratio diverges to the one side or the +other of the mint ratio, while the coin made from the dearer metal +acquires a premium, and is exported or hoarded. Hence it is said +bimetallism really means the use of but one metal in a country at a +time. It is not a double standard, but an alternate standard. + +To this the bimetallist replies that the concurrent use of the two money +metals, side by side, in the same markets, is a matter wholly of +indifference. The merit of the bimetallic scheme does not depend on this +at all. + +The object of bimetallism is, by joining the two metals together in the +coinage, at a fixed ratio, to diminish the extent of the fluctuations to +which the value of each would be separately liable, by generating a +compensatory action between the two, by which the cheapening metal shall +receive a larger use, while the appreciating metal drops partially out +of its former demand, thus making the two fall together, if there must +be a fall, or rise together, in the opposite case: or, conceivably, +making the tendency of one to fall precisely counteract the tendency of +the other to rise. + +Thus we may suppose four successive cases to illustrate the working of +this principle. + +The first is, where the demand for the use of either metal in trade +remaining the same, a large increase in the supply of one metal, A, +takes place, the supply of the other, B, remaining unchanged. In this +case, without the bimetallic system, the value of A would tend to fall +rapidly through a considerable space, while the value of B would stand +fast. With the bimetallic system, the joint supply of the two metals +would be applicable to meet the joint demand for the two. Now, as the +joint supply has been increased without any change in the joint demand, +there must be a fall in value; but the fall will be in the two +indistinguishably, except for a slight degree of delay and friction in +exchange. Both will fall, but the depth of the fall will be diminished +as the surface over which it is to take place has been enlarged. + +The second is where, the demands of trade for both metals remaining the +same, a diminution occurs in the supply of A, while the supply of B +remains unchanged. Here, by the operation of the same principle, a rise +in the value of money will take place, since the joint supply has been +reduced without any corresponding change in the joint demand. The rise +will be a rise of the two metals indistinguishably, the height of the +rise being diminished as the surface over which it is to take place has +been enlarged. + +The third case is where, demand remaining the same, the supply of both +metals undergoes a change in the same direction, either of increase or +of diminution, at the same time. In this event, the fall or rise will +again be of the two indistinguishably, the point reached being a mean +between the points which would have been reached by the two severally. + +The fourth case is where, demand remaining the same, the supply of the +two metals undergoes a change at the same time, but in opposite +directions, A through diminution, B through increase. In this case, the +opposite tendencies will counteract each other. If of equal force, the +value of money will be stable; if of unequal force, there will be +movement in the direction of the stronger to the extent of the +difference between the two. Instead of one falling and the other rising +in value, the change will be wrought in the two indistinguishably. + +It will appear from the foregoing statements that, under the bimetallic +system, the value of money will be liable to vary more frequently than +under the monometallic system. That is, a change in respect to either +constituent of the money mass will produce a change of value; and it is +apparent that the chances of change are greater with two constituents +than with one. On the other hand, the variations under the bimetallic +system are likely to be less extensive. Indeed, it is a matter of +practical certainty that they will be far less extensive than they would +be under the monometallic system, whichever metal were adopted as the +standard of deferred payments. + +But, again, the monometallist interposes the objection that the +bimetallic system is only to be supported at great expense to the States +maintaining it; that they lose by the exchange of the dearer for the +cheapened metal, even though they acquire a certain premium in doing so, +and that sooner or later the stock of the dearer metal in the bimetallic +countries will become exhausted, and the system will collapse, the price +of the two metals no longer being held closely or nearly at the former +ratio by the possibility of exchanging them at that ratio, freely, in +any amount. + +How far a bimetallic country loses by the alternation of the metals in +circulation, as now one and now the other becomes the cheaper at the +coinage ratio, is a nice question. + +That the service rendered to the commerce of the world by establishing a +normal price for each metal in terms of the other, and thus creating and +maintaining a par-of-exchange between gold countries and silver +countries, is worth far more than its cost, seems to me beyond a +rational doubt. It would, in my view, be as reasonable to doubt whether +London Bridge repays the expense of its erection and repair. Were the +cost of this bimetallic service, whatever it is, properly assessed upon +and collected from each commercial nation of the world by turns, +according to the proportion in which it derives advantage therefrom, I +think it might safely be said that no one of these nations would sustain +a single other charge which so fully justified itself in the return it +made, whether that other charge were for works of construction, for the +administration of justice, or for any other strictly necessary purpose. + +But there is no assurance that the cost of the bimetallic system will be +thus equitably assessed. If the whole charge of erecting and repairing +London Bridge were thrown upon the merchants of the two or three streets +nearest thereto, while yet the whole population were allowed to use the +bridge, free of toll, there would not unnaturally arise a strong sense +of injustice on the part of those who bore this burden for the public +benefit; it might even become a question whether the undoubted +advantages derived by them from the use of the bridge repaid the +disproportionate expense which it caused them. If the maintenance of the +bimetallic system involves a certain burden on the nations which sustain +it, as I am disposed to think is the case, it fairly becomes a question +whether those individual nations are compensated for bearing the whole +expense of the service by their share of the advantages resulting +therefrom to the trade and industry of the world. + +That England could well have afforded, throughout the present century, +to maintain this system for her own benefit, whatever it cost, even +though other nations profited by it in greater or less degree, is clear +as the light. That France, a country of far less extended international +trade, has been compensated for bearing so large a part as she has done +of the burden of maintaining a par-of-exchange for the commerce of the +world, by her share of the resulting advantages, I make no question; but +it must be admitted to be fairly a matter of dispute. + +On such a point it is evidence of no small value that the French people +themselves and the French statesmen, though singularly acute and +sagacious in matters of finance, have apparently not doubted that the +bimetallic system was for the interest of their country. Certain of the +French political economists--MM. Chevalier, Levasseur, Bonnet, +Mannequin, Leroy Beaulieu--from their theory of the subject have held +that France lost by her policy in this respect; but the financiers of +that remarkable nation held firmly to the "double standard" from 1785 +to 1874. And though France at the latter date restricted her silver +coinage, and two years later stopped it altogether, it was not done as +the result of any change of views. Partly it was from deference to her +monetary allies, Belgium and Switzerland, but chiefly because the +demonetization of silver by Germany and the sale of the discarded metal +of that empire brought a sudden strain upon the bimetallic system which +threatened to break it violently down. Hence France closed her mints to +silver, but not with any confession that her policy had been erroneous +under the conditions previously existing; not from any desire to abandon +that policy should the future offer conditions which would admit the +resumption of bimetallism. It was the declaration of M. Léon Say, the +French Minister of Finance, the President of the International Monetary +Conference of 1878, that France, in suspending the coinage of silver, +had taken no step towards the single gold standard, but had placed +herself in a position to await events, a position which she would not +leave till good reasons for action should appear, and then most probably +to re-enter on the system of the double standard.... + +The objection that the stock of the dearer metal in the bimetallic +States must, if the drain be indefinitely continued, become after a +while exhausted, and that the system will then lose all its efficiency +in holding the two metals together, is unquestionably valid; but an +altogether unreasonable weight has been assigned to it in the discussion +of bimetallism as a scheme of practical statesmanship. + +If we look at almost any treatise written from the monometallic point of +view, we shall find that it is taken as conclusive against that scheme, +that conditions of supply and demand can be assumed for the two metals +separately which would result in the complete exhaustion of the dearer +metal, and the consequent loss of all virtue in the bimetallic scheme. +The bimetallist is confronted with a series of adverse conditions, taken +each at its maximum and piled one above the other without the least +regard to the modesty of nature, or the experience of the past; and is +then challenged to say whether the system he proposes could be +maintained under such circumstances. If he is candid enough to admit +that bimetallism would fail there, it is taken for granted that the +whole question is disposed of. + +Now, human institutions are not to be judged of, and approved or +disapproved, by such methods. The folly of reasoning like this would be +seen at once were it applied to ordinary political matters. No +government on earth could stand against one-fourth or one-tenth of the +elements of hostility which might conceivably be arrayed against it. +Mankind do not, therefore, refuse to form governments. + +Bimetallism is a political institution for practical ends, and is +entitled to be judged with reference to reasonable probabilities. It may +claim the benefit of the chance that adverse conditions will be offset +by conditions favourable, and that the adverse conditions will not prove +so severe at the start as they may be conceived, and that their force +will be more quickly spent than might be feared. + +It would be perfectly legitimate ground on which to establish European +bimetallism, that the French system, with so little of support from +other States, passed within a quarter of a century through the three +successive shocks of the gold discoveries of Siberia, the gold +discoveries of California, and the gold discoveries of Australia, and +yet was not brought to the ground. + +With Germany, France, and England joined in a monetary union, no changes +reasonably to be anticipated in the conditions of supply of the one +metal or the other would succeed in moving the market ratio far apart +from the mint ratio thus supported by maintaining over so wide a surface +a legal equivalence between the two metals in payment of debts. + +And, moreover, while bimetallism is entitled to be judged like any other +political institution, with reference to the reasonable probabilities of +the future, the allowance which requires to be made for error and +extraneous force is less than in most political institutions, inasmuch +as the failure of bimetallism involves no disaster to industry or +society. + +When an engineer designs a bridge which is intended to sustain a weight +of eighty tons, he introduces a "factor of safety," say three or five, +and makes the bridge strong enough to bear two hundred and forty or four +hundred tons. The greater the calamity which would result from the +breaking down of the bridge--the deeper the chasm which it spans, the +swifter the torrent below--the larger the factor of safety. With many +political institutions, likewise, the consequences of failure would be +so disastrous that the statesman seeks to introduce a high factor of +safety; but in the case of bimetallism no catastrophe whatever is to be +anticipated, even in the event of failure. At the worst, after the drain +of the dearer metal, in consequence of changes in the conditions of +supply, is completed, the bimetallic country is simply in the same +position with the countries of the single standard using the cheapened +metal. While the process of substitution is going on, it sells the +dearer metal at a premium; when the process is over, it is no worse off +than it would have been had it originally selected as its sole money of +full legal-tender power the metal which it has bought at a discount, and +which other countries, perhaps its immediate neighbours, are still +using. It is not the case of a country seeking to reject the cheapening +metal, and to supply its place with the metal which is continually +becoming scarcer and dearer.... There is all the difference, in the two +cases, between going down hill and going up hill. + +Not only is no catastrophe involved in the failure of bimetallism +through the exhaustion of the dearer metal, but it is always in the +power of the Government to arrest the drain at any point without shock. + +Thus, in 1874, France and her monetary allies, seeing the prospect of a +considerable drain of gold through the importation of the discarded and +cheapened silver of Germany, and having decided, whether wisely or +unwisely, not to prevent that drain, restricted the coinage of silver +without repealing or suspending the law which made gold and silver legal +tender indifferently at a fixed ratio. Two years later, finding that the +forces operating to lower the value of silver were powerful and +persistent, the coinage of silver was peremptorily stopped. + +Can one point to any sign that France has suffered any special injury to +her trade and production from this act?... + +We now have to note ... that every additional State which joins the +bimetallic group, having the same mint ratio between gold and silver, +does not only share the cost or the burden with those already in the +system, but diminishes the aggregate cost or burden to be borne, and +this, not in a slight, but in an important degree, so that should the +monetary league become general, the total cost or burden to be divided +among the many allies would be inappreciable; while, should the system +come to embrace all commercial States, there would, in theory, be no +burden at all to be borne by any one. + +Thus let us suppose the commercial world to be divided into sixteen +States, A to P, inclusive, the first six having the single gold +standard, four, G to J, the so-called double standard of gold and +silver, say at 15-1/2:1; the remaining six States having the single +standard of silver, thus: + + A, B, C, D, E, F (G, H, I, J), K, L, M, N, O, P. + +It is evident that in the case of a change in the conditions of supply +tending to cheapen silver relatively to gold, the new silver would pass +into the countries of the double standard, G to J, be there exchanged +for gold at the rate of 15-1/2: 1, with some small premium as the profit +of the transaction, and the gold would go to the gold countries, A to F, +in settlement of trade balances. + +The rapidity with which this substitution of silver for gold will go +forward will depend, first, on the force of the natural causes operating +to cheapen silver, and, secondly, on the force of the commercial causes +operating to maintain or advance the value of gold. The length of time +during which the drain of the dearer metal can be sustained without +exhaustion will (given the rate of movement) depend solely on the stock +of that metal existing in the bimetallic States jointly when the drain +begins. + +But chief among the commercial causes operating to maintain or advance +the value of gold is the exclusive power with which gold is invested by +law to pay debts within States A to F; while the stock of the dearer +metal available to sustain the drain described is made up, not of all +the gold in the sixteen States A to P, or in the ten States A to J, but +only of the gold in the four bimetallic States, G to J. + +Hence we see that for every gold State which adopts the "double +standard" the amount of gold available, in the case of a cheapening of +silver, to meet the drain of the dearer metal (on which the virtue of +the bimetallic system depends) is increased; while the demand for gold +in preference to silver at 15-1/2:1 (the only cause which threatens the +stability of the bimetallic system) is, in just so far, diminished. On +the other hand, every silver State that adopts the "double standard" +strengthens the bimetallic system in the case of a cheapening of gold. + +Let us suppose the sixteen commercial States to be divided as four gold +States, eight gold and silver States, and four silver States, as +follows: + + A, B, C, D (E, F, G, H, I, J, K, L), M, N, O, F. + +We see that the bimetallic system is now not twice as strong merely as +in the case first assumed, but many times as strong, since not only is +the amount of the dearer metal (whichever that may at the time be) +subject to drain greatly increased, but the demand for that metal, in +preference to silver at 15-1/2:1, now comes from four countries only, +instead of six, as formerly. The transfer of still another State from +each of the two single-standard groups would vastly increase the +stability of the bimetallic system, A, B, C (D, E, F, G, H, I, J, K, L, +M), N, O, P. Not only would the base of the system be broadened by +bringing the dearer metal of ten States, D to M, under tribute in the +event of changes operating on the supply of either to affect its value; +but the force of the causes threatening the equilibrium of the system +would be reduced, since the demand for the dearer metal would now come +from only three States: A, B, C, in the case of a cheapening of silver +relatively to gold; N, O, P, in the case of a cheapening of gold +relatively to silver. + +Bring still another State from each group into the monetary union, and +the danger of a breaking down of the system, under any change in the +conditions of supply which it would be reasonable to anticipate, almost +disappears. + +A, B (C, D, E, F, G, H, I, J, K, L, M, N), O, P. Twelve States now +supply the dearer metal; only two States will take it in preference to +the other at the ratio of the mint. Those two States--whether A, B, or +O, P--can not take the dearer metal indefinitely. They will soon be +surfeited. A further increase of money in them would only be followed +by a fall in its value, which would soon proceed so far as to bring the +metals together again. What the one metal would tend to lose in value +through increase of supply, the other would tend to lose through +diminution of demand. + +This is the Modern Bimetallic Scheme advocated by Wolowski and Cernuschi +in France, Malou and de Laveleye in Belgium, Mees and Vrolik in Holland, +Schneider in Germany, Haupt in Austria, Seyd and the Liverpool writers +in England, Horton, Nourse, and George Walker in the United States. + +It differs widely from the plan of the so-called "double standard," +which was pronounced impracticable by Locke, Adam Smith, and Ricardo. +Not the smallest presumption against the reasonableness of this scheme +is created by the fact that eminent economists of the past century, and +of the first half of the present, declared in favour of the single +standard, whether of gold or of silver. Those writers contemplated a +condition of international relations in which anything like general and +permanent concert of action, in establishing and maintaining a ratio +between the metals in the coinage, would have been wholly beyond +reasonable expectation.... + +A general or universal system of bimetallism would involve no machinery, +no international accounts, no detail whatever. The simple agreement of +governments to coin at a certain ratio would be sufficient for all the +objects that have been discussed. If unification of coinage, identity of +moneypieces, and mutual acceptance of coins by the several nations +forming such a monetary league, were to be added, some machinery for the +redemption of worn pieces might require to be brought into existence; +but this is not a necessary feature of successful bimetallism, which +would be entirely compatible with the retention by each State of its own +devices and denominations, and with the exchange of moneys as at present +effected.... + +FOOTNOTES: + +[15] Francis A. Walker. _Money in Its Relations to Trade and Industry_, +pp. 164-176; 178-182. Henry Holt & Company. New York. 1889. + + + + +CHAPTER VII + +THE SILVER QUESTION IN THE UNITED STATES + +[16]Such was the singular combination of events after the peace of 1865 +that almost at the moment when a million citizens were turned from +organised destruction to pursuit of peaceful industry, the avenues of +American employment and production were widened in a degree +unprecedented in the history of trade. Within eight years after Lee's +surrender, the railway mileage of the United States was literally +doubled. Only a fraction of this increase belonged to the +transcontinental lines which linked the two oceans in 1869. Quite aside +from the 1,800 miles of the Pacific railways, upwards of 30,000 miles of +track were laid in the United States between 1865 and 1873. Four +noteworthy economic developments accompanied this extension of the +transportation system. A fertile interior domain, hitherto untouched, +was opened up to industry. With the rush of population to these Western +districts, not only did the disbanded army resume production without +industrial overcrowding such as followed the Napoleonic wars, but +provision was made for three or four hundred thousand immigrants +annually. European capital in enormous volume was drawn upon to provide +the means for this development. Finally, the United States rose from the +position of a second- or third-class commercial State to the first rank +among agricultural producers and exporters. Each of these several +phenomena had its special influence on the period. + +Not less immediately connected with this opening up and settlement of +our agricultural West was still another phenomenon, of peculiar interest +to the study of the ensuing period. The average price of grain had +advanced with great rapidity during the Civil War. In 1867, the price of +wheat, even on the Chicago market, reached the remarkable level of +$2.85 per bushel; nor was this price very greatly above the annual +maximum of the period. In a large degree, this advance resulted from +inflation of the American currency. But the upward movement was +world-wide; in 1867 and 1868 the average price, even in England, was +close to the equivalent of two dollars a bushel. That any such abnormal +market could be maintained in the face of the new American supplies was +at least improbable. The increase in cereal production was twice as +rapid as the country's increase in population; the United States became +therefore the leading figure in the world's export markets; and this was +certain to have important influence on prices. + +As in America, so in Europe, production received immediate stimulus. +While American capital was opening up the Mississippi Valley, European +capital was similarly busy along the fertile river basins of the Dnieper +and the Danube. The Russian railway system grew during this period from +something like 2,000 miles to upwards of 13,000. In Austria-Hungary the +percentage of increase was almost equally large. All of these new +transportation lines, like our own new Granger railways, were at once +engaged in carrying to the seaboard supplies of grain which never before +had reached an export market. The problem of an earlier generation had +been how to feed the constantly increasing population; a wholly new +problem was presently to arise, based on the question how to find a +ready and profitable market for the year's output of breadstuffs. +Prices, in short, which rose almost continuously throughout the world +during the period of slack production from 1858 to 1873, receded almost +as continuously in the ensuing generation. Nowhere was this phenomenon +destined to have more immediate importance, economically, socially, and +politically, than in the United States. + +The opinion is more or less widely held that the decline in prices, +notably of grain, has resulted from legislation on the currency. Without +for the present arguing that proposition, it may be affirmed with entire +safety that a good share of the period's currency legislation has +resulted from the decline in the price of grain. The fall in wheat has +been the typical argument for arbitrary increase of the silver or paper +currency in almost every Congressional debate since 1872. What is +perhaps even more significant, the division in almost every +Congressional vote upon these subjects has been, not political but +geographical--the commercial East against the agricultural West. + + +AGITATION FOR SILVER AND THE PASSAGE OF THE BLAND BILL + +[17]In the summer session of 1876, several bills had been introduced, +providing for increased silver coinage and for remonetization of the +silver dollar. None of these propositions came to anything; they were +chiefly remarkable from the fact that they first gave vogue to the +theory of the "crime of 1873"--a theory which assumed that the dropping +of the silver dollar from the list of coins in the statutes of that year +was the outcome of a conspiracy which carried its legislation through in +secret. The entire baselessness of this assertion has been demonstrated +often enough and in convincing detail; this very provision regarding the +silver dollar was a subject of public discussion in the House, and met +with no serious opposition. The assertion in itself is so patently +absurd that I shall not pause to discuss it. The truth is that silver in +1873, and during a generation before that date, was worth more to its +owner in the form of bullion than in the form of coin. In 1872 the +silver requisite to coin a dollar at the established ratio was worth +$1.02. For years, therefore, nobody thought of bringing his silver to +the mint for coinage; he sold it in the commercial markets. The total +silver-dollar coinage of the United States, between 1789 and 1873, was +barely eight million dollars, and when, in 1873, the law provided that +except for the so-called trade dollar coined for export, "no deposit of +silver for other coinage shall be received," no one had interest enough +in the matter to offer criticism. + +But in 1874 and 1875 came one of those curious coincidences which render +possible for all time conflicting theories of an economic event. +Germany, having adopted the gold standard of currency in July, 1873, +began to sell its old silver coin as bullion. At exactly the same time, +Mackay and Fair, in the heart of the Nevada Mountains, were opening up +the Great Bonanza. The Pacific Coast was in fact going wild over the +rise in mining shares while the East was financially and industrially +paralysed. + +The statute dropping the silver dollar from this country's coinage list +was enacted February 12, 1873; the German law for retirement of silver +coinage was adopted July 9, 1873; and a year later the news of the rich +Nevada "ore-finds" became public property. Between the German sales and +the sales at Nevada City, the price of silver yielded. In 1874, for the +first time in a generation, 412-1/2 grains of standard silver would have +been worth more when coined into a legal-tender dollar than when sold in +the bullion market. The motive of the mining interest in the free-silver +coinage agitation of 1876 and 1877 was not mysterious. + +The motive of the anti-Administration party in Congress was somewhat +different. There is not the slightest question that the silver-coinage +movement, in the agricultural West particularly, had the same origin and +the same following as the paper inflation movement of a few years +before. Mr. Bland himself, the author of the silver bill, declared that +the question was presented as between what he called "honest resumption" +with silver coinage, "or on the other hand a forced unlimited inflation +of paper money." In the heat of debate on the silver bill, the same +statesman declared in Congress that if his coinage plan could not be +passed, he was "in favour of issuing paper money enough to stuff down +the bondholders until they are sick." The point of these remarks lies in +their frank assumption that the free-silver sentiment and the fiat-money +sentiment were interchangeable. + +So much, then, for the origin and nature of the silver movement. The +Bland Bill passed the House on November 5, 1877, under the previous +question and without debate, by a vote of 164 to 34, and the resumption +operations of the Government came to an instant halt. The market price +of silver then was such that the legal-tender dollar of the Act would +have been worth intrinsically less than ninety cents. Foreign +subscribers to our resumption bonds suspected instantly that payment of +the Government debt in a depreciated coin was planned by Congress; their +suspicions were confirmed by a resolution introduced December 6th by +Stanley Matthews, Mr. Sherman's own successor in the Senate, and passed +by both houses. The resolution explicitly declared that in the opinion +of Congress, all the bonds of the United States, "issued or authorized +to be issued," were payable in the silver dollars of the Bland Law. The +extraordinary character of this resolution may be judged from the fact +that it was proposed and passed in both houses while the Coinage Act was +still pending, and while, therefore, there was not in existence the coin +which was duly declared a legal tender for settlement with public +creditors. To the conservative portion of the public, the resolution +seemed a piece of financial lunacy; to the Treasury, it was not only +embarrassing but humiliating. Hardly a month before, in his annual +report to Congress, the Secretary had repeated his official statement, +previously made to bond subscribers, that payment of the bonds in gold +might safely be anticipated. The publication of this statement in New +York and London had been followed by greatly increased subscriptions to +the bonds, in payment of which gold was required by the Government. The +Matthews resolution amounted, so far as Congress was concerned, to +repudiation of a formal bargain of which the Government had already +obtained the fruits. The debate was such as might have been expected on +a measure of the sort. It centred repeatedly on denunciation of +Government bond investors. Foreign subscribers were treated with +especial scorn; indeed, our foreign customers in general were not +spared. It was this debate which drew forth Senator Matthews's somewhat +celebrated query: "What have we got to do with abroad?"--a remark which +was perhaps as typical of the session's deliberations as any utterance +made from the floor of Congress. + +The situation, during the early months of 1878, was extremely critical. +For the time the three direct assaults on the public credit were warded +off. The Matthews resolution was "concurrent," and hence a mere +expression of opinion without binding force. The bill repealing the +Resumption Act of 1875 was killed by disagreement in the Senate. +Meantime the Silver-Coinage Act was modified by the Senate into a +compromise requiring purchase and coinage by the Government of two to +four millions' worth of silver monthly. Even thus modified, it +encountered the veto of the President, but was passed over his veto, +without a day's delay, by the requisite two-thirds majority. Executive +conservatism seemed to be fruitless; nevertheless, there is no doubt +whatever that the steadfast policy of Mr. Hayes did much to stem the +current of reaction. + +Congress adjourned on June 19th. Even before Congressional adjournment, +the canvass for the November State elections had begun. The State +Convention platforms in the summer of 1878, were not in all respects +such as the session's work in Congress would have suggested. + +The opposition had gone too far in Congress, and popular opinion to that +effect was expressed with sufficient emphasis in November, 1878. The +Administration party gained what amounted to a decided victory. There +were but four States, East or West, where opposition majorities were +increased in 1878 or Administration majorities diminished, and these +were agricultural States, where the season's sharp decline in wheat had +stirred up discontent. There was not much danger from the closing +session of a Congress whose earlier ventures had received this response +from the people. + + +PROVISIONS OF THE ACT OF 1878 + +[18]Although the silver dollar of which the coinage was resumed in 1878, +dates back as a coin to the earlier days of the Republic, its reissue in +that year marks a policy so radically new that the experience of +previous years throws practically no light on its working. The act of +1878 provided for the purchase by the Government, each month, of not +less than two million dollars' worth, and not more than four million +dollars' worth of silver bullion, for coinage into silver dollars at the +rate of 412-1/2 grains of standard silver (or 371-1/4 grains of fine +silver) for each dollar. The amount of the purchases, within the +specified limits, was left to the discretion of the Secretary of the +Treasury. As every Secretary of the Treasury, throughout the period in +which the act was in force, kept to the minimum amount, the practical +result was a monthly purchase of two million dollars' worth of silver +bullion. + +The act is sometimes described as having called for a monthly issue of +two million silver dollars; but this was not the exact situation. The +amount of silver obtainable with two million dollars obviously varies +according to the price of the metal in terms of the dollars with which +the purchases are made. In February, 1878, when the first purchases were +made, those dollars were the inconvertible United States notes, or +greenbacks, worth something less than their face in gold. The amount of +silver bullion obtainable with two million such dollars depended, on the +one hand, on the price of silver bullion in terms of gold, and on the +other hand on the value of the dollars themselves in terms of gold. When +specie payments were resumed, on the first of January, 1879, and the +greenbacks became redeemable in gold, the measure of value in the United +States became gold, and the extent of the coinage of silver dollars +under the act of 1878 became simply a question of how much silver +bullion could be bought with two million dollars of gold. The price of +silver in 1878 was, in terms of gold, not far from a dollar for an ounce +of standard silver. Since 1878 it has gone down almost steadily, and ... +in 1889 was barely above 80 cents an ounce.[19] The silver dollar of +412-1/2 grains contains less than an ounce (480 grains) of standard +silver. The monthly purchase of two million dollars' worth of silver has +therefore always yielded more than two million silver dollars, the +amount being obviously greater as the price of silver went lower. On the +average, the monthly yield [was] not far from two million and a half of +silver dollars.... Thirty millions of silver dollars a year was roughly +the addition to the currency of the community from the act of 1878. + + +SILVER CERTIFICATES + +[20]An important provision of the act of 1878 was that authorising the +issue of silver certificates against the deposit of silver dollars. This +authority was limited at the time to certificates in denominations only +of ten dollars and upward: a restriction which ... proved to be of great +importance. At the time it does not seem to have been expected that the +silver certificates would enter directly into the circulating medium; we +may infer from the restriction to large denominations that no such +expectation was entertained. But in fact, it has been chiefly in the +form of certificates that the silver has entered into circulation. These +certificates, it is true, are not, like the dollars themselves, a legal +tender; but they are receivable for all public dues, customs included, +and they pass from hand to hand at least as readily as the bulky pieces +which they represent. + + +CAUSES OF THE ACT + +[21]The passage of that act was due to causes easily described. It was +part of the opposition to the contraction of the currency and the +resumption of specie payments which forms the most important episode in +our financial history between 1867 and 1879. The resumption of specie +payments had been provided for by the act of 1875, and was to take place +on January 1, 1879. In the meanwhile, the long-continued depression +which followed the crisis of 1873 intensified the demand for more money +and higher prices. That demand led to the inflation bill passed by both +Houses of Congress in 1878, and killed by the veto of President Grant. +The same feeling led to the silver act. The great fall in the price of +silver, beginning in 1873, and showing itself markedly in 1876, made +silver, at the old ratio, a cheaper currency than gold, and so caused +the opponents of the return to specie payments to prefer silver to gold, +as they preferred paper to either. No doubt some additional force was +given to the movement in favor of the use of silver from the desire of +the silver-mining States and their representatives, that the price of +the metal should be kept up through a larger use of it for coinage.... + + +WHEREIN PECULIAR + +[22]Although the specific measure passed in 1878 thus rested on a long +train of historical causes, it contained details that were essentially +new, not only in our own experience, but in that of the world at +large.... It ... provided for a regular mechanical addition of large +amount to the general circulating medium. No precise experiment of this +kind had ever been tried. It is true that Germany and the countries of +the Latin Union possess, in their circulating medium, large quantities +of overvalued thalers and five-franc pieces which are exactly like our +silver dollars. They also are legal tender without limit; their total +quantity is limited; and it is only by this limitation of the quantity +that their value is kept above that of the bullion contained in them. +But the thalers and francs in these countries are not new additions to +the currency. They are remnants from an earlier period, when Germany had +a silver standard, and the Latin Union a complete bimetallic standard. +No addition whatever to the thalers is made in Germany; and if some +coinage of five-franc pieces takes place in France and in other +countries of the Latin Union, the additions are meant merely to fill the +place of abraded coins, to provide for the ordinary losses from daily +use, and to make any additions to the supply which may be needed for +convenience in making small change. No other country has ever entered on +an addition of overvalued coin to its circulating medium having the +object and extent of that made by our silver act of 1878. This +characteristic of the measure, it need hardly be said, was the result +not of any deliberate intention to try a new experiment, but of the +spirit of compromise which explains so many anomalies in the legislation +of democratic communities. The silver act, as passed by the House of +Representatives, provided for complete bimetallism--for the free and +unlimited coinage of the silver dollar at the old ratio of 16 to 1. In +the Senate, it was amended by the substitution of the provisions for a +limited coinage, which were finally enacted. The compromise was meant to +satisfy both those who objected to the cheaper standard and those who +wanted more money; and it afforded a welcome escape to the legislators +who were trying to satisfy all parties. At the time, no one probably +expected that the measure would remain in force for any great length of +time. The conservative element hoped that it would be repealed after a +short trial; the inflationists (for by that name they might, then at +least, fairly be called) believed that it would soon be superseded by +the free and unlimited coinage of silver. As it happened, the act +remained in force, unamended, and indeed without very serious attempt at +amendment, for over twelve years; and the measure which succeeded it in +1890, though different in many details, followed the same method of +forcing a large regular injection into the circulating medium of money +based on silver purchases by the Government. + + +LIMITED CIRCULATION OF THE SILVER DOLLARS + +[23]The Government has made every effort to get the dollar coins out of +its hands.... But the great bulk of the coins thus got out of the +treasury return to it almost at once. The degree of favor which they +meet with of course ... varies in different parts of the country, +apparently reflecting in a curious way the popular feeling as to the +desirability of having silver currency at all. They circulate very +little east of the Alleghanies, but are used more freely and permanently +in the Mississippi Valley. Among the negroes of the South the big pieces +are said to be favorites, and to find a permanent lodgment. Their +greatest circulation ... was reached in 1886; after that time the change +in the denominations of silver certificates caused a decline in the +amount used. + + +PROVISIONS OF THE ACT OF 1890 + +[24]The act of July 14, 1890, is[25] more remarkable than that of 1878. +It is unique in monetary history. It provides that the Secretary of the +Treasury shall purchase each month at the market price four and a half +million ounces of silver bullion. In payment he shall issue Treasury +notes of the United States, in denominations of between one dollar and +one thousand dollars. These Treasury notes, unlike the old silver +certificates, are a direct legal tender for all debts, public or +private, unless a different medium is expressly stipulated in the +contract. They differ from the silver certificates in another respect; +they are redeemable either in gold or silver coin, at the discretion of +the Secretary of the Treasury. The indirect process of redemption +which,... was applied to the silver certificates, is replaced for the +new notes by direct redemption. The avowed object is to keep the silver +money equal to gold, for it is declared to be "the established policy of +the United States to maintain the two metals at a parity with each other +on the present legal ratio, or such ratio as may be provided by law." +The act of 1878 is repealed; but the coinage of two million ounces of +silver into dollars is to be continued for a year (until July 1, 1891). +Thereafter it is directed that only so many silver dollars shall be +coined as may be needed for redeeming any Treasury notes presented for +redemption. Practically this means that the coinage shall cease; +redemption in silver dollars will not be called for under present +conditions. The coinage of silver dollars accordingly was suspended by +the Treasury on July 1, 1891; a change which was the occasion of some +vociferous abuse and equally vociferous praise, but which in reality was +of no consequence whatever. + + +AMOUNT OF MONTHLY ISSUES + +[26]The monthly issues of the new Treasury notes vary, like those of the +old silver certificates, with the price of silver. But the new issues +vary directly with the price of silver, while as we have seen, the old +issues varied inversely with the price. The volume of Treasury notes +issued is equal to the market price of four and one-half million ounces +of silver. For a month or two after the passage of the act, the price of +silver advanced rapidly, and at its highest, on August 19, 1890, +touched $1.20. After September a steady decline set in.... + + +THE POLICY OF THE BANKS + +[27]Shortly after the passage of the act [of 1890], some sort of +understanding seems to have been reached between the Treasury Department +and the banks of New York. The banks came to an agreement that the new +notes were to be treated as "current funds," receivable in all payments, +clearing-house settlements included.... + +The fact that the new notes were received by the banks from the +Sub-Treasury in settlement of clearings, was of sensible advantage to +the Government. The success of the Government in maintaining its nominal +willingness to pay gold to all comers was due to the forbearance of the +banks. Gold was called for by them only when needed for export. + + +THE ARGUMENT FOR SILVER + + +THE BIMETALLIST ARGUMENTS + +[28]... Is it desirable that we should have more money? Does the +maintenance of the gold standard involve injustice or hardship to +debtors, or to any class in the community? Does it have any ill effects +in hampering industry or checking the advance of production? Is the free +coinage of silver, or any measure leading ultimately to a silver basis, +fairly open to the objections commonly urged against it on the grounds +of dishonesty and injustice?... + +In considering these questions, we must look to the ultimate and +permanent results of the silver standard. The details ... as to the mode +in which the silver issues circulate and the degree of promptness with +which they will affect prices, are here of no great importance. Under a +silver standard the rise in prices will take place in the end; and we +are concerned with the social consequences of such an eventual +result.... + +I propose here to take up chiefly one set of serious arguments--those +which rest on the changes in general prices which have taken place +throughout the civilised world in the last twenty years. The conclusions +in favor of a wider use of silver, drawn from such changes, have been +maintained by distinguished economists. It is true that the particular +plans for the use of silver which are now in vogue in the United States +have generally been opposed by these economists. They have urged +international agreements for the wider use of silver, and have +deprecated independent action by any one nation. But the more +thoroughgoing advocates of free silver in the United States say, +certainly with much force, that an international agreement has proved to +be simply impracticable, and that if the wider use of silver is to be +deferred until there is concerted action by the great nations, it will +never come. If anything in this direction is to be done, some one +country must be courageous enough to take the lead, trusting that others +will follow in due time. And certainly it is true that the scheme for +international bimetallism has practically no prospect of adoption; +while, on the other hand, the serious arguments urged by its advocates +tell, in some degree, in favor of any scheme for enlarging the use of +silver as money. These arguments, moreover, are of weight, and deserve a +more painstaking consideration than is often admitted by those who +oppose the silver legislation of the United States. + +The serious and important arguments, then, among those who, both in this +country and in Europe, advocate a greater use of silver as money, are +derived from the general fall in prices which has been so conspicuous +among the economic phenomena of the last twenty years. To that fall they +ascribe two evils: first, an unjust increase in the burdens of debtors; +and, second, a check to enterprise and to the efficient working of the +productive machinery of the community. The increase in the burdens of +debtors is one which all economists have pointed to as the result of a +general fall in prices, or rise in the value of the circulating medium. +The debtor who borrows a hundred dollars now, and repays them five years +hence, when all prices have fallen, gives back more than he received. On +debts running for short periods of time, changes in general prices are +not likely to be great enough to cause serious hardship; but on debts +running over long periods the loss to debtors and the gain to creditors +will be great and continuing. But such a steady and continuous fall, it +is urged, has taken place since 1873; and the fall is likely to continue +further, and to renew its hardships on each new act of borrowing, +because its cause is a permanent one. That cause is found in the growing +scarcity of gold, which has been selected as the sole standard of value +among civilised countries. The production of gold, after having +increased with great rapidity in the twenty years following the +Californian and Australian discoveries in 1850, has gone on but slowly +since 1870. Meanwhile, the population of the civilized countries, their +wealth, their production of commodities to be exchanged, have increased +with extraordinary rapidity; while the adoption of the gold standard by +Germany in 1873, and the resumption of specie payments by the United +States in 1879 and by Italy in 1883, have added to the demands for which +the scanty annual supply of gold must suffice. Hence the general fall in +prices; in other words, the appreciation of gold. + +The second effect of the appreciation of gold, in checking industrial +progress and promoting industrial depression, has been less insisted on +in the United States than in European countries. The classic economists +had generally reasoned that a general rise or fall in prices was +indifferent, except in regard to the relations of debtor and creditor. +If money became scarce, if its value rose and all prices fell, every +producer, to be sure, would receive a smaller money income than before, +and would have a smaller money capital. But he would be able to buy as +many commodities and as much labor as before, and would be in reality +just as rich and prosperous. In the middle of the eighteenth century, +when economic thought was just beginning to assume its modern form, +David Hume had argued that though a fall in prices is at bottom +indifferent to everybody (except as debtor or creditor), it would yet, +in its effects on men's spirits and expectations, which are all +connected with money and with terms of money, exert a depressing +influence on industry, and would so be harmful; while rising prices, +though also really indifferent to all, would stimulate hope and +confidence, and so arouse to more active exertion and more plentiful +production. The younger Mill, in his _Political Economy_, thought it +worth while to enter on a careful refutation of Hume's reasoning. But +the bimetallists of our time are disposed to agree with the shrewd +Scotchman. They say that the active manager of industry, the business +man or _entrepreneur_, in the first place is always more or less in +debt; in the second place, is always buying labor, or materials, or +goods, with the intention of selling a product at a later date at an +advance in price. He habitually measures his gains in terms of money, +and not in terms of the commodities he can buy with the money. In times +when prices are falling, he finds it harder to meet his debts, and to +dispose of his goods in hand at a money advance over what they cost him. +But the business man, or entrepreneur, in our day is the director and +initiator of industry. He employs labor, borrows capital, sets the +wheels of industry in motion; it is his expectations and fears and hopes +which determine primarily whether the investment of capital shall take +place in large or small amount, and whether the machinery of production +shall move smoothly and effectively, or slowly, hesitatingly, +inefficiently. The argument certainly does not lack plausibility; nor +can it be said to have often been squarely met. No doubt it takes the +form, in the United States, more frequently of confused encomiums on the +inspiriting effects of plentiful money, than of direct reasoning as to +the ill effects of too little money, such as I have endeavored to state +with fairness in the preceding sentences. Yet it does not lack weighty +backing. So eminent an economist as President Francis A. Walker has ... +insisted on the evils of a deficient supply of money as strangling the +arteries of industrial life. + +On the whole, however, the other argument, bearing on the increase in +the burdens of debtors under falling prices, has been more often heard +in the United States, and certainly has been of more effect. Prosperity, +activity, general industrial advance, have been in this country so great +and so obvious that the argument as to any check to industry could take +serious hold only in occasional periods of depression or slackened +advance. The burden on American debtors from falling prices has +therefore been much more steadily complained of, chiefly in regard to +the debts of the farmers and other borrowers on a comparatively small +scale. No doubt there are other debtors whose burdens are affected at +least as much, notably the railways, among whom the practice of +borrowing heavily on long time has sometimes had its serious effects. +But it is the farmer whose case has received most attention, and in some +ways doubtless has deserved it most. + +The discussion of the relations of debtors and creditors under the gold +standard has led to some further conclusions as to the "honesty" of the +gold and silver standards. Those who oppose a silver basis speak of the +silver dollar as a "dishonest" coin. But those who attack the gold +standard retort that the really dishonest dollar is that of gold. It is +pointed out by them that the fall in the price of silver which has taken +place since 1873 has not been greater than that in the prices of +commodities generally. As compared with commodities, therefore, silver +has been more steady in value than gold. The fall in the gold price of +silver, which is adduced by the mono-metallists to show that silver is +not a good standard of value, is said to be the very thing which proves +it to be a good standard of value; for a given amount of silver will buy +the same amount of commodities, roughly, as it would twenty years ago, +while a given amount of gold will buy more. If debts had been expressed +in terms of silver, the debtor would have had to repay the creditor the +same amount of commodities that he received--not more commodities, as he +has had to do, with debts measured and repaid in terms of gold. So far +as the attainment of the closest possible approach to ideal justice is +concerned, a silver standard would have served the purpose better than a +gold one. + + +THE EFFECT OF IMPROVEMENTS IN PRODUCTION + +The bimetallist agitation for a return to the wider use of silver +concurrently with gold first became prominent in the years of depression +which followed the crisis of 1873. For some time those who opposed it +took the ground that the alleged evils did not exist--that in fact there +had been no permanent fall in general prices. The decline in the years +after 1873 was supposed to be simply the usual reaction from the rise +in prices which marks a period of speculative activity. It was expected +that the upward movement of the next period of activity would bring the +average range of prices as high as it had been before. The general +revival which set in after 1879 in all civilized countries did indeed +check the downward tendency, and in some countries brought about an +appreciable rise. But this counter-movement by no means offset the +marked fall which had preceded it; and in any case it soon came to an +end, and was followed by a new fall, which has continued with no +considerable interruption to the present time (1891). It is true that +some part of the fall is no more than a recoil from the abnormally high +prices of the years 1871-73. It is true, also, that some commodities +have shown a tendency to rise, and that in one very important +respect--in money incomes and the money rate of wages--there has been a +striking exception to the general movement. Further, it must be borne in +mind that even the lowered level which has now been reached cannot be +described as abnormally low, being still as high as that which obtained +at the middle of the present century. But on the whole, the fact of a +general fall in the prices of commodities during the last fifteen or +twenty years cannot be denied. The fall has not been uninterrupted; it +has not been so rapid or general as to bear on the face of it proof of +harmful results; but it has been steady, and, in the opinion of the +present writer at least, is likely to continue slowly and steadily for +some time to come. + +Recently, therefore, those who combat the bimetallist reasoning have +taken a different position. They have reasoned that while prices may in +fact have gone down, the fall is not due, as the bimetallists allege, to +an appreciation of gold. It is to be accounted for, they say, by other +causes, notably by the extraordinary improvements in the production of +commodities. New inventions and the perfecting of old ones have +cheapened almost all manufactured articles. Raw materials and food +products have been cheapened partly by the discovery of new sources of +supply, and partly by that improvement which has been transforming the +industrial situation more radically than any other--the wonderful +cheapening of transportation by railways and steamships, which has made +the resources of the plains of our West and of the sheep-runs of +Australia available for the supply of the markets of London and New +York. + +So far as this train of reasoning undertakes to explain the mode in +which the fall in prices has been brought about, it seems to me +impregnable. But in so far as it endeavors to disprove the appreciation +of gold, or to show that the general fall is not due to this +appreciation, I have never been able to see its force. In truth, both +the bimetallists and their opponents seem to confuse the question when +they speak of the appreciation of gold as causing lower prices. The +appreciation of gold _is_ the general fall in prices. The two are not +related as cause and effect; they are simply two names for one and the +same thing--namely, a different rate of exchange between gold on the one +hand and commodities in general on the other, by which the same amount +of gold buys more commodities than before. When the general fall in +prices is admitted, the case of the bimetallists as to the appreciation +of gold is established once for all. Improvements in the production of +commodities may explain how it happens that they are more abundant, and +exchange on less favorable terms with gold, of which the quantity has +not been increased by new rich mines or great improvements in +production; but the fact of the depreciation of commodities, or of the +appreciation of gold, is not thereby explained away. + +Nevertheless, the improvements in production do seem to me to have an +important bearing on the question in hand: a bearing not on the simple +fact of the appreciation of gold, but on the social consequences which +are said to flow from it, and therefore on the questions of policy which +are here under consideration. A moment's thought will show, for example, +that a general increase in the efficiency of labor affects very +materially the mode in which a fall in prices acts on the relations of +debtor and creditor. If A borrows from B a hundred dollars, repayable in +five years, and if at the end of the five years prices in general have +fallen to one-half of the previous rates, B, in paying back to A the one +hundred dollars, clearly returns twice as many commodities as he got. +But if, at the same time, the efficiency of labor has been doubled by +improvements in production, B can produce with the same labor twice as +many commodities as before; and he returns to A the product of the same +quantity of labor as he received. The classic economists and the +socialists (at least some schools of socialists) have maintained alike +that the ideally perfect standard of justice in the exchange of +commodities and services is equality of sacrifice or labor; that if +things so exchanged for each other that equal sacrifice got the same +reward, complete justice would be attained. Applying this test to the +relations of debtor and creditor in the case supposed, we find it not +one of hardship to the debtor, but apparently one of justice to both +parties. It is true the creditor gets more commodities than he gave; but +he gets the product of the same amount of labor as he devoted to the +commodities originally lent; and why should he not share with the rest +of the community the benefits of a general increase in the +productiveness of labor? + +This line of reasoning will become simpler and more concrete if we +approach it from another point of view. Reference has already been made +to the most striking and important exception to the general tendency of +prices to fall, namely, that money wages and incomes in all civilized +countries have shown a tendency not to fall, but to rise. Whether the +incomes of the rich have increased faster than those of the poor, or +whether the movement has shown itself with rough uniformity for all +classes, is immaterial for the present discussion. The admitted fact of +a general upward movement alike among rich, middle class, and poor is +the significant thing. In other words, there has been an inverse +movement of money wages and of the prices of commodities, the one going +up while the other went down. Now, such an inverse movement is what must +take place in case of any real improvement in material welfare. The only +concrete way in which civilized people can become better off, is by +being able to buy more--by their money incomes going further in the +purchase of commodities. The improvement may take the form either of +higher money incomes, with stationary prices; or that of stationary +incomes, with lower prices; or the intermediate form which in fact seems +to have occurred, of money incomes rising somewhat and prices at the +same time falling somewhat. If we assume a monetary supply that is +limited, or does not increase as fast as improved means of production +cause the quantities of commodities to increase, one or the other of the +two forms last mentioned must be found. + +In such a state of things there can hardly be said to be any real +hardship for the debtor. It is true that prices have fallen, and that +the money he repays the creditor will buy more goods than it did when +the loan was contracted; but his own money income has risen, or at least +has not fallen, and the repayment of the loan can cause him no special +hardship--none greater than he must have expected. The case clearly +differs fundamentally from that of a simple rise in the value of money, +or general fall in both prices and wages.... The fall in prices in the +United States since 1879, and that in European countries in the period +since 1873, are the result, on the whole and in the long run, of ... the +general improvements in production; they have not been accompanied by a +fall in money incomes, and they cannot be said to have caused an +increase in the burden of debtors. + +The reasoning of the preceding paragraphs bears also on the second part +of the bimetallist indictment--that, namely, as to the depressing +effects of falling prices on industrial enterprise. Whether a simple +rise in the value of money, unaccompanied by any other circumstance, +would have the depressing effects which the bimetallists predict and the +classic economists deny, is a question radically different from that +which in fact presents itself. It may be that in this simple case the +bimetallists might prove to be, in some degree at least, in the right, +and that the classic reasoning, here as on many other subjects, while +sound in the long run, would need some qualifications and correction. In +the long run, no doubt, it is immaterial whether prices are high or low, +whether money returns fall or rise; and yet it might turn out that the +habitual association of gain or loss with "making money" would cause a +period of simple falling prices to be one of hesitating investment of +capital and unenterprising conduct of business. But what the world in +fact has seen has been the complex case of a fall in prices accompanied +by great improvements in production. The business man and capitalist has +had, to be sure, to deal with falling prices; but the same amount of +capital and labor has turned out more commodities than before; and his +total money returns, so far from declining, have generally increased. +The money incomes of the managers of industry have shown the same upward +movement as the money incomes of the other classes in society. So long +as this is the case, it is idle to talk of a depressing effect on +enterprise from the fall in prices, or of a strangling of the industrial +organism from insufficiency of the circulating medium. In fact, the +immediate cause of the fall in prices has been the pushing on the market +for sale of larger and larger quantities of commodities, produced with +profit at lower and lower cost: a state of things fortunate for the +community, and surely not depressing for the business man.... + +This effect on the entrepreneur of improvements and of falling prices +combined, doubtless accounts for the failure of the bimetallist +agitation to secure any appreciable hold in the business world. The +bimetallists, both in England and on the Continent, have labored +zealously to engage support among the business men, but never with a +degree of success at all proportionate to the energy displayed. The +simple reason is that the business world has not been in any state of +chronic depression. In the ups and downs of industrial activity there +have been periods which seemed to confirm the pessimistic accounts of +the bimetallist and of other persons malcontent with the present order +of things; but in due time the tide has always turned.... + +On the whole, then, the fall in prices, when considered in connection +with the other great changes which have accompanied it, does not afford +so much countenance to the bimetallist proposal as at first sight it +seems to. The rise in money incomes and the improvements in production +disprove any intolerable burden on debtors, and make it highly +improbable that the change has had any general depressing effect on +industry. + + +THE CASE OF THE FARMER + +Nevertheless, there is something more to be said, in explanation and +justification of the discontent with falling prices, and of the silver +agitation which rests on that discontent. While the effects of the fall +in prices on debtors as a class and on producers as a whole have not +given real grounds for complaint, certain particular debtors and +producers have undoubtedly been injured. The case of these latter have +given plausibility to the general arguments of the bimetallists, and, +what is more important at the present juncture, has given strength to +the movement in the United States for more money and more silver. + +The situation will be best understood if we contrast for a moment the +different modes in which the improvements in production have been +brought about in manufacturing industries on the one hand, in +agriculture on the other hand. In manufactures the improvements have +been better machinery, new processes, labor-saving inventions, the +conduct of business on a larger scale, and so the greater and more +effective division of labor. In agriculture the main cause of cheaper +production has been different: it has been the opening up of new lands +and new sources of supply. No doubt there are important exceptions to +these general statements. In agriculture there have been advances in the +arts--new plants, better fertilizers, improved implements, more +effective ways of cultivating the soil. In manufactures, on the other +hand, there have been important changes due to the discovery of new and +rich mines of materials, such as coal, iron, copper. But on the whole, +the difference holds good. In agriculture undoubtedly the opening of new +lands through the improvements in transportation has been the most +important single cause at work. The cheapening of agricultural products +has been due not so much to the more effective use of the soil already +under cultivation, as to the development of soil not formerly available +for the supply of the market. + +The changes in production and prices have consequently affected the +producers in these two branches of production in very different ways. In +manufactures all alike have felt them, and have been able to accommodate +themselves to the effects. No doubt the shrewder producers adopt +improvements and new inventions first, and, so long as they keep in the +lead, have the advantage of their competitors. They gain by doing a +large business at lower prices, while for the time being their slower +competitors lose. But new processes and new inventions spread over the +whole field in no long time. The opening of a new source of supply, on +the other hand, cheapens production through a process which the holders +of the old source of supply cannot avail themselves of. If wheat is +raised in large quantities in Dakota, the price goes down as effectively +as if the wheat fields of England and New York had suddenly become more +fertile; but as those wheat fields produce no more than before, the +farmer or land owner on the old soil has nothing to offset the lower +price. This is the explanation of the agricultural distress of which so +much has been heard in Europe in recent years, and which has been the +main occasion of the revival of protectionist feeling in France, +Germany, and other countries of the Continent. The farmer on the old +lands does not find in improvements in production any compensation for +lower prices. If he owns the land, he must pocket the loss, and perhaps +in the end abandon his land and turn to something else; such has been a +common case in New England. If he is a tenant on the land, he will +probably, after a period of struggle and hardship, get lower rents, +leaving the landlord as the permanent sufferer; such has been the +outcome in old England. If he was in debt before the change took place, +he will find his debts growing more burdensome as his money income goes +down; such has been the result with many a Western farmer. + +It is in causes of this sort that we find the explanation, in part at +least, of the restlessness among the Western farmers of which the silver +agitation is one sign. The fall in the prices of wheat, corn, and other +staples has been due to enormously increased production in regions which +were formerly out of reach of the market: in India, Australia, Russia, +as well as in California, Dakota, Washington, Oregon, and the Far West +generally.... + +It is probable that some of the complaints in regard to the burden of +debt on the farmers are simply a legacy from the old days of inflated +paper money. Not a few of the debts of the present [1891] go back to the +years before 1870, when we had prices high in terms of over-issued paper +money. These debts have been renewed and continued, in whole or in +part; and the fall in prices has made them heavier and heavier to bear. +The evil here again is real, and a remedy is now hard to find. The only +conclusion which can be laid down with perfect conviction is that we +should make sure of preventing the recurrence of a new era of excessive +paper money. + +... Another important circumstance is the general transition in +agricultural methods inevitable in those western states which have been +settled for a generation or more. When new land is first taken into +cultivation the most effective use of it is found in the continuous +production of some staple crop like wheat and corn, which can be grown, +so long as the cream of the soil is not exhausted, year after year with +large returns. After a while, however, the land begins to show signs of +exhaustion. The staple crops do not yield as largely as before, and less +crude methods of using the soil must be resorted to. Manures have to be +applied, and the rotation and selection of crops practised. Meat and +dairy products, vegetables, fruits, and the miscellaneous agricultural +articles, must take their place in rural economy. This change has been +carried through very largely in states like New York, Pennsylvania, and +Ohio. In the heart of the Mississippi Valley it is now under way; but +the transition is trying, and to some of the farmers it is impossible. A +good share of the American agricultural population has been so steadily +bred to the easy and careless use of virgin soil that it cannot +accommodate itself to more intensive methods. It is constantly moving +westward; settling for a generation in one spot, and then, as the land +shows signs of exhaustion, moving farther west. The more intelligent and +versatile stay behind, adapt themselves to new conditions, and in time +prosper under them. The least active also stay behind, and flounder +hopelessly in the old ways. But a large number are always moving west. +In every state between the Alleghanies and the Missouri river there are +large tracts formerly cultivated by native settlers, who have sold their +lands, as they showed signs of giving out, to German or Swedish +immigrants. These latter have not infrequently paid good prices for the +lands: but they have been bred to intensive farming, to careful and +varied use of the soil, and they have prospered where their native +predecessors have been unwilling or unable to adapt themselves to the +new conditions. The period of transition is a hard one for all of the +native farmers, whether they stay behind or move on, and the lesson of +using the soil with more skill and care is learned only under the +pressure of necessity. In such periods all sorts of remedies for hard +times make their appearance and have their run. + + +THE REPEAL OF THE SHERMAN SILVER PURCHASE ACT AND THE FINANCIAL AND +ECONOMIC CONSEQUENCES OF SILVER LEGISLATION + +[29]For fourteen years, 1878-1892, only an insignificant amount of gold +was paid out of the Treasury in the redemption of legal-tender notes; +the total amount of gold in the Treasury increased almost steadily and +continuously from $140,000,000 on January 1, 1879, to $300,000,000 in +1891. In 1890 the new issue of Treasury notes, together with a change in +commercial conditions, placed heavy burdens upon the reserve, the rapid +diminution of which is shown in the following figures: + + _Date_ _Net gold reserve_ + + June 30, 1890 $190,232,405 + June 30, 1891 117,667,723 + June 30, 1892 114,342,367 + June 30, 1893 95,485,413 + June 30, 1894 64,873,025 + +The reasons for the fall in the gold reserve are too various and +complicated to be treated here: the failure of the great English +banking-house of Baring Brothers in 1890 brought about a considerable +withdrawal of English capital invested in the United States; and an +unhealthy and inflated industrial development in this country was +stimulated by the new tariff. To outward appearances the country was +very prosperous; expenditures were large, imports increased, and a +failure of the crops in Europe in 1891 enlarged our grain exports. For a +brief season only, were the natural effects of the Sherman law delayed: +Europe soon recovered, American exports fell, and in the six months +ending June 30, 1893, the balance of trade against the United States +was $68,800,000. The tariff of 1890 was followed by diminished customs +receipts. The revenue from customs was as follows: + + 1890 $229,668,000 + 1891 219,522,000 + 1892 177,452,000 + 1893 203,355,000 + 1894 131,818,000 + +... Fortunately the internal revenue receipts maintained their customary +level with something to spare; but increased appropriations, due largely +to the passage of a dependent pension bill in 1890, cut deep into the +funds of the Treasury. In 1890 the surplus was $105,344,000; in 1891, +$37,239,000; in 1892, $9,914,000; in 1893, $2,341,000; but in 1894 +appeared a deficit amounting to $69,803,000. The Treasury had been +weakened by the reluctance of Secretary Windom to deposit government +funds in national bank depositories, and by his preference to rely +entirely upon the purchase of bonds for getting money back into +circulation. In the earlier years of Harrison's administration, bonds +were purchased freely--too generously in view of the impending strain +upon the resources of the Treasury. + +Another element of concern was due to the change in the kind of money +received by the Government in the payment of revenue. Before the passage +of the Sherman Act nine-tenths or more of the customs receipts at the +New York custom-house were paid in gold and gold certificates; in the +summer of 1891 the proportion of gold and gold certificates fell as low +as 12 per cent., and in September, 1892, to less than 4 per cent. The +use of United States notes and Treasury notes of 1890 correspondingly +increased.... + +The reason for this substitution of notes for gold was partly due to a +reversal in Treasury practice. For many years it had been the custom of +the Sub-Treasury in New York to settle its clearing-house balances +almost exclusively in gold or gold certificates. For example, in the +fiscal year 1889-1890 the Sub-Treasury paid gold balances to the banks +of nearly $230,000,000, and in the next year $212,000,000. The banks +were thus daily supplied with gold which they in turn could furnish to +their customers either for customs purposes or export deliveries. In +August, 1890, the Treasury began the policy of using ... the new +Treasury notes in the settlement of New York balances, and in the year +ending June, 1891, Secretary Foster, apparently convinced of the need of +a larger gold reserve to support the credit of the Treasury notes, +increased the use of the older United States notes and held on to the +gold reserve. The unexpected result was that the banks, deprived of +their usual supply of gold for trade purposes, sought for it at the +Treasury by the presentation of government notes.... + +In March, 1893, Cleveland for a second time entered upon the presidency. +He demanded as the first condition of relief the suspension of silver +purchases. The silver advocates, however, were still powerful in both +parties, and President Cleveland was at a disadvantage in not having the +undivided support of his own party. Even the position of Secretary +Carlisle was ... doubted: it was publicly declared that he stood ready, +if expediency demanded it, to redeem the Treasury notes of 1890 in +silver instead of gold, and, while standing upon the letter of the law +which demanded their redemption in _coin_, practically to cut asunder +the parity of gold and silver which had thus far been maintained. +Although the President attempted by a specific declaration to make clear +the harmonious purpose of the administration that redemption would +continue in gold, public apprehension would not be allayed. Whatever +might be the wishes of the administration, it was feared that it would +not have power to carry them out; particularly when it was announced in +April, 1893, that the gold reserve had been drawn down to $96,000,000 by +redeeming the Treasury notes of 1890. + +At this juncture of financial and commercial difficulties, in June, +1893, the British Government closed the mints in India to the free +coinage of silver. The price of silver bullion fell promptly and +rapidly, and, while such a decline might on another occasion have +produced no immediately serious consequences to the Treasury, it came at +a moment when public opinion, at least in the Eastern States, was +aroused to a belief that the entire financial problem was associated +with the coinage of silver; and it thus furnished one of the +contributory forces which drove the commercial community into a state +of panic. + +It was not until June 30, 1893, when the panic was well under way, that +a special session of Congress was called for August 7; only by the most +strenuous efforts could an adequate support, composed of elements in +both political parties, be rallied to uphold the President's insistence +that purchases of silver by the Government should cease. The House +quickly acquiesced, and on August 21, by a vote of 239 to 108, passed a +bill for the repeal of the purchasing clause; but the Senate was +stubborn, and not until October 30 could a favorable vote, 43 to 32, be +secured. So far as the Treasury was concerned, the mischief had been +done; although the Government was relieved from further purchase of +silver which increased the volume of the obligations to be supported by +gold, the old burdens still were sufficiently heavy, in connection with +the low state of commerce and industry, to exhaust its immediate +revenues. Thus on December 1, 1893, the actual net balance in the +Treasury above the gold reserve, pledged funds, and agency accounts was +only $11,038,448. Trade and industry had been disorganized; the panic of +1893 extended into every department of industrial life. In December, +1893, the Comptroller of the Currency announced the failure during the +year of 158 national banks, 172 state banks, 177 private banks, 47 +savings banks, 13 loan and trust companies, and 6 mortgage companies. +Some of these institutions afterwards resumed business, but the +permanent damage was great. The fright of depositors was general and the +shrinkage in deposits enormous; bank clearings were the lowest since +1885; clearing-house loan certificates were once more resorted to, this +time on a much larger scale than ever before, and extended to cities +throughout the country. + +The production of coal, both anthracite and bituminous, fell off; the +output of pig-iron, which had been about 9,157,000 tons in 1892, fell to +6,657,000 tons in 1894; new railway construction almost ceased; in 1894 +there were 156 railways, operating a mileage of nearly 39,000 miles, in +the hands of receivers; among these were three great railway +systems,--the Erie, Northern Pacific, and Union Pacific. The total +capitalization in the hands of receivers was about $2,500,000,000, or +one-fourth of the railway capital of the country. The earnings of +railroads and the dividends paid to stockholders were seriously +affected; securities fell to one-half and even one-quarter their former +value; commercial failures increased from 10,344 in 1892, with +liabilities of $114,000,000, to 15,242 in 1893, with liabilities of +$346,000,000. The problem of the unemployed became general; special +committees were organized in nearly all of the large cities to provide +food, and in many places relief work by public bodies was instituted. In +the spring of 1894 general want and distress led to labor strikes and +riots, as in Chicago, and even to more abnormal outbreaks, as seen by +the march of Coxey's army of unemployed from Ohio to Washington. The +distress was increased by the failure of the corn crop in 1894; the +demand for wheat in Europe fell off and wheat was sold on the Western +farm for less than fifty cents a bushel. + + +SALE OF BONDS FOR GOLD + +Under these adverse conditions it was inevitable that the revenues of +the Government should continue to decline. In the six months, January to +June, 1893, the excess of expenditures over receipts was $4,198,000, and +during the fiscal year ending June 30, 1894, this excess increased to +$69,803,000. It was even necessary to encroach upon the gold reserve for +current expenses, and for months this fund was far less than caution and +prudence demanded. When the integrity of the gold reserve was first +assailed, both Secretary Foster, in the closing months of Harrison's +administration, and Secretary Carlisle, at the beginning of Cleveland's +term, endeavored, with some success, to tide over emergencies by +appealing to the banks to exchange gold for legal tenders. The banks +recognized that the instability of Government credit seriously affected +the value of all securities in which they were interested; and in +February, 1893, they handed over to the Treasury about $6,000,000 in +gold, and in March and April about $25,000,000 more. The expedient was +not enough to stop the continued drain upon the Treasury. At the very +moment that the Government was relieved of notes through the exchange +of gold by the banks, other notes were presented to the Treasury for +redemption, largely to draw gold for exportation in the settlement of +trade balances.... + +The only way to protect the fund of gold reserve under the circumstances +was borrowing--that is, the sale of bonds for gold--yet some people who +were opposed to the overthrow of the gold standard consistently urged +that borrowing be postponed until the last moment, so as to add as +little as possible to the resources available for purchases of silver. +Some of the gold party would even have permitted the drain to go on to +the end, notwithstanding the inevitable evils, in the belief that the +country could be convinced of its errors in no other way. + +Eventually, to prevent a suspension of specie payments in gold, the +Treasury Department made successive issues of bonds for the purchase of +gold. These issues are very interesting to the student of finance. No +administration wishes to add to public indebtedness in times of peace; +and Secretary Carlisle had scruples against selling bonds, except with +the authority of the Congress then sitting; hence the issue of bonds was +put off to the last possible moment. The only existing authority for +selling bonds was the resumption act of 1875; this provided only for +ten-year 5 per cent., fifteen-year 4-1/2, and thirty-year 4 per cent. +bonds, all of which would command a premium so high as to diminish their +attractiveness as an investment, and, taken in connection with the +length of time which they ran, to hamper the Treasury in purchasing or +refunding the debt when the crisis was over. The administration asked +for the issue of low-rate bonds, but Congress, inspired in part by free +silver arguments, and in part by political intrigues to discredit the +administration, paid no attention to the recommendation of the +Secretary. Finally, in January, 1894, without special legislation, but +under the ancient authority of the resumption act, $50,000,000 of 5 per +cent. ten-year bonds were sold, yielding $58,660,917; and again in +November an equal amount of bonds with like conditions were marketed, +yielding $58,538,500. The sale of the first issue was on the whole +creditable, considering that at about the same time the President was +obliged to veto a bill providing for coining the silver seigniorage, +and that an effort had been made in the courts to enjoin the Secretary +of the Treasury from selling bonds under the law of 1875. + +In each case the sale of bonds called for subscriptions in gold, but the +new supplies were quickly exhausted by fresh redemption of notes. The +fluctuations in the volume of gold in the Treasury as a consequence of +the bond sales is seen in the following figures: + + _Date_ _Gold in Treasury_ + January 31, 1894 $65,650,000 + February 10, " 104,119,000 _Bond issue._ + November 20, " 59,054,000 + November 30, " 105,424,000 _Bond issue._ + February 9, 1895 41,393,000 + +The endless chain appeared to be in full and unceasing operation; not +only was gold being withdrawn for export but also for individual +hoarding, in fear of an impending suspension of gold payments. The +Treasury finally recognized the futility of selling bonds for gold, most +of which was drawn out of the Treasury itself, by the presentation of +legal-tender notes for redemption. A new device was tried: in February, +1895, the Secretary of the Treasury entered into a contract with certain +bankers for the purchase of 3,500,000 ounces of standard gold at the +price of $17.80441 per ounce, to be paid for by the delivery of United +States bonds having thirty years to run and bearing 4 per cent. +interest; not less than one-half of this gold was to be procured abroad, +and the parties with whom the contract was made stipulated that they +would "as far as lies in their power exert all financial influence and +make all legitimate efforts to protect the Treasury of the United States +against the withdrawals of gold, pending the complete performance of +this contract." An ounce of standard gold was worth $18.60465, and the +difference between that sum and the contract price represented the +premium received by the Government on the bonds, making the price at +which the bonds were accepted $104.4946. A condition was affixed to the +contract, by which, in case Congressional authority could be secured, a +3 per cent. _gold_ bond might be substituted, and for this the syndicate +agreed to pay a higher price. + +In view of the unfavorable terms of the bargain imposed by this +contract, the administration hoped that Congress would promptly act and +authorize the issue of the lower and more remunerative bond. Faithful in +its adherence to silver, Congress could not be swerved; it defeated the +bill authorizing the sale of a low-rate gold bond, and then engaged in +an angry debate denouncing the Executive for his subserviency to the +gold standard banking interests in entering into a contract not only +disgraceful but illegal. In reply it could be shown that the New York +Sub-Treasury was within forty-eight hours of gold exhaustion.... + +At first the syndicate was successful, because of some slight +improvement in trade, but later it practically failed to control the +price of exchange. It once more became cheaper for merchants to ship +gold than to purchase bills, and gold continued to be withdrawn from the +Treasury. On December 3, 1895, the gold reserve stood at $79,333,000, +and after the commercial apprehension caused by President Cleveland's +Venezuelan message a fortnight later, the reserve was still further +reduced. Once more the administration resorted to a bond sale, and again +the action was preceded by a special message from the President to +Congress asking for a grant of authority to issue gold bonds instead of +coin bonds, and also for the retirement of the legal-tender notes which +continued in an endless chain their journey to the Treasury, and drove +off gold to the commercial market. As Congress still refused to act, the +Treasury resorted to a fourth issue of $100,000,000 4 per cent. bonds. +The Treasury now carefully avoided any appearance of dealing through a +syndicate and publicly advertised for offers, with the encouraging +result of 4,640 bids, amounting to $684,262,850. Seven hundred and +eighty-one bids were accepted and the premium yielded about $11,000,000. +The relief obtained by the Treasury, however, was meagre, for it is +estimated that $40,000,000 of the bonds were purchased with gold +withdrawn from the Treasury by the redemption of notes. This was the +Government's penalty for its endeavor to separate itself from all +dealings with a banking syndicate. + +In spite of this sale of bonds the reserve remained near the traditional +danger line. In July, 1896, it fell to $90,000,000 because of hoarding +due to popular apprehension as to the success of the silver movement in +the November presidential election. Fearful that a new bond issue might +strengthen the claims of the silver advocates, bankers and dealers in +foreign exchange voluntarily combined to support the Treasury by +exchanging gold for notes. The effort succeeded, and the reserve was +placed in safety. After the elections in November gold came out from its +hiding-places, and was turned into the Treasury in large amounts. +Business and revenue improved and the difficulties of the Treasury +Department were tided over. + +Many Republicans held the earnest conviction that the issue of bonds +would not have been necessary if the revenue had been sufficient. Not +only had industry and commerce been unsettled by the tariff act of 1894, +but the operations of the endless chain must certainly continue, it was +held, until there was a generous income in excess of expenditures, +whereby a considerable part of the credit currency might be covered into +the Treasury and thus lessen the possible claims for redemption. The +administration emphatically replied that at no time when bonds were +issued was there intention of paying the expenses of the Government with +their proceeds, and that the Treasury Department had no authority +whatever to issue bonds for such purposes. President Cleveland was +insistent that on each occasion of a bond issue there were sufficient +funds in the Treasury to meet the ordinary expenditures of the +Government. The proceeds of the bonds sold for the maintenance of the +national credit were, however, turned into the general fund of the +Treasury, and consequently, though not originally designed for that +purpose, employed to meet indiscriminately all demands made upon the +Government, whether for redemption of notes or the payment of debts.... +There was a series of deficits beginning with 1894, but the deficit by +no means equalled the amounts of bonds sold. + +FOOTNOTES: + +[16] Adapted from A. D. Noyes, _Forty Years of American Finance_, pp. +2-6 G. P. Putnam's Sons, New York and London. 1909. + +[17] _Ibid._, pp. 35-44. + +[18] F. W. Taussig, _The Silver Situation in the United States_, pp. 8, +9. G. P. Putnam's Sons. New York. 1893. + +[19] I have stated the price here, for simplicity, in terms of so much +per ounce of standard silver, _i. e._, silver containing 10 per cent. of +alloy. The usual quotation in the United States is per ounce of fine +silver. [Thus, the New York price, March 10, 1916, was 56-3/4 cents per +ounce of fine silver.] + +[20] _Ibid._, pp. 9, 10. + +[21] _Ibid._, pp. 10, 11. + +[22] _Ibid._, pp. 11-13. + +[23] _Ibid._, pp. 19, 20. + +[24] _Ibid._, pp. 50, 51. + +[25] [Present tense because written while the act was still in force.] + +[26] _Ibid._, pp. 51, 52. + +[27] _Ibid._, pp. 52, 59. + +[28] _Ibid._, pp. 84-106. + +[29] Davis R. Dewey, _Financial History of the United States_, pp. +442-455. Longmans, Green and Company, New York, 1915. + + + + +CHAPTER VIII + +INDEX NUMBERS + + +[30]Index numbers are used to indicate changes in the value of money. +The objects for which this measurement is undertaken are thus well +stated by Sir R. Giffen (Second Report of the committee appointed for +the purpose of investigating the best method of ascertaining and +measuring variations in the value of the monetary standard. Report of +the British Association, 1888): (1) The fixation of rents or other +deferred payments extending over long periods of time, for which it has +been desired to obtain a currency of a more stable sort than money is +supposed to be. (2) To enable comparisons to be made between the value +of money incomes in different places, which is often an object of great +practical interest; not only individuals contemplating residential +changes, but also governments and other large spending bodies, spending +money in widely distant places, having to consider this question. (3) To +enable historians and other students making comparisons between past and +present to give an approximate meaning to the money expressions which +they deal with, and say roughly what a given fine, or payment, or amount +of national revenue or expenditure in a past age would mean in modern +language. To which some would add: (4) To afford a measure of the extent +to which trade and industry have been injuriously affected by a +variation in prices; and of the correction which it would be desirable +to apply to the currency. + +An index number is constructed by combining several items, each of which +is a ratio between the price of a certain article at a particular date +under consideration (_e. g._, last year or month) and the price of the +same article at a period taken as base or standard (_e. g._, 1867-77, in +the index number constructed by Mr. Sauerbeck, _Journal of the +Statistical Society_, 1886 and 1893). These ratios are generally +expressed as percentages. _E. g._, the percentage for _flour_ in 1885, +as given by Mr. Sauerbeck, is 63; meaning that the price of flour in +1885 is to the average price of the same article in 1867-77 as 63:100. +The term index number is sometimes applied (_e. g._, by Mr. Sauerbeck, +_op. cit._) to each of these items, as well as to their combination. + +The percentages are usually compounded by taking an AVERAGE of them. But +a result of equal generality may be obtained by taking their sum. One of +the best-known index numbers, that of the _Economist_, is thus +constructed. Twenty-two articles having been selected, the price of each +article at the current date compared with its price at the standard +period (1845-50) is expressed as a percentage; and the sum of these +percentages is put as the index number. Thus the _Economist_ index +number for the year 1873 is 2947; such a sum is easily reduced to the +form of an average by simple division (_e. g._, 2947 ÷ 22 = 134). +Accordingly in what follows it will be sufficient to consider the latter +form only. + +The construction of an index number presents the following problems: +(_a_) What are the commodities of which the prices are to be taken? +(_b_) How are the prices to be ascertained? (_c_) How are the ratios +between the prices of each article at the current and the standard dates +to be combined? + +The answers to these questions vary according to the purpose in hand.... +As appropriate to the first purpose, a standard of deferred payments, +two methods present themselves, viz., to arrange that the debtor should +pay, the creditor receive, either (1) the same quantity of goods and +services, the same amount of utility, so to speak; or (2) the product of +the same quantity of labour--or more exactly effort and sacrifice. + +Of these methods the former has been more generally accepted. It is +adopted for instance by the British Association Committee already +referred to, as _par excellence_ the measure of the change in the value +of the monetary standard. The former method is indeed more intelligible. +However, in favour of the latter there are some weighty considerations +and authorities. It seems to be the nearest possible approach to +Ricardo's conception of a commodity invariable in value, "which at all +times requires the same sacrifice of toil and labour to produce it." +(_Principles_, iii. ch. xx., "On Value and Riches," cp. Mill, bk. iii. +ch. xv., "On a Measure of Value.") "A standard," says Mr. Leonard +Courtney, "should be something which as far as possible involves the +same labour and the same sacrifice in obtaining it" (_Nineteenth +Century_, March, 1893). Prof. Marshall, in his evidence before the royal +commission on gold and silver, says, speaking of appreciation of gold: +"When it is used as denoting a rise in the real value of gold, I then +regard it as measured by the diminution in the power which gold has of +purchasing labour of all kinds--that is, not only manual labour, but the +labour of business men and all others engaged in industry of any kind" +(Question 9625). + +If the first method is adopted, the answers to the questions above set +are as follows: (_a_) The commodities of which the prices are to be +taken should be articles of consumption rather than materials and +implements. Payments for personal services should be included, but not +wages in general. (_b_) Retail prices should be used. (_c_) The proper +combination of the ratios is an average of the kind technically called +_weighted_.... The general principle according to which the weights are +to be assigned is that they should represent the importance of each +commodity to the consumer. But this idea may be embodied in different +plans. + +1. One plan is to assign as the weight of each percentage, or ratio +between prices, the value of the corresponding commodity at the initial +or standard period. According to this plan the index number is the ratio +between these two values: the quantities initially consumed at the +prices of the current date, and the same quantities at the standard +prices. This method is exemplified by Sir R. Giffen's estimate of the +change in the value of money between 1873 (and 1883) and _earlier_ +years, in his report on prices of exports and imports, 1885, table v. + +2. Another plan is to assign, as the relative importance of each +percentage, its value at the particular epoch, the current year. This +plan is adopted by Mr. Palgrave in his memorandum on _Currency and +Standard of Value_ ... in the third report of the royal commission on +depression of trade and industry, table xxvii. + +3. According to another plan, the index number is the ratio between the +following two values: the quantities consumed at the current date at the +current prices, and the same quantities at standard prices. This plan is +adopted by Mr. Sauerbeck (_Journ. Stat. Soc._, 1886, p. 595). + +4. Or, instead of taking either the initial quantities or those of the +current date, a mean between the two may be taken. This is the plan +adopted by the British Association Committee. They estimate "the average +national expenditure on each class of article at present and for the +last few years"; and put for the relative importance of each commodity a +round number corresponding to that estimate. Thus the estimated +expenditure per annum on _wheat_ is £60,000,000, and on _meat_ +£100,000,000: that is respectively 6.5 per cent., and 11 per cent. of +the sum of the corresponding estimates for all the commodities utilized +by the committee. As convenient approximations, the weights five and ten +are recommended by the committee. + +If the index number based on labour ... rather than on consumption, is +adopted as the standard for deferred payments, it would be proper by +analogy to take as the measure of appreciation or depreciation the +change in the pecuniary remuneration of a certain set of services, +namely all, or the principal, which are rendered in the course of +production throughout the community during a year, either at the initial +or the current epoch; or some expression intermediate between the two +specified. But it may be doubted whether the statistics requisite for +this method are available. + +With regard to the second and third of the purposes above enumerated, +the determination of the comparative value of money at distant places +and remote times--one or other of the two methods indicated would seem +to be theoretically proper. + +For the fourth purpose, the regulation of currency, the proper +construction of the index number would seem to be as follows: (_a_) The +"articles" of which the prices are taken into account should be both +commodities and services; (_b_) both wholesale and retail prices should +be used; (_c_) the relative importance of each article should be +proportioned to the demand upon the currency which it makes. But here as +in other parts of the subject theory halts a little, and statistics lag +far behind theory. + +Considering the theoretical doubts and statistical difficulties which +attend the determination of _weights_ proper to each purpose, there is +much to be said in favour of assigning equal relative importance to all +the items; especially if care is taken to include many articles such as +_corn_, _cotton_, etc., which for any of the purposes which may be +contemplated must be of first-rate importance. Such is the character of +some of the principal index numbers which have been constructed--those +of the _Economist_, of Jevons, of Soetbeer, and of Mr. Sauerbeck. + +In the construction of such an index number the use of the arithmetic +mean is not imperative. Jevons employs the geometric mean. His reasons +for preferring it are not very clear (the "Variation of Prices," +_Currency and Finance_, p. 120).... The geometric mean has also the +advantage of being less liable than the ordinary average to be unduly +affected by extremely high prices (_Report of the British Association_, +1887, p. 283). The great objection to the geometric mean is its +cumbrousness. + +There is another kind of mean which has some of the advantages of the +geometric, and is free from its essential disadvantage; namely, the +median ... which is formed by arranging the items in the order of +magnitude, and taking as the mean that figure which has as many of the +items above as below it. For instance the median of the forty-five +percentages on which Mr. Sauerbeck's index number is based was, for +1892, 66; while the arithmetic mean was 68. It is difficult to see why +the latter result is preferable to the former; if what is required is an +_index_ of the change in general prices, not specially referred to any +particular purpose, such as of securing a constant benefit to a legatee. + +The perplexity of a choice between such a variety of methods is much +reduced by the two following considerations. _First_, beggars cannot be +choosers. The paucity of statistical data (see the report drawn up by +Sir R. Giffen in the _Report of the British Association_ for 1888, p. +183) restricts the operation. Thus for the purpose of index numbers +based on consumption ... retail prices are theoretically appropriate; +but "practically it is found that only the prices of leading +commodities, capable of being dealt with in large wholesale markets, can +be made use of" (Giffen, _loc. cit._). _Second_, the difference between +the results of different methods is likely to be less than at first +sight appears. For instance, the probable difference between the index +number constructed by the British Association committee, and six others +which have been proposed by high authorities--supposing the different +methods to be applied to the same data, viz., the prices of twenty-one +articles specified by the Committee may thus be expressed. The +discrepancy which is as likely as not to occur between the committee's +and other results is from 2 to 2.5 per cent. The discrepancy which is +very unlikely to occur is from 8 to 11 per cent. (_Report of the British +Association_ for 1888, p. 217). In fact, the index number for the year +1885, as determined from the same data by seven different methods, +proved to be 70, 70.6, 73, 69, 72, 72, 69.5 (_ibid._, p. 211). + +The practical outcome of these two considerations is thus well expressed +by Giffen (_loc. cit._ p. 184), "The articles as to which records of +prices are obtainable being themselves only a portion of the whole, +nearly as good a final result may apparently be arrived at by a +selection without bias, according to no better principle than +accessibility of record, as by a careful attention to weighting.... +Practically the committee would recommend the use of a weighted index +number of some kind, as, on the whole, commanding more confidence.... A +weighted index number, in one aspect, is almost an unnecessary +precaution to secure accuracy, though, on the whole, the committee +recommend it." + +FOOTNOTES: + +[30] _Dictionary of Political Economy_, edited by R. H. T. Palgrave. +Vol. II, pp. 384-7. Macmillan and Company, Limited. London. 1912. + + + + +CHAPTER IX + +BANKING OPERATIONS AND ACCOUNTS + + +[31]The intermediate employed in actual transactions is, in increasing +degree, that form of currency called credit, the lowest order of +currency, rather than money itself. Checks and drafts make up a +progressively larger share of the circulating medium. The net deposit +credits in the national banks in the United States--to say nothing of +the other banks--are double the volume of the actual money in the +country. And a large share of this actual money is really employed as +reserves to support the credit circulation. More than 90 per cent. of +the larger sorts of transactions are mediated through the use of deposit +credit, and probably more than one-half of the remaining transactions +are similarly effected. Thus the study of banking is essential to any +understanding of monetary problems.... + +[32]For a bank, as well as for any other considerable establishment, it +is requisite that a capital should be provided at the outset. There can +be no constant proportion between the amount of this capital and the +extent of the business which may be built up by its means. We can only +say that, other things being equal, the larger the business that can be +carried on with safety with a given capital, the larger will be the +field from which profits can be earned, and the higher the proportion +which the profits will bear to the original investment; but the point at +which the extension of the business passes the line of safety, must be +determined by the circumstances of the particular bank, by the kind of +business carried on by those dealing with it, and by the condition of +the community in which it is established. The attempt has sometimes +been made to limit by law for incorporated banks the proportion of +transactions for a given amount of capital, but no such provision has +any foundation except a conjectured average, too rough to be of service +in any individual case. In this respect, as in so many others, the +judgment of the persons most interested, acting under the law of +self-preservation, is far more trustworthy than any legislative +decision. + +The capital thus to be provided at the outset is, of course, in the case +of a private bank, the contribution of the partners, as in any other +undertaking. In the case of an incorporated bank the capital is divided +by law into equal shares or units of fixed amount; as _e. g._, under the +law of the United States, a capital of $100,000 is divided into 1,000 +shares of $100 each; and these shares are contributed by the individual +shareholders, in such proportion as they please. The law may as a matter +of public policy limit the proportion of capital stock to be owned by +any one individual or firm, and it may also limit the liability of +shareholders for debts due by the bank, in case of its failure; but in +general, in the absence of special provisions to the contrary, the +powers, rights, and liabilities of every shareholder are now usually +determined by the number of shares of the stock contributed or owned by +him. In the election of directors and of other officers for the +immediate management of the business, every share entitles its owner to +cast one vote; the dividend of profit is divided in the ratio of shares +owned, and contributions to meet losses, if required by law, are called +for in the same ratio. + +The capital subscribed by the intending shareholders must necessarily be +paid in in money or in the legal tender of the country. It is not +necessary that the whole should be paid in at the outset, but the +payment of the whole usually precedes the full establishment of the +business; and, in the case of incorporated banks, the law often requires +that some definite proportion, as _e. g._, one-half, shall be paid in +before the opening of business, in order to insure good faith and a +solid basis for the business undertaken. + +If, now, we undertake to represent by a brief statement of account the +condition of a bank having a capital of $100,000 paid in, in specie, on +the morning when it opens its doors for business, we shall have the +following: + + _Liabilities_ _Resources_ +Capital $100,000 Specie $100,000 + +It may at first sight appear to be a contradiction in terms, that the +capital should be set down as a liability and not as a resource. But we +must here distinguish between the financial liability for what has been +received from the shareholders and the right of property in the thing +received. The bank has become accountable to its shareholders for the +amounts paid in by them respectively, but the money actually paid in has +become the property of the bank; or, in the language of accountants, the +bank has become liable for its capital, and the money in hand is for the +present its resource for meeting this liability, or for explaining the +disposition made of what has been received. + +As the bank requires banking-rooms and a certain supply of furniture and +fixtures for the convenient transaction of its business, we may suppose +it to expend $5,000 of its cash in providing this "plant." The property +thus procured, with the remaining $95,000 in cash, will then be the +aggregate resources by means of which the capital is to be accounted +for, and the account will stand as follows: + + _Liabilities_ _Resources_ +Capital $100,000 Real estate, furniture, fixtures, etc. $ 5,000 + Specie 95,000 + -------- -------- + $100,000 $100,000 + +The bank, however, cannot answer the purposes of its existence, or earn +a profit for its shareholders, until its idle cash is converted into +some kind of interest-bearing security. Nor is it enough that a +permanent investment of the ordinary kind should be made, as by the +simple exchange of the cash for government bonds or railway securities. +It is the chief business of the bank to afford to purchasers and dealers +the means of using, by anticipation, funds which are receivable by them +in the future, and this implies both the purchase of private securities +or "business paper" to a considerable extent, and also frequent change +and renewal of purchases. Moreover, while the private capitalist finds +it advantageous to make simple investments of a permanent sort, this +would plainly be insufficient for the shareholders of a bank, who have +to pay from its profits some serious expenses of management, and need, +therefore, a larger field for earnings than the ordinary returns on +their capital alone. The bank being obliged then to extend its +operations beyond the amount of its capital, is compelled for this +purpose to make use of its credit. In fact, it is only by such a use of +its credit that the establishment becomes in reality a bank. + +Most of the conditions of the case are best answered by the "discount" +of commercial paper as above described. The time for which such +obligations have to run varies with the custom of the trade which gives +rise to them, but is in most cases short enough to imply early repayment +to the bank. And even where custom gives the paper longer time, if the +paper itself is used only as a collateral security, the note which is +the actual object of negotiation with the bank is by preference usually +made not to exceed four months. It is easy then to arrange the purchases +of paper with reference to the times of maturity, so as to provide for a +steady succession of payments to the bank, and thus facilitate the +reduction of the business, if necessary, or its direction into new +channels, as prudence or good policy may require. The certainty of +prompt payment at maturity, needed for this end, is presented in a high +degree by the paper created in the ordinary course of business. +Independently of the collateral security which the bank may hold, the +written promise of a merchant or manufacturer to pay on a fixed day is +an engagement which involves the credit of the promisor so far that +failure is an act both of legal insolvency and of commercial dishonor. +Selected with judgment, then, such paper is not only the investment +which most completely answers the purposes of the bank's existence, but +is probably as safe as any investment which could be found. + +It may easily happen, however, that the bank may find it desirable to +invest a part of its resources in some other form, either because good +commercial paper cannot be procured in sufficient amount, or as a matter +of policy. In this case it will purchase such other securities as offer +not only complete safety of investment, but the possibility of easy +conversion into cash in case of need. In this country United States +bonds, and many descriptions of State, municipal, and corporation bonds +might answer this purpose. Stocks would more rarely answer it, being +more liable to the fluctuations in price caused by misfortune or the +ordinary vicissitudes of business. Mortgages on real estate, however, +would not be admissible, except when held as a security, collateral to +some other which is more easily convertible, for even when the mortgaged +property is so ample and stable as to insure the goodness of the +mortgage, the conversion of the mortgage into cash by sale is not always +easy, and is especially difficult at those times when the bank most +needs to have all its resources at command. Indeed, the danger to be +apprehended from the locking up of resources, in securities which may be +solid but are not easily realized, is so great, that it has been said to +be the first duty of the banker to learn to distinguish between a note +and a mortgage, his business lying with the former. Real estate, of +course, cannot be regarded as a banking security, however desirable it +may be as an investment for individuals, for it is not only subject to +great fluctuations in value, but is at times unsaleable.... + +The results of the process of investment in commercial paper and in +other securities are best understood when we trace the effect in the +account of the bank. Taking then the account as it stood after the +purchase of fixtures, let us suppose that the bank buys paper or +securities from those dealing with it, or, in the common phrase, makes +"loans to its customers," to the amount of $90,000, the paper being in +many pieces and having various lengths of time to run, but averaging +about three months. Supposing the interest to be computed at 6 per +cent., we should have the account changed by the operation as follows: + + _Liabilities_ _Resources_ + +Capital $100,000 Loans $90,000 +Undivided profits 1,350 Real estate, furniture, fixtures, etc. 5,000 +Deposit 88,650 Specie 95,000 + -------- -------- + $190,000 $190,000 + +Here we have the securities which certify the right of the bank to +demand and receive $90,000 at a future date placed among the resources; +the net proceeds of the securities, or the aggregate of the sums which +the bank holds itself liable to pay for them on demand, stand among the +liabilities as deposits; and the interest deducted in advance, or the +profit on the operation, which the bank must at the proper time account +for to the stockholders, also stands as a liability. This, however, is +the condition of the account at the moment of making the investment, +when the bank has made its purchase of securities by merely creating a +liability. As this liability is real and must be met, so far as the +depositors at any time see fit to press it, let us suppose that +depositors call for cash to the amount of $15,000, and we shall have a +further change in the account as follows: + + _Liabilities_ + +Capital $100,000 +Undivided profits 1,350 +Deposits 73,650 + ------ + $175,000 + + + _Resources_ + +Loans $90,000 +Real estate, etc 5,000 +Specie 80,000 + ------ + $175,000 + +It is clear that, unless the enforcement of the liability for deposits +and consequent withdrawal of specie goes much farther than this, the +bank can safely increase its loans or its purchase of securities, +although its method of doing so is by the increase of its liabilities. +We will suppose it, therefore, to have expanded its affairs until it has +reached something like the average condition of those banks in the +United States, which, being incorporated under the laws of the several +States, are not authorized to issue notes. It will then stand thus: + + _Liabilities_ + +Capital $100,000 +Surplus 29,000 +Undivided profits 10,000 +Deposits 305,000 + -------- + $444,000 + + _Resources_ + +Loans $305,000 +Bonds and stocks 23,000 +Real estate 15,000 +Other assets 20,000 +Expenses 1,000 +Legal-tender notes } +Cash items } 80,000 +Specie } + -------- + $444,000 + +Postponing for the present the consideration of some terms which here +occur for the first time, it appears from the above account that +purchases of securities have been made to more than three times the +amount of the capital, and that this has been effected chiefly by the +creation of liabilities in the form of deposits. What determines the +limit to which this process can be carried? + +If depositors seldom demanded the payment to which they are entitled, +but were contented with the mere transfer of their rights among +themselves as a conventional currency, the bank might dispense with +holding any large amount of specie or cash in any form and keep most of +its resources employed in its productive securities. The expansion of +the deposits would then resemble in its effects the expansion of any +other currency and might go on until a check should be interposed by the +consequent rise of prices and demand for specie for exportation. And it +is true, as we shall see, that in communities where banking is largely +practised, the use of deposits as currency by transfer from hand to hand +is so extensive, that a bank in good credit can rely upon their being +withdrawn so slowly, or rather to so small an extent, as to make it +unnecessary to have cash in readiness for the payment of more than a +small proportion at any given moment. But in a period of financial +disorder or alarm, withdrawals may be made earlier or more frequently, +and a larger provision of cash may be needed for safety, than at other +times; the kind of business carried on by depositors may expose one +bank, or the banks in one place, to heavier occasional demands, or may +on the other hand make demands steadier, than is the case elsewhere; and +a city bank may be more subject to heavy calls from depositors than a +country bank. In general, then, for every bank, in its place and under +the circumstances of the time, there is some line below which its +provision of cash cannot safely fall. This provision of cash, which in +the account last given includes the cash items, specie, and legal-tender +notes, is called the reserve, and the necessity of maintaining a certain +minimum reserve fixes a limit to the ability of the bank to increase its +securities. For obviously any increase of securities, that is, of loans +or bonds, must ordinarily be effected, either by an increase of +deposits, or by an actual expenditure of cash. If, then, the reserve +were already as low as prudence would allow, or were threatened by +approaching heavy demands from depositors, no increase of securities +could be made without serious risk. + +What proportion the reserve should bear to the liabilities which it is +to protect is a question which the law has sometimes attempted to +settle, by requiring a certain minimum, leaving it to every individual +bank to determine for itself how much may be required in addition to +this minimum. And this is no doubt as far as any general rule can go. As +has already been suggested, the requirements for safety of different +banks and in different places must vary, and so must the requirements of +the same bank at different times. In fact, the question as to the proper +amount of reserve never depends simply on the absolute ratio of the +reserve to the liabilities, but always involves further questions as to +the probable receipts of cash by the bank and probable demands upon it, +in the near future. It can only be said that the reserve should be large +enough, not only to insure the immediate payment of any probable demand +from depositors, but also to secure the bank from being brought down to +the "danger line" by any such demand. If 25 per cent. is the minimum +consistent with safety, the reserve should be far enough above this to +be secure from reduction to a point where any further demand or accident +may make the situation hazardous. + +In the management of its reserve the bank itself necessarily feels a +strong conflict of interests. On the one hand, it is impelled to +increase its securities as far as possible, for it is from them that it +derives its profits, and the retention of a large amount of idle cash is +felt as a loss. On the other hand, the maintenance of a reserve +sufficient, not only to enable the bank to continue its payments but to +inspire the public with confidence in its ability to continue them, is a +necessity of its existence, even though a part of its resources do thus +appear to be kept permanently idle. As a natural consequence, the actual +settlement of the question in favor of a large or of a small reserve in +any particular case will depend in good measure on the temperament of +the managers. In every banking community may be found "conservative" +banks, the caution of whose managers forbids them to take risks by +extending their business at the expense of an ample reserve; and by +their side may be seen the more "active" banks, whose managers +habitually spread all possible sail, and provide for the storm only when +it comes. + +It is to be observed that the necessity of providing a cash reserve is +not met by the excellence of the securities held by the bank. Although +their certainty of payment at maturity be absolute, still the demands +upon the banks are demands for cash, and cannot be answered by the offer +of even the best securities. If the depositor or creditor does not +receive cash in full for his demand when it is made, the bank has +failed, and any satisfaction of his claim by the delivery of a security +is, as it were, only the beginning of a division of the property of the +bank among its creditors. Specie, therefore, or the paper which is a +substitute for it as a legal tender for debt, forms the real banking +reserve. The reserve of the bank may, however, be greatly strengthened +by the judicious selection of securities. For example, if, in the +account above given, the "bonds and stocks" are, as they should be, of +descriptions which are readily saleable, they afford the means of +replenishing the reserve in case of need, without foregoing the +enjoyment of an income from this amount of resources for the present. In +extreme cases of general financial panic, it is true, even the strongest +government securities may find but few purchasers; still such a +provision is the best support which can be had in the absence of, or as +an auxiliary to, a sufficient reserve of actual cash. + +The natural method of securing the proper apportionment of resources +between securities and reserve, under ordinary circumstances, is by +increasing or diminishing the loans, or, in other words, the purchases +of securities made from day to day in the regular course of business. +That part of the securities which consists of the promises of +individuals or firms to pay to the bank at fixed dates, is made up of +many such pieces of commercial paper, maturing, if properly marshalled, +in tolerably steady succession. The payment of one of these engagements +when it becomes due may be made either in money, or by the surrender to +the bank of an equal amount of its own liabilities ... [in the form of +deposits]. In the former case, the payment of the maturing paper to the +bank is in fact the conversion of a security into cash, and increases +the reserve without change in the liabilities; in the latter, the +reduction of securities is balanced by a reduction of liabilities which +raises the proportion of reserve. If, then, the bank stops its +"discounts" or the investments in new securities, or if it even slackens +its usual activity in making such investments, the regular succession of +maturing paper will gradually strengthen its reserve; if it increases +its activity in investment, it will weaken or lower its reserve; and if +it adjusts the amount of its new investments to the regular stream of +payments made by its debtors, it may keep the strength of its reserve +unaltered, until some change in the condition of affairs brings cash to +it or takes cash away by some other process. + +This natural dependence of the reserve upon the more or less rapid +re-investment of its resources by the bank is distinctly recognized by +the law of the United States, which provides that when the reserve of +any national bank falls below the legal minimum, such bank "shall not +increase its liabilities by making any new loans or discounts," until +its reserve has been restored to its required proportion. By a less +harsh application of the same principle, the Bank of England operates +upon its reserve by lowering or raising its rate of discount, and thus +encouraging or discouraging applications for loans. And it was with a +view of facilitating the replenishment of the reserve by the curtailment +of loans, that the law of Louisiana formerly provided that the banks of +New Orleans should hold what were called "short bills," or paper +maturing within ninety days, to the amount of two-thirds of their cash +liabilities, so that the constant stream of payments of such paper might +always insure to every bank the early command of a large part of its +resources. + +To return, in conclusion, to the account last given; we have there among +the liabilities certain sums classified as "surplus" and as "undivided +profits." Taken together these sums represent the profits which have +been made, but not divided among the stockholders, and which are +therefore to be accounted for by the bank. The surplus is that portion +of these profits which as a matter of policy it has been determined not +to divide and pay over to the stockholders, but to retain in the +business, as in fact, although not in name, an addition to the capital. +The remaining portion, the undivided profits, is the fund from which, +after payment of current expenses and of any losses which may occur, the +next dividend to the stockholders will be made. The current expenses are +for the present entered on the other side of the account, as they +represent a certain amount of cash which has disappeared; but at the +periodical settlement of accounts they must be deducted from the +undivided profits, and will thus drop out from the statement. "Other +assets," here set down as an investment, may be supposed to cover any +form of property held by the bank and not otherwise classified, but +especially the doubtful securities, or such property, not properly dealt +in by a bank, as it may have been necessary to take and to hold +temporarily, for the purpose of securing some debt not otherwise +recoverable. For example, although the bank could not properly invest in +a mortgage, it might be wise for it to accept a mortgage in settlement +with an embarrassed debtor, and in this case the mortgage would stand +among the "other assets." And, finally, "cash items" include such +demands on individuals or other banks as are collectible in cash and can +therefore fairly be deemed the equivalent of cash in hand. In the +absence of any legal provision limiting the classification of such +demands as reserve, they may be regarded as virtually a part of the +reserve, which in the case before us may therefore be treated as made up +of cash items, specie, and legal-tender notes. + +To illustrate what has been said in this chapter we will now suppose the +bank to make the following operations: + +a. To add to its securities $20,000, by discount of three-months paper +at 6 per cent., three-fourths being purchased by the creation of +liabilities, and one-fourth by the expenditure of cash. The account +would then stand as follows: + + _Liabilities_ + +Capital $100,000 +Surplus 29,000 +Undivided profits 10,300 +Deposits 319,775 + -------- + $459,075 + + _Resources_ + +Loans $325,000 +Bonds and stocks 23,000 +Real estate 15,000 +Other assets 20,000 +Expenses 1,000 +Reserve 75,075 + -------- + $459,075 + +b. To retrace its steps by diminishing its "discounts" or holding of +securities to the extent of $50,000, of which four-fifths are paid to it +by the surrender of demands for deposits to a like amount and one-fifth +in cash; to pay $1,250 for current expenses; and further to increase its +reserve by the sale of bonds and stocks to the amount of $10,000. The +following would then be the state of the account: + + _Liabilities_ + +Capital $100,000 +Surplus 29,000 +Undivided profits 10,300 +Deposits 279,775 + -------- + $419,075 + + _Resources_ +Loans $275,000 +Bonds and stocks 13,000 +Real estate 15,000 +Other assets 20,000 +Expenses 2,250 +Reserve 93,825 + -------- + $419,075 + +c. To sell $2,000 of its other assets for cash with a loss of $500; to +make a semi-annual dividend of 4 per cent., of which one-half is +credited to stockholders who happen to be depositors also, and one-half +is paid in cash; to sell $4,000 of bonds at a profit of 15 per cent., +and to carry $1,000 of its undivided profits to surplus. The account +would then stand at the beginning of the new half year, as follows: + + _Liabilities_ + +Capital $100,000 +Surplus 30,000 +Undivided profits 3,150 +Deposits 281,775 + -------- + $414,925 + + _Resources_ + +Loans $275,000 +Bonds and stocks 9,000 +Real estate 15,000 +Other assets 18,000 +Reserve 97,925 + -------- + $414,925 + + +STATEMENT OF A REPRESENTATIVE NATIONAL BANK + + _Resources_ + +Loans and discounts $739,743.27 +Overdrafts, secured 973.08 +U. S. bonds deposited to +secure circulation 100,000.00 +U. S. bonds pledged to +secure U. S. deposits 1,000.00 +Bonds other than U. S. +bonds pledged to secure +postal savings deposits 7,000.00 +Other Securities 191,098.05 +Stock of Federal Reserve +bank 4,800.00 +Banking House 30,000.00 +Furniture and Fixtures 5,000.00 +Due from Federal Reserve +Bank 20,000.00 +Due from approved reserve +agents 89,919.25 +Due from other banks 12,074.23 +Checks on banks in same +city 6,051.46 +Outside checks and other +cash items 13,171.83 +Fractional currency, nickels, +and cents 283.14 +Notes of other national +banks 1,295.00 +Coin and certificates 38,604.05 +Legal-tender notes 25,000.00 +Redemption fund 3,500.00 + ------------- + $1,289,513.36 + + _Liabilities_ + +Capital stock +paid in $100,000.00 +Surplus fund 60,000.00 +Undivided +profits 40,877.46 +Less current +expenses, interest, +and +taxes paid 17,110.28 23,767.18 +Circulating +Notes Out-standing 98,500.00 +Individual deposits +subject +to check 404,871.37 +Certificates of +deposit due +in less than +30 days 596,335.82 +Certified +Checks 125.00 +United States +deposits 1,000.00 +Postal savings +deposits 4,913.99 + ------------- + $1,289,513.36 + +[33]~The Method and Extent of Credit Issue.--~Assume that a bank with a +cash capital of $100,000 is opening for business in an isolated town and +is the only bank in that town. How much can it lend? Ordinarily a bank +lends by discounting a customer's note and by giving the customer a +deposit credit upon its books for the proceeds of the note.... If, now, +our bank in question lends $100,000, giving deposit credit for this sum, +it has $100,000 of cash on hand against $100,000 of cash liability. Its +statement will stand as follows: + + _Resources_ + +Cash $100,000 +Notes 100,000 + -------- + $200,000 + + _Liabilities_ + +Capital Stock $100,000 +Deposits 100,000 + -------- + $200,000 + +Now let it lend another $100,000. With its loans and deposits each +standing at $200,000 its reserves are 50 per cent. of its demand +liability. Only with $666,666 of loans will its reserves have reached +... [a] 15 per cent. limit: + + _Resources_ + +Cash $100,000 +Notes (Loans and Discounts) + 666,666 + -------- + $766,666 + + _Liabilities_ + +Capital Stock $100,000 +Deposits 666,666 + -------- + $766,666 + +Further: Suppose that $100,000 of cash is deposited with the bank from +the channels of business; how much more can it lend? Fifteen thousand +dollars must be retained as reserve against the new liability; $85,000 +is available as reserves against further lending. Based upon these +further reserves loans may be granted to the extent of nearly $600,000 +more. In fact, only with an expansion of $1,233,333 in loans and in +derived deposits--a total deposit of $1,333,333--has its reserve fallen +to the ratio of 15 per cent. of its liability. + + _Resources_ + +Cash (original) $100,000 +Loans and Discounts 666,666 +Cash (new) (85,000 + (15,000 +L & D (new) 566,666 + ---------- + $1,433,333 + + _Liabilities_ + +Capital Stock $100,000 +Deposits 666,666 +Deposits (new) (100,000 + (566,666 + ---------- + $1,433,333 + +The situation summarizes as follows: On its asset side the bank has +$200,000 of cash and $1,233,333 of securities (Bills and Notes). Its +deposit liabilities amount to $1,333,333. + +Its cash is 2/13.3+ of its liability--15 per cent. + +~The Function of Reserves.~--If this is what actual banking means, is +banking safe? What would happen if all these deposits were immediately +called for in cash? True, not all are likely to be called for, but some +cash will be demanded. In fact, the borrowers, instead of accepting all +of the proceeds of these notes in deposit credit, will in some measure +require and receive cash. Precisely so; and so the bank must keep on +hand a cash reserve to meet this possibility. For the most part, +however, the customers of the bank make payments through checks upon the +bank, and these credits are deposited in turn to the credit of other +customers. No cash, but only bookkeeping, is required. And if some +customers draw out cash, other customers will probably receive it and +return it to the bank. A reserve of 15 per cent. is enough for the case. +There, would, indeed, be small gain in banking if against every deposit +an equal sum in cash must be held in store by the bank. + +~Economy of Redemption Money.~--It is thus evident that the employment of +$200,000 cash as a banking reserve has made possible the existence of a +more than sixfold volume of circulating medium--currency. Against each +$1,000 of deposit liability there need be only $150 of actual cash. The +bank customer, however, thinks of his deposit claim as money, and it +really serves him all the purposes of money. The right to have the money +when desired is as good as the actual money, is more convenient, and is +as readily and as serviceably transferred. + +The economy of money through the use of credit substitutes for money +extends really further than the foregoing analysis indicates. Under the +[now superseded] law, three-fifths of the reserves of a rural bank may +be on deposit with banks in reserve cities. Thus against $100,000 of +deposit liability the rural bank needs hold only $6,000 of reserve +money. Against the deposit of the remaining $9,000, the reserve city +bank is required in turn to hold a reserve of only 25 per cent.--$2,250. +And of this required $2,250, one-half may be represented by deposits in +central reserve cities, _e. g._, New York, Chicago, and St. Louis. +Against the $1,125 deposited with it the central reserve bank is +required to hold only 25 per cent. of reserves--$281.25. Thus at the +outside limit of credit extension, $100,000 of deposit currency may be +supported by only $7,406.25 of reserves in money, + + (6000 + 1/2 × (9000/4) + (1125/4)). + +one dollar of reserves upholding $13 of currency.[34] + +It is, of course, not true that the banks ordinarily allow their +reserves to run as low as the legal limit, or make the utmost possible +use of the privilege of counting claims against one another as legal +reserves. Nor is it accurately true that all forms of money are of equal +efficiency in the support of credit. Not all forms of money, but only +those of the higher levels in the money scale, are allowed to be counted +as legal reserves.... Some forms of money make demands upon other forms +for redemption, or are limited in exchange power to the exchange power +of the form in which redemption is to be made. The total exchange +efficiency of the money of a country is, then, not accurately to be +computed on the assumption that all moneys are equally efficient for all +purposes--that some are not in varying degree burdens upon the money +functions of the others. + +~Banking Viewed in Detail and in the Aggregate.~--And one further +modification is called for. The analysis so far made, while valid for +any isolated bank, or for the banking system regarded as an aggregate, +is not precisely accurate for the affairs of any one competing bank +among other banks. When the check drawn by the borrowing depositor may +be deposited in other banks and collected by them against the lending +bank, its granting of credits rapidly draws down its reserves to swell +the reserves of its competitors. One hundred thousand dollars of new +reserves may not mean to it an increase of lending power of more than, +say, $125,000. For banks in the aggregate, however, this increase of +reserves brings its full several-fold increase of lending power, +provided that all the reserve efficiency is utilized in whatever bank it +rests. As the lending by each bank is depleting its reserves, the +lending which other banks are doing is reinforcing these reserves. The +aggregate possible extension of credit is not changed. + +~What Banks Actually Do and Lend.~--It follows from the foregoing analysis +that, in the main, banks do not lend their deposits, but rather, by +their own extensions of credit, create the deposits; that these deposits +are funds which the deposit-creditors of the bank can lend if they will, +and that many men into whose hands these deposits fall through transfer +are certain to use them as funds to be lent. In fact, also, even when +the deposits in the bank are not derived from the lending activity of +the bank, but are really funds deposited from outside sources, these +funds are commonly used by the bank as a reserve basis on which loans +are extended rather than as funds which are themselves loaned out by the +bank. Banks are, in truth, mostly intermediaries between debtors and +creditors--but not in the sense of borrowing funds from one class of +customers in order to lend them to another class, but rather in the +sense of creating for their borrowing customers funds which may be used +by these borrowers as present purchasing power. The borrower becomes +indebted to the bank in order that for his own purposes he may use the +promise of the bank as the equivalent of cash to himself. In the form of +a deposit liability the bank becomes a debtor to whomever the borrower +shall nominate. The fact that the borrower pays interest while the bank +undertakes a noninterest-bearing obligation, or pays relatively low +interest, explains in the main the gains attending the business of +commercial banking. + +~Deposits and Solvency.~--It is, therefore, a sheer blunder to infer that +a bank is rich or strong because of its great total of deposits, or to +regard deposits in banking institutions as making part of the aggregate +wealth of the community. Instead, the deposits indicate for a bank the +extent of its operations, and indicate for a community the extent to +which the banks, under the guise of noninterest-bearing obligations, +have assumed the debts of business men, on terms of these business men +becoming debtors--and interest-paying debtors--to the banks. The +solvency of the bank is in its portfolio of securities. Its deposits are +not its assets, but its liabilities. These liabilities it has mostly +created for the use of its borrowers. The further it may safely go in +assuming liabilities, the larger its holdings of borrowers' notes may +be, and the more interest or discount charges it may collect. +Essentially, therefore, the business of a bank is a form of +suretyship--the guaranteeing of its borrowers' solvency--an underwriting +of the credit of its customers. The bank transfers its customers' +prospective future paying power into present funds. It is for this +reason that the contract takes the form of a money loan and the premium +the guise of an interest payment. + +~Bank Loans Related to Currency and Loan Funds.~--And note now that it is +precisely because the business of a bank is to furnish to its borrower +a present purchasing power for his own use that the business of banking +becomes the source of the larger part of the circulating medium of +society. In their service to their customers the banks create currency; +and in creating currency they create loan funds which, in the hands of +the holders of them, are available like other currency for any purpose, +either lending or other. + +~The Sources of Currency Supply.~--It is, then, clear that the larger part +of the circulating medium of society is not money; that not all of the +money that there is is bullion money; and that not even all of the +bullion money need be ultimate money--redemption money of the highest +rank. The sources of currency in society are various--some of it +bullion, with a cost of production limit upon its supply, some of it +government paper, substantially free of cost, some of it banking credit +with certain peculiar and appropriate costs attending its issue. + +~Currency and Its Cost of Production.~--It is obvious that the actual +limitations upon the supply of exchange media must be made clear if we +are to understand the influences which are fundamental to the exchange +values of the currency unit. Only, indeed, by this investigation of the +sources of the supply, and of the terms on which each different factor +of the supply is available, are we in position to understand the +influences which impose upon bidders for money a certain level of +sacrifice in obtaining it. + +What, then, are the limitations upon the supply of credit currency +supplied by the banks? In other words, what are the banking costs in the +granting of demand deposit rights to customers? Evidently limitations +there must be, and limitations in the nature of costs, else the +competitive activity of the banks would indefinitely increase the supply +of currency, and any would-be purchaser of goods or payor of debts or +projector of an enterprise could have the time use of purchasing power +gratis; no limit would exist to the rise in prices which must attend +this increase in the circulating medium. + +What are these limitations? (1) Each bank must conform the volume of its +lending, and therewith its issue of circulating credit, to the +fundamental requirement that it be always able to make good its +agreement to discharge its deposit liabilities on demand. To maintain +reserves involves expense. Especially may it be expensive if they have +been allowed to get low; securities may have to be marketed at a +sacrifice, or good customers pressed for payment at inconvenient times. +In periods of general pressure or panic, other banks are not likely to +be in a position to lend their own reserve funds or to consent to create +deposit credit in aid of still other suffering banks. Not rarely the +Bank of England, in the attempt to attract reserve funds, advances bank +notes or deposit credit to importers of gold, without imposing the +customary interest charge for the covering of the delays of the mint. In +at least one case, in 1890, it borrowed reserves from the Bank of +France. In 1907 the United States Treasury made especially large money +deposits with the national banks of New York to help eke out the needed +reserves. Meantime the interior banks were compelled to pay to exporting +merchants generous premiums for exchange bills upon Europe, through +which, despite the high interest rates ruling in European markets, these +banks were able to import 107 millions of gold for their own reserve +requirements. In fact, the banking business involves the hazard not +merely that some of the debtors of the bank may become insolvent, but +also the general and overhead hazard attaching to its underwriting +service that it may itself in time of stress become unable to meet its +obligations. Its liabilities must not be allowed to get seriously out of +ratio to its cash resources. + +~The Protection of Reserves.~--In point of fact also the efforts of the +various different banks to maintain each its own reserve place a limit +on the extent to which any one bank can extend its activity in the +expansion of loans and of the derivative liabilities. Just as a +relatively liberal granting of credit by one bank must tend to transfer +its reserves to other banks, so a relatively great extension of credit +in one center or in one country must tend to transfer the reserves, _e. +g._, gold, to other centers or countries. Even were it true that a local +credit expansion has no effect upon local prices and thereby upon the +currents of trade, some transfers of reserves would still take place, +and would impose a policy of restriction in credit accommodations.... +The influence is actually exerted by both methods. + +~(2) Another Cost in Bank-Made Currency.~--The loan rates of the bank must +also provide a fund to cover its costs of administration--salaries, +clerk hire, rents, and the like. Where transactions run in large units +the ratio of expense to the volume of business may be low. This is in +part the explanation for the low rates of discount in the great +financial centers compared with the rates outside. Credit currency has +its cost of production rate as truly as any other service upon the +market.... + + +THE RELATION BETWEEN LOANS AND DEPOSITS + +[35]The money of modern English commerce and finance is the cheque, and +the credit dealt in in the London money market is the right to draw a +cheque.... + +Now that we have come to the point at which the manufacture of the right +to draw cheques has to be made as clear as may be, it will be well to +come into close touch with the facts of the case and look at a bank +balance-sheet of to-day. In order to get a fair average specimen I have +taken the latest available balance-sheets of half a dozen of the biggest +London banks, and put their figures together.... Let us examine the +aggregated specimen that I have drawn up. + + _Millions of £_ + Capital paid up 16 + Reserve Fund 11 + Current and deposit accounts 249 + Acceptance on behalf of customers 16-1/2 + Profit and Loss account 1-1/2 + ------- + 294 + + _Millions of £_ +Cash in hand and at the Bank of England 43 +Loans at call and short notice 27-1/2 +Bills discounted and advances 153 +Investments 48 +Liability of customers on acceptances 16-1/2 +Premises 6 + ------- + 294 + +The above statement does not include the figures of the Bank of England, +but is an agglomeration of the balance-sheets of six of the biggest of +the ordinary joint-stock banks. + +The first feature that strikes the casual observer is the smallness of +the paid-up capital of the banks when compared with the vastness of the +figures that they handle. We see that only 16 millions out of the 294 +that they have to account for have been actually paid up by +shareholders, though 11 millions have been retained out of past profits +and accumulated in reserve funds ["surplus," in United States], and +1-1/2 millions are due to shareholders, for distribution as dividend or +addition to reserve, in the shape of the profit and loss account balance +for the period covered by the balance-sheet. A profit of 1-1/2 millions +on 16 is handsome enough, especially when it is considered that most of +these balance-sheets covered a half-year's work, but 1-1/2 millions out +of 294 is a trifle, and it thus appears that a narrow margin of profit +on their total turnover enables the banks to pay good dividends, and +that the business of credit manufacture earns its reward, as might be +expected, out of the credit that it makes. + +Proceeding in our examination, we see that the item of acceptances on +behalf of customers on one side is balanced by the liability of +customers on the other. This means that the banks have accepted bills +for their customers (so making them first-class paper and easily +negotiable), and are so technically liable to meet them on maturity; but +since the customers are expected to meet them, and have presumably given +due security, this liability of the customer to the bank is an +offsetting asset against the acceptance. And since the acceptance +business is a comparatively small item, and a bank's liability under its +acceptances is not a liability in quite the same sense as its deposits, +and does not immediately affect the present question of the manufacture +of currency, it may be omitted for the present. We can thus simplify the +balance-sheet by taking out this contra entry on both sides. + +Further analysis of the liabilities shows that the capital, reserves, or +surplus, and profit and loss balance may be regarded as due from the +banks to their shareholders, and that the remaining big item, current +and deposit accounts, is due to their customers. This is the item which +is usually spoken of as the deposits, according to the tiresome habit of +monetary nomenclature which seems to delight in applying the same name +to a genus and one of the species into which it is divided. Just as the +bill of exchange is divided into cheques and bills of exchange, so the +English banks' deposit accounts are divided into current and deposit +accounts. But most people who have a banking account know the meaning of +this distinction. Your current account is the amount at your credit +which you can draw out, or against which you can draw cheques, at any +moment; your deposit account is the amount that you have placed on +deposit with the bank and can only withdraw on a week's or longer +notice, and it earns a rate of interest, usually 1-1/2 per cent. below +the Bank of England's official rate. The essential point to be grasped +is the fact that the banks' deposits, as usually spoken of, include both +the current and deposit accounts, and are due by the banks to their +customers. + +Now let us see how this huge debt from the banks to the public has been +created. An examination of the assets side of the balance-sheet proves +that most of it has been created by money lent to their customers by the +banks, and that the cheque currency of to-day is, like the note currency +of a former day, based on mutual indebtedness between the banks and +their customers. For the assets side shows that the banks hold 43 +millions in cash and at the Bank of England, 48 millions in investments, +and 6 millions invested in their premises--the buildings in which they +conduct their business--and that 180-1/2 millions have been lent by them +to their customers, either by the discounting of bills or by advances to +borrowers, or by loans at call or short notice. We can now reconstruct +our balance-sheet, leaving out the acceptances on both sides, as +follows: + + _Millions of £._ _Millions of £._ +Due to shareholders 28-1/2 Cash in hand and at Bank +Due to customers 249 of England 43 + -------- Investments 48 + 277-1/2 Premises 6 + Due from customers 180-1/2 + -------- + 277-1/2 + +And it thus appears that nearly three-quarters of the amount due from +the banks to their customers are due from their customers to the banks, +having been borrowed from them in one form or another. And this +proportion would perhaps be exceeded if we could take the figures of +English banking as a whole. But that cannot be done at present, because +some of the smaller banks do not separate their cash from their loans at +call in their published statements. The greater part of the banks' +deposits is thus seen to consist, not of cash paid in, but of credits +borrowed. For every loan makes a deposit, and since our balance-sheet +shows 180-1/2 millions of loans, 180-1/2 out of the 249 millions of +deposits have been created by loans. + +To show how a loan makes a deposit, let us suppose that you want to buy +a thousand-guinea motor-car and raise the wherewithal from your banker, +pledging with him marketable securities, and receiving from him an +advance, which is added to your current account. Being a prudent person +you make this arrangement several days before you have to pay for the +car, and so for this period the bank's deposits are swollen by your +£1,050, and on the other side of its balance-sheet the entry "advances +to customers" is also increased by this amount, and the loan has clearly +created a deposit. + +But you raised your loan for a definite purpose, and not to leave with +your bank, and it might be thought that when you use it to pay for your +car the deposit would be cancelled. But not so. If the seller of your +car banks at your bank, which we will suppose to be Parr's, he will pay +your cheque into his own account, and Parr's bank's position with regard +to its deposits will be unchanged, still showing the increase due to +your loan. But if, as is obviously more probable, he banks +elsewhere--perhaps at Lloyd's--he will pay your cheque into his account +at Lloyd's bank, and it will be the creditor of Parr's for the amount of +£1,050. In actual fact, of course, so small a transaction would be +swallowed up in the vast mass of the cross-entries which each of the +banks every day makes against all the others, and would be a mere needle +in a bottle of hay. But for the sake of clearness we will suppose that +this little cheque is the only transaction between Parr's and Lloyd's on +the day on which it is presented; the result would be that Parr's would +transfer to Lloyd's £1,050 of its balance at the Bank of England, where +all the banks keep an account for clearing purposes. And the final +outcome of the operation would be that Parr's would have £1,050 more +"advances to customers" and £1,050 less cash at the Bank of England +among its assets, while Lloyd's would have £1,050 more deposits and +£1,050 more cash at the Bank of England. And the £1,050 increase in +Lloyd's deposits would have been created by your loan, and though it +will be drawn against by the man who sold you the car, it will only be +transferred perhaps in smaller fragments to the deposits of other banks; +and as long as your loan is outstanding there will be a deposit against +it in the books of one bank or another, unless, as is most unlikely, it +is used for the withdrawal of coin or notes; and even then the coin and +notes are probably paid into some other bank, and become a deposit +again; and so we come back to our original conclusion that your +borrowing of £1,050 has increased the sum of banking deposits, as a +whole, by that amount. + +The same reasoning applies whenever a bank makes a loan, whatever be the +collateral, or pledge deposited by the borrower, whether Stock Exchange +securities, as in the case cited, or bales of cotton or tons of copper; +or, again, whenever it discounts a bill. In each case it gives the +borrower or the seller of the bill a credit in its books--in other +words, a deposit; and though this deposit is probably--almost +certainly--transferred to another bank, the sum of banking deposits is +thereby increased, and remains so, as long as the loans are in +existence. And so it appears that the loans of one bank make the +deposits of others, and its deposits consist largely of other banks' +loans.... + + +RELATION BETWEEN RESERVES AND DEMAND LIABILITIES AGAIN + +[36]... a bank must so regulate its loans and note issues as to keep on +hand a sufficient cash reserve, and thus prevent insufficiency of cash +from ... threatening. It can regulate the reserve by alternately selling +securities for cash and loaning cash on securities. The more the loans +in proportion to the cash on hand, the greater the profits, but the +greater the danger also. In the long run a bank maintains its necessary +reserve by means of adjusting the interest rate charged for loans. If it +has few loans and a reserve large enough to support loans of much +greater volume, it will endeavor to extend its loans by lowering the +rate of interest. If its loans are large and it fears too great demands +on the reserve, it will restrict the loans by a high interest charge. +Thus, by alternately raising and lowering interest, a bank keeps its +loans within the sum which the reserve can support, but endeavors to +keep them (for the sake of profit) as high as the reserve will support. + +If the sums owed to individual depositors are large, relatively to the +total liabilities, the reserve should be proportionately large, since +the action of a small number of depositors can deplete it rapidly. +Similarly, the reserves should be larger against fluctuating deposits +(as of stock brokers) or those known to be temporary. The reserve in a +large city of great bank activity needs to be greater in proportion to +its demand liabilities than in a small town with infrequent banking +transactions. + +Experience dictates differently the average size of deposit accounts for +different banks according to the general character and amount of their +business. For every bank there is a normal ratio and hence for a whole +community there is also a normal ratio--an average of the ratios for the +different banks. No absolute numerical rule can be given. Arbitrary +rules are often imposed by law. National banks in the United States, for +instance, are required to keep a reserve for their deposits, varying +according as they are or are not situated in certain cities designated +by law as "reserve" cities, _i. e._, cities where national banks hold +deposits of banks elsewhere. These reserves are all in defense of +deposits. In defense of notes, on the other hand, no cash reserve is +required--that is, of national banks. True, the same economic principles +apply to both bank notes and deposits, but the law treats them +differently. The Government itself chooses to undertake to redeem the +national bank notes on demand. + +The state banks are subject to varying restrictions. Thus the +requirement as to the ratio of reserve to deposits varies from 12-1/2 +per cent. to 22-1/2 per cent., being usually between 15 per cent. and +20 per cent. Of the reserve, the part which must be cash varies from 10 +per cent. (of the reserve) to 50 per cent., usually 40 per cent. + +Such legal regulation of banking reserves, however, is not a necessary +development of banking.... + + +THE RÔLE OF A SPECIE RESERVE ILLUSTRATED BY THE INCONVERTIBLE NOTES OF +THE BANK OF ENGLAND ISSUED DURING THE OPERATION OF THE RESTRICTION +ACT[37] + +[38]... Your Committee proceeded, in the first instance, to ascertain +what the price of gold bullion [in terms of Bank of England notes] had +been, as well as the rates of the foreign exchanges, for some time past; +particularly during the last year. + +Your Committee have found that the price of gold bullion, which, by the +regulations of his Majesty's Mint, is £3 17_s._ 10-1/2_d._ per ounce of +standard fineness, was, during the years 1806, 1807, and 1808, as high +as £4 in the market. Towards the end of 1808 it began to advance very +rapidly, and continued very high during the whole year 1809; the market +price of standard gold in bars fluctuating from £4 9_s._ to £4 12_s._ +per ounce. The market price at £4 10_s._ is about 15-1/2 per cent. above +the Mint price.... + +It is due,... in justice to the present Directors of the Bank of +England, to remind the House that the suspension of their cash payments, +though it appears in some degree to have originated in a mistaken view +taken by the Bank of the peculiar difficulties of that time, was not a +measure sought for by the Bank, but imposed upon it by the Legislature +for what were held to be urgent reasons of state policy and public +expediency. And it ought not to be urged as matter of charge against the +Directors, if in this novel situation in which their commercial company +was placed by the law, and entrusted with the regulation and control of +the whole circulating medium of the country, they were not fully aware +of the principles by which so delicate a trust should be executed, but +continued to conduct their business of discounts and advances according +to their former routine. + +It is important at the same time to observe that under the former +system, when the Bank was bound to answer its notes in specie upon +demand, the state of the foreign exchanges and the price of gold did +most materially influence its conduct in the issue of those notes, +though it was not the practice of the Directors systematically to watch +either the one or the other. So long as gold was demandable for their +paper, they were speedily apprised of a depression of the exchange, and +a rise in the price of gold, by a run upon them for that article. If at +any time they incautiously exceeded the proper limit of their advances +and issues, the paper was quickly brought back to them, by those who +were tempted to profit by the market price of gold or by the rate of +exchange. In this manner the evil soon cured itself. The Directors of +the Bank having their apprehensions excited by the reduction of their +stock of gold, and being able to replace their loss only by reiterated +purchases of bullion at a very losing price, naturally contracted their +issues of paper, and thus gave to the remaining paper, as well as to the +coin for which it was interchangeable, an increased value, while the +clandestine exportation either of the coin, or the gold produced from +it, combined in improving the state of the exchange and in producing a +corresponding diminution of the difference between the market price and +Mint price of gold, or of paper convertible into gold. + +Your Committee do not mean to represent that the manner in which this +effect resulted from the conduct which they have described, was +distinctly perceived by the Bank Directors. The fact of limiting their +paper as often as they experienced any great drain of gold, is, however, +unquestionable.... + +It was a necessary consequence of the suspension of cash payments, to +exempt the Bank from that drain of gold, which, in former times, was +sure to result from an unfavourable exchange and a high price of +bullion. And the Directors, released from all fears of such a drain, and +no longer feeling any inconvenience from such a state of things, have +not been prompted to restore the exchanges and the price of gold to +their proper level by a reduction of their advances and issues. The +Directors, in former times, did not perhaps perceive and acknowledge the +principle more distinctly than those of the present day, but they felt +the inconvenience, and obeyed its impulse; which practically established +a check and limitation to the issue of paper. In the present times the +inconvenience is not felt; and the check, accordingly, is no longer in +force.... + +By far the most important ... consequence ... [of the Restriction Act] +is, that while the convertibility into specie no longer exists as a +check to an over-issue of paper, the Bank Directors have not perceived +that the removal of that check rendered it possible that such an excess +might be issued by the discount of perfectly good bills. So far from +perceiving this ... they maintain the contrary doctrine with the utmost +confidence.... That this doctrine is a very fallacious one, your +Committee cannot entertain a doubt. The fallacy, upon which it is +founded, lies in not distinguishing between an advance of capital to +merchants, and an addition of supply of currency to the general mass of +circulating medium. If the advance of capital only is considered, as +made to those who are ready to employ it in judicious and productive +undertakings, it is evident there need be no other limit to the total +amount of advances than what the means of the lender, and his prudence +in the selection of borrowers, may impose. But in the present situation +of the Bank, intrusted as it is with the function of supplying the +public with that paper currency which forms the basis of our +circulation, and at the same time not subjected to the liability of +converting the paper into specie, every advance which it makes of +capital to the merchants in the shape of discount, becomes an addition +also to the mass of circulating medium. In the first instance, when the +advance is made by notes paid in discount of a bill, it is undoubtedly +so much capital, so much power of making purchases, placed in the hands +of the merchant who receives the notes; and if those hands are safe, the +operation is so far, and in this its first step, useful and productive +to the public. But as soon as the portion of circulating medium in which +the advance was thus made performs in the hands of him to whom it was +advanced this its first operation as capital, as soon as the notes are +exchanged by him for some other article which is capital, they fall into +the channel of circulation as so much circulating medium, and form an +addition to the mass of currency. The necessary effect of every such +addition to the mass is to diminish the relative value of any given +portion of that mass in exchange for commodities. If the addition were +made by notes convertible into specie, this diminution of the relative +value of any given portion of the whole mass would speedily bring back +upon the Bank which issued the notes as much as was excessive. But if by +law they are not so convertible, of course this excess will not be +brought back, but will remain in the channel of circulation, until paid +in again to the Bank itself in discharge of the bills which were +originally discounted. During the whole time they remain out, they +perform all the functions of circulating medium; and before they come to +be paid in discharge of those bills, they have already been followed by +a new issue of notes in a similar operation of discounting. Each +successive advance repeats the same process. If the whole sum of +discounts continues outstanding at a given amount, there will remain +permanently out in circulation a corresponding amount of paper; and if +the amount of discounts is progressively increasing, the amount of +paper, which remains out in circulation over and above what is otherwise +wanted for the occasions of the public, will progressively increase +also, and the money prices of commodities will progressively rise. This +progress may be as indefinite as the range of speculation and adventure +in a great commercial country.... + +FOOTNOTES: + +[31] Herbert Joseph Davenport, _The Economics of Enterprise_, pp. 259, +60. The Macmillan Company, New York. 1913. + +[32] Charles F. Dunbar, _Chapters on the Theory and History of Banking_, +pp. 20-38, G. P. Putnam's Sons, New York and London. 1902. + +[33] Herbert Joseph Davenport, _The Economics of Enterprise_, pp. 260-6. +The Macmillan Company. New York. 1913. + +[34] It should not be overlooked, furthermore, that the velocity of the +circulation of deposits is approximately two and one-half times that of +money.--EDITOR. + +[35] Hartley Withers, _The Meaning of Money_, pp. 57-73. E. P. Dutton +and Company. New York. 1914. + +[36] Irving Fisher, _The Purchasing Power of Money_, pp. 45-47. The +Macmillan Company. New York. 1911. + +[37] This act, passed in 1797 in order to prevent a drain of gold to the +continent during the Napoleonic War, forbade the Bank of England to +redeem its notes. It remained in force until 1821, when specie payment +was resumed.--EDITOR. + +[38] Report from the Select Committee on the High Price of Gold Bullion. +Ordered by the House of Commons, to be printed, 8 June, 1810. + + + + +CHAPTER X + +THE USE OF CREDIT INSTRUMENTS IN PAYMENTS IN THE UNITED STATES + +[39]Discussions concerning the issue of notes by banking institutions, +which largely occupied the attention of students of finance and business +men in the eighteenth and the first three quarters of the nineteenth +centuries, have been succeeded by equally intense discussions of the +amount and influence of credit deposits on the books of the banks, when +drawn on by their customers with checks. The fact that the use of checks +against deposits renders unnecessary a large amount of money, or +currency, attracted attention early in the history of deposit banking, +and efforts have been made from time to time to determine the proportion +of money, or currency, replaced with checks and credit documents of +similar character.[40] + +We may summarize the results of our inquiry and inferences therefrom +briefly as follows: + +1. In the first place, it is very clear that a large proportion of the +business of the country, even the retail trade, is done by means of +credit instruments. While it is probably true that wage-earners, as a +class, do not commonly use checks, it is also true that a great many of +them do. Moreover, the use of checks is common among people who derive +their income from other sources, even though it be not larger than the +well-paid day laborer. We are justified ... in concluding that 50 or 60 +per cent. of the retail trade of the country is settled in this way. + +2.... Over 90 per cent. of the wholesale trade of the country is done +with checks and other credit documents. + +3. The very general use of checks is shown in the deposits of "all +other" depositors. The average is close up to that of the wholesale +trade, and while many corporations, public and private, are doubtless +represented here, and many speculative transactions are included, there +is no reason for excluding any one of those in determining the +proportion of business done, whatever we may think of its legitimacy +from the point of view of public morals or public utility. + +4. The use of checks is promoted in a measure by the payment of wages by +check. It appears from our investigation that of weekly pay rolls +reported by the banks, aggregating $134,800,000 for the week ending +March 13 last, 70 per cent. was in checks.... + +5. The great use of checks is shown also by the large number of accounts +under $500.... + +6. We may therefore safely accept an average of 80 to 85 per cent. as +the probable percentage of business of this country done by check. + +7. The fact that so large a proportion of business is done with credit +paper may or may not be a good thing. Whether it is or not depends on +circumstances. If any part of the country is compelled to use checks +because of the lack of currency, when it would prefer the latter, the +situation is an evil. + +8. The transaction of so large a volume of our business by checks is an +element of danger in times of stringency and crisis. In such times the +uncalled balance of credit transactions creates a larger demand for +money, but the habit of settling by check has meantime kept the +available amount of money at a minimum. + +9. Consequently there ought to be some means of supplying additional +currency when credit as a means of payment diminishes. This currency +ought to be as safe and as uniform as the ordinary currency, and it +should be capable of being quickly emitted and recalled. That is, it +should possess elasticity. + +10. The large money circulation of the country is explained by the facts +that our prices and wages range high, that our people probably carry a +larger average amount of money on their persons than do foreigners, +that some portion of our currency has been destroyed or lost or +hoarded.... As our business grows, the amount of money needed as reserve +to perform this vast volume of business transactions increases, too.... + +13. The volume of credit transactions very likely tends to increase as +population and business grow. It does not increase uniformly, however, +but by periodic movements. That is to say, the rate of increase of +credit transactions, as compared with the whole volume of business, +grows, as it were, by jerks and at a decreasing rate. + +Several important questions are closely related to the inquiry which has +been [made and summarized]. Among them are these: + +1. What is the amount of money rendered unnecessary by the use of credit +paper? + +2. What is the influence of the vast volume of credit transactions on +the value of money or the level of prices?[41] + +3. Why is it that our per capita circulation is so large and where is +the money in active circulation?... + +1. We will take these questions up in order.... No one can say ... with +definiteness what is the amount of money released if 75 or 80 per cent. +of our business transactions are settled by means of credit paper. This +is a matter in which the long experience of practical bankers is the +only safe guide, because the amount in question is changing from day to +day as the conditions change. No simple rule about it can be laid +down.... + +One point needs to be carefully borne in mind. However great the volume +of credit exchanges, however extensive the use of credit may become in a +community, they can never fully displace sales for direct money payment. +The extensive use of credit is not of itself a sign that a community is +well off. Credit is used in poor as well as in rich communities. Its +extensive use in a poor and undeveloped country is likely to indicate a +lack of capital rather than an abundance of wealth. Every community +tends to use the cheapest medium of exchange accessible to it. If its +capital is of very high value for producing goods for direct +consumption, a community will be averse to investing much of it in a +medium of exchange. + +This is the reason why undeveloped countries, as our own was a century +ago, try to effect their exchanges by means of credit paper to a larger +extent than wealthier communities. Under such conditions paper money is +commonly thought to be the cheapest medium of exchange. If, now, part of +the money exchanges are replaced with credit exchanges, the amount of +money released, or the amount without which the community could now get +on, would be the whole amount formerly used in money payments ... minus +the reserve necessary to do this credit business. The important point, +however, is that less money is necessary. How much less we can not be +sure. We can get some light on the subject, however, by noting the +volume of business done by credit paper and the balances which from time +to time are carried as a basis of settlement. + +It is important to note also that an increase in the volume of credit +transactions does not necessarily mean that we must get a proportionate +increase in our reserve of money. Every refinement of the credit +mechanism makes it possible to do a larger volume of business on the +same reserve.... + +The volume of business that can be done by credit paper depends on +several circumstances. Obviously, in the first place, it depends upon +the banking facilities of the country. If the banks are widely +distributed, if they are willing to deal in transactions small enough to +be within the reach of large numbers of people, many more transactions +will be settled through them than would otherwise be the case. This fact +undoubtedly explains in large measure the development of what may be +called the "banking habit" among the people of the United States. +Undoubtedly our people pay by check much more commonly and much more +largely than people of any other country. We settle smaller transactions +by check; our banks are willing to carry smaller accounts. Indeed, the +rapid industrial development of our country is probably due in no small +degree to our system of independent banks and the facility with which we +have permitted banks to be established. The small independent bank in +the country community has felt that its interests and success were bound +up with the interests and success of the community, and, therefore, has +undoubtedly been willing to do more for the general interests than a +branch of a large bank in some remote commercial center would have felt +like doing, even if it had been justified in doing so. The small capital +with which we have permitted banks to be established also has +undoubtedly been a contributing factor to our rapid economic +development, as well as to the promotion of the banking habit among our +people. + +In the next place, the density of population is, of course, an important +factor for the growth of credit exchanges. A larger volume of business +is settled by bank paper in a commercial center than in an agricultural +community, even though the proportion of total business thus settled may +not be larger. However, it is necessary that there should be a certain +number of people within reach of a common center in order to have a bank +established there. Of course the smaller the bank the fewer the people +thus required. Thus again our inclination in the past to favor the +establishment of the small independent banks has facilitated the spread +of banking and promoted the volume of business settled in the country +districts by credit payment and stimulated the banking habit among our +people. + +Finally, the general education and intelligence of the mass of the +people is an important factor. Men do not use banks unless they have +confidence in them, and they have come to be regarded as a settled part +of the ordinary commercial mechanism of the community. Our people are +people of a wide general education and high order of intelligence. They +understand the place and work of the bank in a community much better +than the same number of people, for example, in a European country. This +fact is strikingly brought out by a study of the proportion of retail +business settled by means of checks, in what are called the "foreign" +districts of our large cities, on the one hand, and in an agricultural +community on the other. The European immigrant is not a man who has had +banking connections in his home country, and he does not use them here, +even though the facilities are more numerous. + +Such evidence as there is seems to indicate that payment by check has +shown an increase during the past few years: + +(a) In the first place, the returns of our reports show a larger +percentage in retail trade.... + +(b) The prosperity of the farmers in the Central West has enabled many +to have bank accounts who fifteen years ago could not carry balances. +The writer's information from central Illinois is strongly in this +direction. + +(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, +significant.... + +On the other hand, the increase of that part of the population which +consists of the wage-earning class, by whom the use of checks is small, +is undoubtedly greater than that of our other classes of population. +However, the wealthy classes, though fewer in number, have more to spend +and their use of checks raises the proportion of credit paper in +payments. + +We can not expect any social movement to continue steadily in one +direction for an indefinite time. Such evidence as inquiries of this +character furnish seems to show that there is a certain ebb and flow in +the proportion of checks used in business payments. With a given amount +of money a certain proportion of it can be used for bank reserves on +which to build credit transactions. For a time the volume of business +will increase more rapidly than the money supplies, so that the +proportion of credit business to the whole will increase, the +improvement of the credit machinery in the meantime facilitating the +movement. But the perfection of the facilities for utilizing to the +utmost a given reserve, or a slowly increasing one, will come to a stop +after a time, and it will be necessary to increase the money supply for +any further expansion of credit. In the language of business, another +unit of capital must be added to plant. The unit added to the social +capital devoted to exchange--that is, the additional amount of +money--will be larger than is necessary for most profitable immediate +use, consequently the proportion of money exchanges will for a time show +an increase. We may conclude, therefore, that the volume of business +done on credit gradually increases as the population and total amount of +business are enlarged, but at a decreasing rate and with occasional or +periodic retardations. + +2. _Relation of credit exchanges to the volume of money and prices._--It +is pertinent to inquire, now, what effect, if any, this great settlement +of indebtedness by means of credit paper has upon the value of money. +Evidently, it can influence this value, or the general price level, only +as it changes the amount of demand for money. We have seen reason, now, +to think that 80 per cent. of our business transactions are settled by +means of credit paper. Credit paper cancellation enables a larger amount +of business to be done with the same amount of money and has an effect +in determining the value of money by increasing the demand for +reserves.... + +... The use of credit paper in effecting credit exchanges makes possible +a far larger volume of business than could otherwise be done, and that +this increased volume of business must in some way influence prices +seem[s] undeniable.... + +... We are told by many that there is a vast amount of credit +transactions embodied in banking and clearing-house statistics which may +be termed "fictitious." That is to say, they are not a part of the +necessary work of exchange in a community. For example, the cotton and +wheat crops are sold several times over on the exchanges of the country, +but not all these purchases and sales are a necessary part of the +process of getting the cotton from the planter to the manufacturer. +These sales, we are told, are purely speculative and born out of the +credit organization, which, it is urged, merely makes the transactions +possible.... However,... these exchanges actually exist. All the +purchases involved constitute a part of the demand for means of +settlement. Therefore they are to be regarded as a proper part of the +exchange business of the country, and in some degree they must influence +the need for money.... + +... The demand for money to effect exchanges includes, first, demand for +money for direct exchanges; second, demand for reserves for credit +exchanges. Some goods exchange by direct barter and still more probably +by indirect barter. If these last exchanges just cancelled one another, +the credit paper that grows out of them would also cancel, and no +balances would remain to be settled with money. Usually, however, they +do not cancel, and the balance must be settled with cash; hence a +reserve is necessary.... This demand for reserve is certainly one of the +influences that go to determine the value of money. In short, the demand +for money includes a demand for direct payment and a demand for +reserve.... + +3. _Our monetary circulation._--Our per capita circulation, as estimated +by the Comptroller of the Currency, has increased from $21.10 in 1906 to +$34.72 in 1908.[42] This is larger than the per capita circulation of +other great industrial and commercial countries with the exception of +France. Why is it necessary and where is it? It is necessary, perhaps, +for the following reasons: + +(a) A larger amount of money is needed in this country because, in the +first place, our prices range higher. If the prices of articles commonly +consumed range 20 per cent. higher than they do abroad, the people who +buy them and pay for them with money need a larger amount to make their +purchases. The same cause makes a larger reserve necessary to exchange a +given volume of goods by credit. The demand for money, therefore, both +for reserve and direct money transactions, is greater on account of the +higher scale of prices. + +(b) The same kind of reasoning applies to our wage scale. Whether the +wage scale be the cause of the higher cost of living or the higher cost +of living be the cause of the higher wage scale, more money will be +needed in proportion to the trade. If wages are paid with checks, more +money will be needed by the amount that the reserve must be increased to +furnish a basis for the checks. + +(c) Our country is more sparsely settled than England, France, or +Germany. In spite of the large increase in the banking facilities of the +country, it still remains true that very many places are remote from +banks, so that business, so far as it is not barter, will probably be +carried on with money. It is necessary, therefore, to have a larger +amount of money than if population were denser.... + +(d) It may be that our spirit of individualism plays some part. So large +a proportion of our wage-earning population have come from conditions +where they had opportunity to handle very little money, that they like +to carry money on their persons. It makes them feel, as one man said to +the writer, "more independent." To quote the same informant, they would +"rather pay higher prices and have more money to pay with." + +(e) Doubtless there is a good deal of hoarding by people who distrust +banks or are not near enough to use them. It might be urged that no +larger proportion of people here hoard than is the case in Europe. +Without disputing this, it is true, however, that if only the same +proportion hoard and in the same relative amounts as is done by +corresponding classes of the population, the absolute amount thus +withdrawn would be larger because of our higher scale of wages and +prices.... + +FOOTNOTES: + +[39] David Kinley, _The Use of Credit Instruments in Payments in the +United States_, pp. 1, 2; 199-216. Senate Document No. 399. 61st +Congress, _2d Session_. + +[40] In this discussion the phrase "credit documents" or "credit +instruments" does not include bank notes. + +[41] [The effect of credit exchanges on the value of money, treated at +length in the next chapter, is only briefly discussed in the extracts +here reproduced.] + +[42] [Approximately $40 in 1916.] + + + + +CHAPTER XI + +A SYMPOSIUM ON THE RELATION BETWEEN MONEY AND GENERAL PRICES + + The form of this chapter was suggested by the proceedings of + a session of the 1910 Meeting of the American Economic + Association, devoted to a consideration of the causes of the + rise in prices between 1896 and 1909. Selections from papers + there presented, and from the relative discussion, make up a + considerable part of the chapter, and it is suggested that + all of the selections, except the last, may well be + considered for purposes of study as having come from the + papers and discussion of the session referred to, although + numerous additions and substitutions have been made in order + to render the treatment one of principles involved in the + determination of general prices without special reference to + any particular period of years. + + +IRVING FISHER[43]: Overlooking the influence of deposit currency, or +checks, the price level may be said to depend on only three sets of +causes: (1) the quantity of money in circulation; (2) its "efficiency" +or velocity of circulation (or the average number of times a year money +is exchanged for goods); and (3) the volume of trade (or amount of goods +bought by money). The so-called "quantity theory,"[44] _i.e._, that +prices vary proportionately to money, has often been incorrectly +formulated, but (overlooking checks) the theory is correct in the sense +that the level of prices varies directly with the quantity of money in +circulation, provided the velocity of circulation of that money and the +volume of trade which it is obliged to perform are not changed. + +The quantity theory has been one of the most bitterly contested theories +in economics, largely because the recognition of its truth or falsity +affected powerful interests in commerce and politics. It has been +maintained--and the assertion is scarcely an exaggeration--that the +theorems of Euclid would be bitterly controverted if financial or +political interests were involved. + +The quantity theory has, unfortunately, been made the basis of arguments +for unsound currency schemes. It has been invoked in behalf of +irredeemable paper money and of national free coinage of silver at the +ratio of 16 to 1. As a consequence, not a few "sound money men," +believing that a theory used to support such vagaries must be wrong, and +fearing the political effects of its propagation, have drifted into the +position of opposing, not only the unsound propaganda, but also the +sound principles by which its advocates sought to bolster it up.[45] +These attacks upon the quantity theory have been rendered easy by the +imperfect comprehension of it on the part of those who have thus invoked +it in a bad cause. + +Personally, I believe that few mental attitudes are more pernicious, and +in the end more disastrous, than those which would uphold sound practice +by denying sound principles because some thinkers make unsound +application of those principles. At any rate, in scientific study there +is no choice but to find and state the unvarnished truth. + +The quantity theory will be made more clear by the equation of exchange, +which is now to be explained. + +The equation of exchange is a statement, in mathematical form, of the +total transactions effected in a certain period in a given community. It +is obtained simply by adding together the equations of exchange for all +individual transactions. Suppose, for instance, that a person buys 10 +pounds of sugar at 7 cents per pound. This is an exchange transaction, +in which 10 pounds of sugar have been regarded as equal to 70 cents, and +this fact may be expressed thus: 70 cents = 10 pounds of sugar +multiplied by 7 cents a pound. Every other sale and purchase may be +expressed similarly, and by adding them all together we get the equation +of exchange _for a certain period in a given community_. During this +same period, however, the same money may serve, and usually does serve, +for several transactions. For that reason the money side of the equation +is of course greater than the total amount of money in circulation. + +The equation of exchange relates to all the purchases made by money in a +certain community during a certain time. We shall continue to ignore +checks or any circulating medium not money. We shall also ignore foreign +trade and thus restrict ourselves to trade within a hypothetical +community. Later we shall reinclude these factors, proceeding by a +series of approximations through successive hypothetical conditions to +the actual conditions which prevail to-day. We must, of course, not +forget that the conclusions expressed in each successive approximation +are true solely on the particular hypothesis assumed. + +The equation of exchange is simply the sum of the equations involved in +all individual exchanges in a year. In each sale and purchase, the money +and goods exchanged are _ipso facto_ equivalent; for instance, the money +paid for sugar is equivalent to the sugar bought. And in the grand total +of all exchanges for a year, the total money paid is equal in value to +the total value of the goods bought. The equation thus has a money side +and a goods side. The money side is the total money paid, and may be +considered as the product of the quantity of money multiplied by its +rapidity of circulation. The goods side is made up of the products of +quantities of goods exchanged multiplied by their respective prices. + +The important magnitude, called the velocity of circulation, or rapidity +of turnover, is simply the quotient obtained by dividing the total money +payments for goods in the course of a year by the average amount of +money in circulation by which those payments are effected. This velocity +of circulation for an entire community is a sort of average of the rates +of turnover of money for different persons. Each person has his own rate +of turnover which he can readily calculate by dividing the amount of +money he expends per year by the average amount he carries. + +Let us begin with the money side. If the number of dollars in a country +is 5,000,000, and their velocity of circulation is twenty times per +year, then the total amount of money changing hands (for goods) per year +is 5,000,000 times twenty, or $100,000,000. This is the _money_ side of +the equation of exchange. + +Since the money side of the equation is $100,000,000, the goods side +must be the same. For if $100,000,000 has been spent for goods in the +course of the year, then $100,000,000 worth of goods must have been sold +in that year. In order to avoid the necessity of writing out the +quantities and prices of the innumerable varieties of goods which are +actually exchanged, let us assume for the present that there are only +three kinds of goods,--bread, coal, and cloth; and that the sales are: + + 200,000,000 loaves of bread at $ .10 a loaf, + 10,000,000 tons of coal at 5.00 a ton, and + 30,000,000 yards of cloth at 1.00 a yard. + +The value of these transactions is evidently $100,000,000, _i. e._, +$20,000,000 worth of bread plus $50,000,000 worth of coal plus +$30,000,000 worth of cloth. The equation of exchange therefore (remember +that the money side consisted of $5,000,000 exchanged 20 times) is as +follows: + + $5,000,000 × 20 times a year + = 200,000,000 loaves × $ .10 a loaf + + 10,000,000 tons × 5.00 a ton + + 30,000,000 yards × 1.00 a yard + +This equation contains on the money side two magnitudes, viz. (1) the +quantity of money and (2) its velocity of circulation; and on the goods +side two _groups_ of magnitudes in two columns, viz. (1) the quantities +of goods exchanged (loaves, tons, yards), and (2) the prices of these +goods. The equation shows that these four sets of magnitudes are +mutually related. Because this equation must be fulfilled, the prices +must bear a relation to the three other sets of magnitudes--quantity of +money, rapidity of circulation, and quantities of goods exchanged. +Consequently, these prices must, as a whole, vary proportionally with +the quantity of money and with its velocity of circulation, and +inversely with the quantities of goods exchanged. + +Suppose, for instance, that the quantity of money were doubled, while +its velocity of circulation and the quantities of goods exchanged +remained the same. Then it would be quite impossible for prices to +remain unchanged. The money side would now be $10,000,000 × 20 times a +year or $200,000,000; whereas, if prices should not change, the goods +would remain $100,000,000, and the equation would be violated. Since +exchanges, individually and collectively, always involve an equivalent +_quid pro quo_, the two sides _must_ be equal. Not only must purchases +and sales be equal in amount--since every article bought by one person +is necessarily sold by another--but the total value of goods sold must +equal the total amount of money exchanged. Therefore, under the given +conditions, prices must change in such a way as to raise the goods side +from $100,000,000 to $200,000,000. This doubling may be accomplished by +an even or uneven rise in prices but some sort of _a rise of prices +there must be_. If the prices rise evenly, they will evidently all be +exactly doubled.... If the prices rise unevenly, the doubling must +evidently be brought about by compensation; if some prices rise by less +than double, others must rise by enough more than double to exactly +compensate. + +But whether all prices increase uniformly, each being exactly doubled, +or some prices increase more and some less (so as still to double the +total money value of the goods purchased), the prices _are_ doubled _on +the average_.... From the mere fact, therefore, that the money spent for +goods must equal the quantities of those goods multiplied by their +prices, it follows that the level of prices must rise or fall according +to changes in the quantity of money, _unless_ there are changes in its +velocity of circulation or in the quantities of goods exchanged. + +If changes in the quantity of money affect prices, so will changes in +the other factors--quantities of goods and velocity of +circulation--affect prices, and in a very similar manner. Thus a +doubling in the velocity of circulation of money will double the level +of prices, provided the quantity of money in circulation and the +quantities of goods exchanged for money remain as before.... + +Again, a doubling in the quantities of goods exchanged will not double, +but halve, the height of the price level, _provided_ the quantity of +money and its velocity of circulation remain the same.... + +Finally, if there is a simultaneous change in two or all of the three +influences, _i. e._, quantity of money, velocity of circulation, and +quantities of goods exchanged, the price level will be a compound or +resultant of these various influences. If, for example, the quantity of +money is doubled, and its velocity of circulation is halved, while the +quantity of goods exchanged remains constant, the price level will be +undisturbed. Likewise, it will be undisturbed if the quantity of money +is doubled and the quantity of goods is doubled, while the velocity of +circulation remains the same. To double the quantity of money, +therefore, is not always to double prices. We must distinctly recognize +that the quantity of money is only one of three factors, all equally +important in determining the price level.... + +We now come to the strict algebraic statement of the equation of +exchange.... Let us denote the total circulation of money, _i. e._, the +amount of money expended for goods in a given community during a given +year, by _E_ (expenditure); and the average amount of money in +circulation in the community during the year by _M_ (money). _M_ will be +the simple arithmetical average of the amounts of money existing at +successive instants separated from each other by equal intervals of time +indefinitely small. If we divide the year's expenditures, _E_, by the +average amount of money, _M_, we shall obtain what is called the average +rate of turnover of money in its exchange for goods, _E_/_M_ that is, +the velocity of circulation of money. This velocity may be denoted by +_V_, so that _E_/_M_ = _V_; then _E_ may be expressed as _MV_. In words: +the total circulation of money in the sense of money expended is equal +to the total money in circulation multiplied by its velocity of +circulation or turnover. _E_ or _MV_, therefore, expresses the money +side of the equation of exchange. Turning to the goods side of the +equation, we have to deal with the prices of goods exchanged and +quantities of goods exchanged. The average price of sale of any +particular good, such as bread, purchased in the given community during +the given year, may be represented by _p_ (price); and the total +quantity of it purchased, by _Q_ (quantity); likewise the average price +of another good (say coal) may be represented by _pŽ_ and the total +quantity of it exchanged, by _QŽ_; the average price and the total +quantity of a third good (say cloth) may be represented by _pŽŽ_ and +_QŽŽ_ respectively; and so on, for all other goods exchanged, however +numerous. The equation of exchange may evidently be expressed as +follows: + + _MV_ = _pQ_ + + _pŽQŽ_ + + _pŽŽQŽŽ_ + + 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 _MŽ_ to express the +total deposits subject to transfer by check; and _VŽ_ 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_ + _MŽVŽŽ_. +The equation of exchange, therefore, becomes: + + _MV_ + _MŽVŽ_ = 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, _MŽ_, 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 _MŽ_. 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 +_MŽ_, 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_ + _MŽVŽ_ = Sigma_pQ_; for if, say, _M_ and _MŽ_ +are doubled, while _V_ and _VŽ_ 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_ + _MŽVŽ_ = Sigma_pQ_. This represents the +mechanism of exchange. But in order to conform to such a relation the +displacement of any one part of the mechanism spreads its effects during +the transition periods [_i.e._, periods of rising or falling prices] +over all parts. Since periods of transition are the rule and those of +equilibrium the exception, the mechanism of exchange is almost always in +a dynamic rather than a static condition....[50] + +[Illustration] + +[51]It is interesting to make a quantitative comparison of the various +magnitudes with the increase in the quantity of money as the most +important factor in raising the price level. While it is true, as shown +by the diagram, that the volume of deposits subject to check has +increased greatly, the major part of the increase has to be ascribed to +the increase in the quantity of money. Only so far as the volume of +deposits subject to check has increased relatively to the money in +circulation, can the increase of deposits be regarded as an independent +cause of the rise in prices. We have thus to consider the relative +importance of the five causes affecting prices: + +1. The quantity of money in circulation (M). + +2. The volume of bank deposits subject to check considered relatively to +money (MŽ/M). + +3. The velocity of the former (VŽ). + +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 MŽ/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, VŽ, 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 MŽ/M is represented by 23, + +The importance of V is represented by 28, + +The importance of M is represented by 45. + +That is, the increase in the quantity of money had an importance nearly +double that of any other one price-raising factor, during the period +mentioned. + + +INDIRECT INFLUENCES ON PURCHASING POWER[52] + +Thus far we have considered the level of prices as affected by the +volume of trade, by the velocities of circulation of money and of +deposits, and by the quantities of money and of deposits. These are the +only influences which can _directly_ affect the level of prices. Any +other influences on prices must act through these five. There are +myriads of such influences (outside of the equation of exchange) that +affect prices through these five. It is our purpose ... to note the +chief among them.... + +We shall first consider the outside influences that affect the volume of +trade and, through it, the price level. The conditions which determine +the extent of trade are numerous and technical. The most important may +be classified as follows: + +1. _Conditions affecting producers._ + +(a) Geographical differences in natural resources. + +(b) The division of labor. + +(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 +fall. + +3 (a). Anything which facilitates intercourse tends to increase trade. +Anything that interferes with intercourse tends to decrease trade. First +of all, there are the mechanical facilities for transport. As Macaulay +said, with the exception of the alphabet and the printing press, no set +of inventions has tended to alter civilization so much as those which +abridge distance,--such as the railway, the steamship, the telephone, +the telegraph, and that conveyer of information and advertisements, the +newspaper. These all tend, therefore, to decrease prices. + +3 (b). Trade barriers are not only physical but legal. A tariff between +countries has the same influence in decreasing trade as a chain of +mountains. The freer the trade, the more of it there will be.... + +3 (c). The development of efficient monetary and banking systems tends +to increase trade. There have been times in the history of the world +when money was in so uncertain a state that people hesitated to make +many trade contracts because of the lack of knowledge of what would be +required of them when the contract should be fulfilled. In the same way, +when people cannot depend on the good faith or stability of banks, they +will hesitate to use deposits and checks. + +3 (d). Confidence, not only in banks in particular, but in business in +general, is truly said to be "the soul of trade." Without this +confidence there cannot be a great volume of contracts. Anything that +tends to increase this confidence tends to increase trade.... + +We see, then, that prices will tend to fall through increase in trade, +which may in turn be brought about by improved transportation, by +increased freedom of trade, by improved monetary and banking systems, +and by business confidence. Historically, during recent years, all of +these causes have tended to grow in power, except freedom of trade.... + +Having examined those causes outside the equation which affect the +volume of trade, our next task is to consider the outside causes that +affect the velocities of circulation of money and of deposits. For the +most part, the causes affecting one of these velocities affect the other +also. These causes may be classified as follows: + +1. _Habits of the individual._ + +(a) As to thrift and hoarding. + +(b) As to book credit. + +(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 +disbursements. + +3. _General causes._ + +(a) Density of population. + +(b) Rapidity of transportation. + +1 (a). Taking these up in order, we may first consider what influence +thrift has on the velocity of circulation. Velocity of circulation of +money is the same thing as its rate of turnover. It is found by dividing +the total payments effected by money in a year by the amount of money in +circulation in a year. It depends upon the rates of turnover of the +individuals who compose the society. This velocity of circulation or +rapidity of turnover of money is the greater for each individual the +more he spends, with a given average amount of cash on hand; or the less +average cash he keeps, with a given yearly expenditure.... + +1 (b). The habit of "charging," _i.e._, using book credit, tends to +_increase_ the velocity of circulation of money, because the man who +gets things "charged" does not need to keep _on hand_ as much money as +he would if he made all payments in cash. A man who pays _cash_ daily +needs to keep cash for daily contingencies. The system of cash payments, +unlike the system of book credit, requires that money shall be kept on +hand _in advance_ of purchases. Evidently, if money must be provided in +advance, it must be provided in larger quantities than when merely +required to liquidate past debts.... + +But we have seen that to increase the rate of turnover will tend to +increase the price level. Therefore, book credit tends to increase the +price level.... + +1 (c). The habit of using checks rather than money will also affect the +velocity of circulation; because a depositor's surplus money will +immediately be put into the bank in return for a right to draw by +check.... + +We see, then, that three habits--spendthrift habits, the habit of +charging, and the habit of using checks--all tend to raise the level of +prices.... + +2 (a). The more frequently money or checks are received and disbursed, +the shorter is the average interval between the receipt and the +expenditure of money or checks and the more rapid is the velocity of +circulation. + +This may best be seen from an example. A change from monthly to weekly +wage payments tends to increase the velocity of circulation of money. If +a laborer is paid weekly $7 and reduces this evenly each day, ending +each week empty-handed, his average cash ... would be a little over half +of $7, or about $4. This makes his turnover nearly twice a week. Under +monthly payments the laborer who receives and spends an average of $1 a +day will have to spread the $30 more or less evenly over the following +30 days. If, at the next pay day, he comes out empty-handed, his average +money during the month has been about $15. This makes his turnover about +twice a month. Thus the rate of turnover is more rapid under weekly than +under monthly payments.... + +Frequency of disbursements evidently has an effect similar to the effect +of frequency of receipts; _i.e._, it tends to accelerate the velocity of +turnover, or circulation. + +2 (b). _Regularity_ of payments also facilitates the turnover. When the +workingman can be fairly certain of both his receipts and expenditures, +he can, by close calculation, adjust them so precisely as safely to end +each payment cycle with an empty pocket. This habit is extremely common +among certain classes of city laborers. On the other hand, if the +receipts and expenditures are irregular, either in amount or in time, +prudence requires the worker to keep a larger sum on hand, to insure +against mishaps.... We may, therefore, conclude that regularity, both of +receipts and of payments, tends to increase velocity of circulation. + +2 (c). Next, consider the synchronizing of receipts and disbursements, +_i. e._, making payments at the same intervals as obtaining receipts.... +This arrangement obviates the necessity of keeping much money or +deposits on hand, and therefore increases their velocity of +circulation.... + +3 (a). The more densely populated a locality, the more rapid will be the +velocity of circulation. + +There is definite evidence that this is true of bank deposits. The +following figures give the velocities of circulation of deposits in ten +cities, arranged in order of size: + + Paris 116 + Berlin 161 + Brussels 123 + Madrid 14 + Rome 43 + Lisbon 29 + Indianapolis 30 + New Haven 16 + Athens 4 + Santa Barbara 1 + +Madrid is the only city seriously out of its order in respect to +velocity of circulation. + +3 (b). Again the more extensive and the speedier the transportation in +general, the more rapid the circulation of money. Anything which makes +it easier to pass money from one person to another will tend to increase +the velocity of circulation. Railways have this effect.... Mail and +express, by facilitating the transmission of bank deposits and money, +have likewise tended to increase their velocity of circulation. + +We conclude, then, that density of population and rapidity of +transportation have tended to increase prices by increasing velocities. +Historically this concentration of population in cities has been an +important factor in raising prices in the United States.... + + +[SUMMARY] + +[53]The purchasing power ... of money has been studied as the effect of +five, and only five, groups of causes. The five groups are money, +deposits, their velocities of circulation, and the volume of trade. +These and their effects, prices, we saw to be connected by an equation +called the equation of exchange, _MV + M'V' = SigmapQ_. The five +causes, in turn,... are themselves effects of antecedent causes lying +entirely outside of the equation of exchange, as follows: the volume of +trade will be increased, and therefore the price level correspondingly +decreased by the differentiation of human wants; by diversification of +industry; and by facilitation of transportation. The velocities of +circulation will be increased, and therefore also the price level +increased by improvident habits; by the use of book credit; and by rapid +transportation. The quantity of money will be increased and therefore +the price level increased correspondingly by the import and minting of +money, and, antecedently, by the mining of the money metal; by the +introduction of another and initially cheaper money metal through +bimetallism; and by the issue of bank notes and other paper money. The +quantity of deposits will be increased, and therefore the price level +increased by extension of the banking system and by the use of book +credit. The reverse causes produce, of course, reverse effects. + +Thus, behind the five sets of causes which alone affect the purchasing +power of money, we find over a dozen antecedent causes. If we chose to +pursue the inquiry to still remoter stages, the number of causes would +be found to increase at each stage in much the same way as the number of +one's ancestors increases with each generation into the past. In the +last analysis myriads of factors play upon the purchasing power of +money; but it would be neither feasible nor profitable to catalogue +them. The value of our analysis consists rather in simplifying the +problem by setting forth clearly the five proximate causes through which +all others whatsoever must operate. At the close of our study, as at the +beginning, stands forth the equation of exchange as the great +determinant of the purchasing power of money. + +J. Laurence Laughlin[54]: To my mind, the following propositions contain +the essence of the theory of prices.... As every one will appreciate, +only general statements, without any limiting qualifications to speak +of, can be given in so small a compass. + +1. The price of a commodity is measured by the quantity of a given +standard for which it will exchange. + +2. A change of prices may be due to changes in the conditions affecting +the supply (thus including expenses of production) of goods, as well as +to changes in the demand for and supply of gold. A statistical statement +of a change of price is not a statement of the cause of the change. + +3. Probably there is not so much difference of opinion regarding the +theory of prices as is sometimes supposed. Other causes being supposed +constant, an increased supply of gold would tend to raise prices. No one +can fail to see that, if by "money" is meant gold, a change in its +quantity would, other things being equal, be a factor affecting prices. +An increasing demand for gold, however, would work against the effect of +an increasing supply. If the new demand offset the new supply, then, if +changes of prices occurred, their cause must be sought in the influences +touching the producing and marketing of goods. + +4. The effective demand for goods (granting their utility) is limited by +the buyer's purchasing power. This purchasing power is not identical +with the quantity of the media of exchange in circulation, any more than +the value of the total exchangeable wealth of the community is identical +with the value of the total money in circulation. + +5. The general level of prices is not independent of particular prices; +since there can be no such thing as a general level, or average, of +prices which is not the resultant of a number of particular prices each +arrived at by individual buyers and sellers. The causes of price changes +must be sought in the forces settling particular prices. This does not +exclude the consideration of any causes affecting the value of the +standard in which the prices of goods are expressed, because the +standard is itself a particular commodity. + +6. In particular cases, competitive prices in this country are arrived +at by the higgling of the market, which depends on buyers' and sellers' +judgment of the demand and supply of the commodity (_e. g._, wheat); +and, when the price is fixed, the credit medium by which the commodity +is passed from seller to buyer comes easily and naturally into existence +and, of course, for a sum exactly equaling the price agreed upon, +multiplied by the number of units of goods. Price-making generally +precedes the demand upon the media of exchange, and does not at all +imply any necessary demand at the moment upon the standard in which the +prices are expressed (cf. 10). + +7. The offer of "money" for goods is only a resultant of price-making +forces previously at work, and does not measure the demand for goods +(cf. 6). That is, the quantity of the actual media of exchange thus +brought into use is a result and not a cause of the price-making +process. The supposed offer of money has no money as its basis, but is +only the offer of a purchasing power, previously existing, based on +saleable goods, which at the moment of payment appears expressed in +terms of the standard. By credit devices the actual transfer of the +standard is reduced to an inconsiderable minimum. In reality (as in +foreign trade) goods are exchanged against goods. + +8. The effect of credit on prices is to be found mainly in banking +facilities by which goods are coined into means of payment, so that, +expressed in terms of the standard gold, they may be exchanged against +each other. Thus credit devices relieve the standard to an incredibly +great degree from the demand for the use of gold as a medium of +exchange, and thus remove a demand, as trade increases, which would +otherwise have enormously affected the value of gold. Thus the effect of +credit on the general level of prices in considerable periods of time is +shown by a tendency to reduce the demand on the standard gold, and hence +to prevent the tendency toward falling prices. + +9. A general proposition is that banks are limited in making loans by +the possession of capital, a bank of large capital and deposits being +able to make large loans, a bank of small capital and deposits, small +loans. A second proposition is that the demand for legitimate loans +varies with the exchanges of goods and collateral and the opportunities +for investment. With an increasing activity in business, however--either +sound or speculative--the expansion of loans is limited by the resources +of the bank. Next, a bank trying to carry a certain amount of loans, +must hold a specified proportion of reserves to demand liabilities under +the rule of banking experience or law. The amount of its capital and the +funds left with it determine the relative size of its loan item; and the +sum of its loans and resultant deposits determine the amount of its +reserves. The reserves of a bank are thus a consequence of the loan +operations. This conclusion, however, as it affects the practical +problem of the present day, is not, in my opinion, invalidated by the +conceivable cases arising, when business tends to outrun banking +facilities, in which anything that makes increasing reserves possible +would increase the power of the banks to lend. When gold becomes +increasingly abundant, the banks having large resources more easily get +the gold reserves needed for their operations. It still remains true +that the fact of an increased supply of gold does not of itself increase +loans, unless conditions of business demand an increase in loans. +Therefore, the expansion of business is not a necessary consequence of +an increasing supply of gold, any more than an expansion of railway +traffic is the necessary consequence of an increasing supply of cars. If +increasing goods are in existence to be transported, then, of course, +there is an increasing demand for cars. Likewise, if there are more bank +resources and loans, there is an increasing demand for that which is +lawful reserve; from which it is claimed that the use of new gold in +bank reserves, under present conditions, is not the significant causal +force which expands business and raises prices (although it may be +contemporary with it). + +10. The problem of explaining the general level of prices is one of +arriving at the adjustment between two terms of a ratio (the standard on +the one side, and goods on the other), each of which is influenced by +supply and demand. Gold being one, and goods being many, a cause working +on gold alone, and important enough to show an appreciable effect, might +explain a general movement of prices. In practical operation, however, +because of the large existing stock of gold, very considerable additions +may take place in the supply of gold without materially changing the +world value of gold as related to goods in general. Rapid changes of +prices are hence more likely to be due to influences in the market for +goods, to speculative changes of demand for goods, or to psychological +forces working independently of facts.... + +In the problem of discovering the causes of changes in the level of +prices, it is necessary first to reach a conclusion as to those causes +which operate on the gold standard in which our prices are expressed. By +so doing we may locate the general level--so far as the standard is +concerned--or the one thing which might work as a cause common to all +goods. The relation between gold and goods might be illustrated by the +familiar mechanical illustration: a rod balanced on a fulcrum, on one +end of which works the forces affecting the value of gold, and on the +other end the forces affecting the value of particular goods. The +relation between goods and gold being a ratio, as one end of the rod +goes up, the other necessarily goes down. + +There are, as we all know, various forces at work to produce the +resultant price level. We may here start from a proposition on which we +can all agree. An increase in the quantity of the monetary standard in +the world--such as gold--would tend, _other things being equal_, to +lower its value and thus raise prices. In trying to find the causes in +the price level at any given time (as in 1896-1909) it is necessary, +therefore, after stating the facts as to the increase of gold, to +examine into the influence of "the other things." + +To begin, we may take up the demand for gold, which, of course, is both +monetary and non-monetary. First as to the non-monetary uses, such as +abrasion, shipwreck, and disappearance in the arts: The statistics of +consumption in the arts are unsatisfactory; at the best they are only +estimates. Although the total production of the world, 1493-1850, was +$3,158,000,000, there is no evidence as to the available stock in 1850. +My belief is that there was not more than $2,000,000,000.[55] In the +period of 1851-1895, the production was $5,641,000,000, and the +consumption in the arts, at the average rate of $50,000,000 a year +requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The +arts in recent years are estimated to use more than $100,000,000.[56] In +the period, 1896-1905, if $1,000,000,000 be deducted from the production +of $2,899,000,000 we have $1,899,000,000. Thus the total available stock +in 1905 would be about $7,690,000,000. The production of the last four +years, 1906-1910, is about $1,600,000,000, or, less the consumption in +the arts, about $1,200,000,000. + +The monetary demand for gold, on the other hand, has shown certain +definite characteristics. Whether it be prejudice, or enlightened +business judgment, the commercial nations of the world have shown a +persistent and continuing disposition to adopt a gold monetary system as +soon as their own means, or the forthcoming supply of gold, has made it +possible. The United States led in 1853, when we declined to change the +ratio in order to bring silver into circulation when only gold was in +use. From 1871-3, Germany, the countries of the Latin Union, +Austria-Hungary, the United States (with the resumption in gold in +1879), and India (in 1893), in response to the preferences of the +commercial world, placed themselves on the gold standard by legal +enactments. The demand for gold all through this period was based upon +considerations independent of the movement of prices. For this was a +time of falling prices when much was heard of the appreciation of gold +and the need of silver. In spite of this tendency toward falling prices, +the movement toward the adoption of gold went on.... It was precisely +this large new supply of gold which enabled the commercial nations to +gratify their desire for what they believed was a more stable standard. + +As we enter the present period (1896-1909) we find this momentum towards +the gold standard still in force: and other countries in emulation +planned to put themselves on an equally stable standard with those +whose means had permitted an earlier action--quite irrespective of the +fact that this last was a period of rising prices, while the former was +one of falling prices. In this period, Russia, Japan, various states in +South America, such as Peru, Argentina, and Brazil, and recently Mexico, +have emphasized the movement away from silver to gold. Moreover, as +backward lands, like Turkey, parts of Asia, Egypt, and various districts +of Africa, have developed their resources and increased their trade, +they have taken on gold in their monetary systems. With increasing trade +also there are more exchanges of goods; hence, even in countries (like +Great Britain and the United States) that do not use gold to speak of, +except in reserves, there are increasing loans and deposits and thus a +demand for more gold reserves. Consequently, in countries long ago +established on the gold standard there will be a steadily increasing +demand for gold as exchanges expand. We find thus a special +characteristic of the demand for gold (certainly not existing in the +demand for silver). The power of developing countries to soak up new +gold is as marked a part of present conditions as is the power of a +porous and sandy soil to soak up a heavy rainfall. We must, therefore, +take full account of the noticeable fact that the recent demand for gold +seems about to keep pace with the new supply; that a shipment of gold +from the mines to London is to-day eagerly competed for, not only by +European countries, but by Egypt, India, Turkey, Argentina, and Brazil. + +Consequently it may be of interest to see which countries have taken the +largest amounts of gold into their stocks since 1895: + + United States $994,000,000 + Russia 427,000,000 + Germany 419,000,000 + South American States 213,000,000 + British Empire 194,000,000 + Austria-Hungary 163,000,000 + Italy 160,000,000 + +Besides the demand for gold in the arts, and the apparent monetary +demand, as thus already presented, we must not omit to take into account +also the large stocks of gold held by banks and institutions which +publish no statements. In the hands of large private institutions like +those of the Rothschilds, Bleichroders, and others, great amounts of +gold are carried. It is from such stores that the needs of states, such +as Austria-Hungary, France, Italy, and even the United States (in +Cleveland's administration), have been supplied without drawing down +visible reserves. + +Thus far, then, we have examined the one factor of demand for gold, +among the "other things" (which were supposed to remain equal). There is +abundant evidence to show that the demand for gold, in this recent +period of rising prices (1896-1909) has been as strong as, or even +stronger than, the demand for gold in the previous period (1873-1896) of +falling prices. + +It looks very much as if we must seek for the causes of rising prices +since 1896 in some of the "other things" not yet examined. There is no +time, however, for extended discussion on these points.... + +The effects of Tariffs and Taxation, Unionism and higher Wages, and +changing Agricultural Conditions in increasing expenses of production in +all industries are so patent as to require no enlargement. Immediately +after the passage of the Dingley Act in 1897, a large list of articles +rose in price precipitously. Moreover, just so far as higher money wages +for the same work, or the same money wages for a reduced number of +hours, have been granted without a corresponding increase in the +efficiency of the labor, the expenses of producing goods in general--and +consequently prices--have risen. But, without doubt, one of the most +important factors in raising prices--directly and indirectly--has been +the increased price of food due to the changing conditions of +agriculture. This most influential cause of higher prices is one of the +"other things" which has been at work quite independent of the quantity +of new gold. Moreover, the indirect effect of high prices of food +produces the most serious practical problem. It wipes out all the gain +of previous increases of wages, and drives laborers to repeat their +demands for higher pay, thus working again to increase expenses of +production. It is not too much to say that the gains of industry, shown +by the fall in prices, as they stood about 1890 have been lost to us by +the high tariffs of 1897 and the wastes of bad farming and the recent +high costs of agriculture. + +Our analysis would be inadequate, however, if we stopped here with our +examination of expenses of production. The really practical problem is +still before us in trying to analyze the forces at work fixing prices in +that vague and dangerous margin between actual expenses of production +and the prices in fact paid by the consumer.... + +The whole _raison d'être_ of monopolistic combinations is to control +prices, and prevent active competition. As every economist knows, in the +conditions under which many industries are to-day organized, expenses of +production have no direct relation to prices. In such conditions, there +is a field in which the policy of charging "what the traffic will bear" +prevails; and this includes industries that are not public utilities. + +Furthermore, we must face the fact of increasing riches not only in this +country, but all over the world. New wealth makes a liberal spender. The +retail dealer finding his expenses increasing and--even when they are +not--tries the experiment of charging his richer customers an increasing +price. The newly rich pay and do not feel it. But what can the poorer +unorganized buyer do when retail prices are raised? What can he do if +his meat bill, or his plumbing-repairs bill, rises enormously? The +extravagance of the rich has increased the cost of traveling, the rates +at hotels, the fees, the luxury of steamships and automobiles, the +consumption of fruits and vegetables out of season once never thought +of, and has generally raised the standard of expenditure. Those of +smaller income find they also must pay the higher prices. Thus we have +reached a point where we have to pay almost whatever any one asks. +Organized buyers are the only offset to organized sellers. + +Moreover, rising prices due to high expenses of production, or to +combinations of sellers, present a paradise for speculation. A movement +upward based on facts can be easily converted into a further rise based +only on speculative manipulation. A rise of prices which brings large +profits to a combination, thus directly affects earnings and gives +especial opportunity to speculation in the securities of industrials. +Hence, the field of speculation spreads from commodities to securities. +The facts as to the movement of prices of securities are well shown in +Brookmire's Economic Charts since 1885; and, while the presence of gold +serves as a fund of lawful money in reserves, the spread of speculation +has gone on seemingly unaffected by the new supplies of gold. That is, +speculative conditions may arise and disappear antecedent to and +seemingly independent of the gold supplies. + + * * * * * + +D. F. Houston[57]: The discussion of money and prices to-day reminds one +very strongly of the discussion forty years ago. Now, as then, the +opinion is that prices have risen; but now, as then, there is wide +difference as to the explanation. Now, as then, a highly respectable +body of economists attribute the rise mainly to the new gold; and now, +as then, a number of economists attribute the rise to influences +immediately affecting the cost of production of commodities in general, +instancing such things as labor unions, monopolies, extravagance, the +tariff, general prosperity, etc.... + +That the tariff has played a part in the situation, I should of course +not deny. By preventing us from securing supplies where they can be more +economically produced, and by making it possible for domestic +manufacturers to monopolize the market, and by tending to compel the +payment for exports in gold, it has unquestionably played a part and is +a notable factor.... In considering the tariff as a factor, however, we +must not forget that we have had the tariff since the beginning, and +that the rates have been nearly as high since the Civil War as they are +to-day; and we must remember, further, that in one of the great +countries which has no protective tariff the tendency of price has been +upward; furthermore, we must not overlook the fact that many of the +tariff rates, which are very high now, are not effective or not nearly +so effective as they were in the earlier period, and also that its +influence is probably greater in things in which the rise of price has +been less marked. + +I should not deny that labor unions and monopolies have had an influence +in increasing price. The evidence seems to justify the conclusion that +monopolies have had some effect in increasing price. I am not sure that +there is sufficient evidence in regard to labor unions to enable us to +form a conclusion.... + +Much has been said in discussion about the influence of extravagance. +This has played a part in similar discussions at all times; every era +has its cry of extravagance, and it is not clear that it has been more +marked in our time than in former times. And one thing is quite clear, +that the extravagance, or economic waste, resulting from the prosecution +of war and its after effects, has been conspicuously absent during the +last fifteen years.... + +The stock of gold in the leading western commercial nations, with which +we are concerned in discussing prices, probably did not exceed +$5,000,000,000 at the end of 1895. During the next fourteen years there +was added to the stock of gold of these countries an amount nearly equal +to the existing stock. In addition, a number of these countries +enormously developed their credit devices. According to all economic +law, these facts create a strong presumption that gold has been the main +factor affecting price. No sufficient evidence has been presented to +overthrow this presumption. + + * * * * * + +E. W. Kemmerer[58]: An adequate discussion of the papers presented by +Professors Fisher and Laughlin would require much more time than the few +minutes at my disposal. I shall accordingly limit myself to a few points +and support my conclusions principally by footnote references. This +procedure is perhaps the more justifiable in view of the fact that my +own philosophy of the relationship between money and prices is given in +detail in the book[59] on money and prices to which Professor Fisher has +so generously referred.[60] + +I have had the opportunity of reading in manuscript Professor Fisher's +forthcoming book on Price Levels, of which his paper to-day represents +one chapter, and find myself in substantial agreement with his main +contentions. His discussion is a permanent contribution to monetary +science of very great value. To a number of minor points, however, it +seems to me, exception must be taken.... + +Professor Fisher's formula expressing the relationship between the +circulating media and prices is essentially the same as my own,[61] but +he pays little attention to the factor of business confidence, which is +a most important consideration in the interpretation of the formula. The +ratio of deposit currency to bank reserves is a function of business +confidence.[62] + +The distinction Professor Fisher draws between the prices of individual +commodities and the general price level appears to me, as to Professor +Laughlin, to be untenable. It is, moreover, contradictory to his general +philosophy of money. His index numbers recognize no general price level +distinct from individual prices. He illustrates the point that the price +of any individual commodity presupposes a general price level by saying +that "the position of a particular wave in the ocean depends on the +general level of the ocean." I can conceive of no such distinction +between the general price level and individual prices as his statements +seem to imply. General prices "are but a combination, or composite +photograph, as it were, of individual prices."...[63] + +Passing to Professor Laughlin's paper, which has been presented to me +merely in the form of an abstract, we find ten propositions, which to a +considerable extent are repetitious. His first five propositions are +rather commonplace generalizations and few economists will be disposed +to dissent from their essential soundness. They place him much closer to +the quantity theory of money than most of us, judging him from his +previous writings, were disposed to think he would go; and in his third +proposition he says, "Probably there is not so much difference of mind +regarding the theory of prices as is sometimes supposed." + +With reference to Professor Laughlin's fourth proposition it may be said +that no economist of standing claims that purchasing power is "identical +with the quantity of the media of exchange in circulation." Effective +purchasing power, however, in our modern business communities, does +depend upon the possession of money or of the right to demand money. The +amount of deposit currency which can be used at any time in purchasing +goods is limited by bank reserves because commercial deposits are +payable in money on demand at the order of the depositor. Other assets, +no matter how good, cannot be used for the purpose of meeting deposit +obligations, except when the entire credit machinery breaks down and +suspension is resorted to under the euphemistic name of clearing house +loan certificates. + +Professor Laughlin's sixth and seventh points are essentially the same +and may be considered together. He says: + + ... Price-making generally precedes the demand upon the + media of exchange, and does not at all imply any necessary + demand at the moment upon the standard in which the prices + are expressed.... The offer of money for goods is only a + resultant of price-making forces previously at work, and + does not measure the demand for goods.... That is, the + quantity of the actual media of exchange thus brought into + use is a result and not a cause of the price-making + process.... + +This contention appears to me to result from a superficial view of the +price-making process. The offer of money for goods and the offer of +goods for money are of course not the first steps. Each person has his +own individual or subjective prices on all sorts of commodities; these +subjective prices represent the valuations which he places upon the +respective commodities in terms of the valuation which he places upon +the money unit. The more of a particular commodity he has the lower his +subjective valuation of a unit of that commodity; the more money he owns +the lower his estimation of a dollar and the higher his subjective +prices; and _vice versa_. Through a process of competition, selection, +and adaptation, some of these subjective prices develop into market +prices, that is, prices at which both buyer and seller benefit, and at +which therefore an exchange takes place. To paraphrase an old adage, the +proof of the market price is in the exchange. It is a common observation +that stock quotations to be of much value must show the number of sales +effected at the prices quoted. A stock for which the maximum bids were +100 and the minimum offers were 110, would not possess a market price +in the strict sense of the word. The fact that sales have recently been +made at a certain price, or are now being so made, is of course +presumptive evidence that intending purchasers can buy at about that +price. A market price, however, is the amount of money paid for a +commodity, not the amount asked, offered, or promised. + +Professor Laughlin's ninth proposition I find very difficult to follow. +His premise that reserves are "a consequence of the loan operations" is +a dangerous half truth; they are also a consequence of most other kinds +of banking operations, cash deposits, cash withdrawals and clearing +house balances, foreign and domestic exchange operations, etc. His other +premise, that "the fact of an increased supply of gold does not _of +itself_ [the italics are mine] increase loans, unless the bank possesses +the control of the capital which is a condition precedent to the loans," +contains an element of truth, but is misleading. While an increased +supply of gold does not of itself increase loans it normally has that +result; and the bank's discount rate and the condition of its reserve +are powerful factors in influencing its loan account. His premises, I +believe, are not sound, and his conclusion, namely, that "the expansion +of business is not a direct consequence of an increasing supply of gold, +any more than an expansion of railway traffic is the direct consequence +of an increasing supply of cars," would not follow from his premises, +even if they were sound. The normal causal chain is more nearly this: +increased gold production results in greatly increased amounts of gold +coming into the monetary uses.[64] This gold comes into the hands of +individuals and is to a large extent deposited in banks; increased money +incomes on the part of individuals lower their estimations of the value +of the money unit, raise subjective prices, and as a consequence market +prices; larger money deposits in banks result in larger reserves, banks +do not make interest on money held in reserves, and accordingly take +measures to invest such surplus money, keeping these reserves as low as +is consistent with law and their ideas of safety;[65] inducements to +borrowers are made in the form of more favorable discount rates; +collateral is not scrutinized so carefully; the speculative market is +stimulated by increasing supplies of call money; confidence everywhere +increases; new enterprises spring up and old ones are expanded; and in a +short time the new gold is absorbed by a higher price level and an +overstimulated business activity. This was the situation after the +Californian and Australian gold discoveries of the last century and it +has been the result of the greatly increased gold production of the last +few years. + + +Professor Laughlin's final point is that since 1895 the new demand for +gold has roughly equalled the new supply, and that the changes in prices +since 1896 must be sought mainly in the "other things," which have not +remained equal. In support of this conclusion he offers two principal +arguments. The first is as follows: + + ... Because of the large existing stock of gold, very + considerable changes may take place in the supply of gold + without materially changing the world value of gold as + related to goods in general. Rapid changes of price are + hence more likely to be due to influences in the market for + goods, to speculative changes of demand for goods, or to + psychological forces working independently of facts.... + +In reply it may be said that the production of gold since 1895 +represents a very large percentage of the total supply. The Soetbeer +figures as supplemented by those of the Director of the Mint show that +the world's gold production for the 405 years 1492-1896 inclusive was in +round numbers $8,982,000,000,[66] and that for the eleven years +1897-1907, was $3,513,000,000; in other words, for these eleven years it +was over 39 per cent. of the total for the preceding 405 years. Probably +the effective supply represents a much larger proportion of recent gold +because of (1) the large amount of loss chiefly by abrasion of the gold +produced in the earlier years, and of (2) the greater degree to which +this early gold has assumed specialized forms, such as jewelry, plate, +etc. + +Satisfactory index numbers of prices for recent years are not available +for all the principal countries of the world. Such as we have, however, +point to a decided rise of prices in all gold standard countries since +about 1897. Comparing standard price index numbers in six of the chief +countries of the world for the years 1897 and 1907, we find the general +price level to have risen as follows:[67] + +United States--Bureau of Labor figures 44.4% +Canada--Coats figures, (weighted) 43.7% +England--Sauerbeck figures 29.0% +France--de Foville, figures for export prices[68] 13.3% +Germany--Hamburg figures 30.8% +Italy--Necco figures for export prices 23.4% + +If we average these figures together, assigning the same importance to +the figures of each country, in order to get a _rough_ idea of the +movement of world prices in gold standard countries during the eleven +years in question, we find that the average increase was 30.8 per cent. +If we follow Professor Laughlin and compare the years 1895 and 1907, we +find the average increase in prices to have been 25.8 per cent., and the +world's gold production for the 13 years 1895 to 1907 to have been about +42 per cent. of that for the preceding 404 years. When to this is added +the fact that the evidence points to a smaller percentage of the world's +annual gold production going into the industrial uses than formerly, and +the further fact that during the period in question the increase and +improvements in the world's banking facilities have greatly economized +the uses of money, we see that a very substantial increase in general +prices would be expected, despite a great expansion of business. World +prices in fact have not increased nearly as rapidly as the flow of gold +into monetary uses since 1897, not to mention the enormous development +of deposit currency. The Director of the Mint estimates each year the +amount of the world's new gold used in the industrial arts. Computations +I have made based upon these figures show a tendency for a decreasing +percentage of the annual production to be used in the arts, although +there is considerable irregularity. For the seven years 1895-1901 the +average percentage was 27.1, and for the seven years 1902-1908 it was +25.3.[69] + +Professor Laughlin's second argument in favor of the proposition that +the recent rise in prices has not been due primarily to the increased +gold production is one of the most beautiful examples of begging the +question that I have seen in economic literature. He says: + + "In recent discussions one of the 'other' factors which has + been slighted is the demand for gold since 1895. The + examination shows that the new demand in countries turning + to the gold standard, and in those already using gold and + extending their demand, amounts in round numbers to about + $3,000,000,000. Hence the new demand has roughly equalled + the new supply, since 1895--a fact which jumps with the + known conditions in the great financial markets like London, + where new arrivals of gold are eagerly competed for by + European banks." + +Of course the demand for gold equals the supply, as does the demand for +wheat or any other commodity, when one interprets demand and supply as +one should, in terms of market prices. The general price level is the +very thing which equilibrates the demand for gold and the supply. The +higher price level about which we are talking is an expression of the +absorption of most of this new gold into the world's circulation. Banks +and merchants eagerly compete for it, because higher prices require more +money to do a given amount of exchange work, and rising prices stimulate +business. + + * * * * * + +Joseph French Johnson[70]: I am glad to observe that there appears to be +a tendency toward agreement with regard to the fact that the value of +money depends upon the demand for it and supply of it. Professor +Laughlin likes the word standard better than I do. It suggests something +permanent and fixed, whereas money is a very changeable thing. While I +am in agreement with Professor Laughlin in the conclusion that the +general level of prices depends upon the demand for and supply of money, +I am unable to give assent to many of the propositions which he puts +forward as links in the chain of reasoning leading to that conclusion. + +For example, Professor Laughlin says, "A change of prices may be due to +changes in the demand for and supply of (thus including the expenses of +production) goods as well as to changes in the demand for and supply of +gold." This proposition is true with regard to changes in the prices of +particular commodities. The price of wheat may rise or fall as a result +of a change in the demand for or in the supply of wheat. The +proposition, however, is not true with regard to a change in the general +level of prices. An increase in the supply of goods will lower the level +of prices for the simple reason that it will increase the demand for +gold. I am not certain that I have understood Professor Laughlin's +exposition of his theory, but he certainly seemed to me to argue that +there could be a change in the general level of prices without any +change whatever in the demand for or supply of gold. Such a position, it +seems to me, is absolutely untenable. + +That Professor Laughlin seeks to hold this untenable position, it seems +to me, is made evident by the qualification with which he accepts the +statement that a change in the quantity of money, other things being +equal, would be a factor affecting prices. He says, "An increasing +demand for gold, however, would work against the effect of an increasing +supply. If the new demand offset the new supply, then, if changes of +price occurred, their cause must be sought in the influences touching +the producing and marketing of goods." The second conditional clause in +that last sentence introduces an impossible supposition, for if a new +supply of gold is offset by a new demand for it, there could be no +change in the general level of prices, so that no cause for any change +would have to be sought in the "influences touching the producing and +marketing of goods." Professor Laughlin appears to have in mind forces +affecting the general level of prices which are entirely hidden from my +sight. A change in the level of prices means a change in the value of +gold, and how can there be a change in that if the new demand for gold +just offsets the new supply? + +Professor Laughlin's analysis of the price-making process is incomplete +and misleading. He is correct when he says that the causes of price +changes must be sought in the forces settling particular prices, but he +is manifestly wrong when he states that the price of wheat is "arrived +at by the higgling of the market, which depends on the buyers' and +sellers' judgment of the demand for and supply of wheat." Such higgling +would determine only the value of wheat. The price of wheat is not fixed +until buyer and seller have reached an agreement in their estimates as +to the value not only of wheat, but also of money. If wheat is +comparatively easy to get, the price falls. If money is easier to get, +the price rises. The demand for and supply of money is evidently just as +important in the determination of the price of wheat as is the demand +for and supply of wheat itself. When Professor Laughlin says that the +offer of money for goods is only a resultant of price-making forces +previously at work, he must have in mind some price-making process and +price-making forces of which I have never heard. I know of no market in +which goods are lowered in price except for the reason that at the +higher price not enough money is offered to absorb the supply; nor of +any market in which goods are raised in price except for the reason that +buyers are willing to offer more money for the goods. + +In his analysis of credit and its relation to the value of money, +Professor Laughlin seems to me to have in mind a hypothetical financial +world, the like of which does not and could not exist on earth. He +strives to show that a bank's ability to make loans depends upon the +amount of its capital and deposits, and that therefore any increase in +the supply of gold would not in itself lead to an increase of loans. +"Expansion of business," he remarks, "is not a direct consequence of an +increasing supply of gold any more than an expansion of railway traffic +is the direct consequence of an increasing supply of cars." He is quite +right if he means that an increase in the amount of gold will not +necessarily cause the exchange of more goods. But this does not appear +to be his meaning. He holds that the use of new gold in bank reserves +cannot be a causal force raising prices, for the bankers cannot increase +their loans, in his opinion, unless the condition of business demands +such an increase. In his hypothetical financial world bankers are +willing to carry idle stocks of gold and to wait until business +conditions make necessary an increase in their loans. In the real +financial world, of course, bankers do nothing of the sort. Bankers with +surplus gold immediately tempt borrowers by lowering the rate of +discount and thus increasing the money demand for goods in the markets. +As a result there is an irregular and general rise of prices. More goods +may not be bought and sold and there may be no expansion of business, +but expressed in terms of money the totals are bigger. There is no +analogy between dollars and freight cars. The carrying capacity of a car +is fixed and unchangeable, but the carrying capacity of a dollar is +elastic--so elastic, in fact, that dollars are always fully loaded no +matter how small the supply of goods. As Professor Laughlin points out, +although he apparently does not see its significance, the new demand for +gold since 1895 has "roughly equalled the new supply." Surely it could +not have been otherwise, and no statistics are necessary to prove the +fact. + + * * * * * + +Murray S. Wildman[71]: My comments on these interesting papers will be +directed upon the methods employed, and certain assumptions involved, in +the arguments of both. Granting that Professor Fisher's analysis shows a +perfect correspondence between the course of prices on the one hand and +the quantity of money and credit instruments on the other hand, I am +still unable to see which magnitudes are properly to be regarded as +causes and which as effects. That variations in the value of gold and in +the price level must be reciprocal, all will admit. If we regard M as +denoting the gold supply for the present, a causal relation between M +and P cannot be denied. But may it not be possible that variations in +MŽ, or credit, and V and VŽ, 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 MŽ +and V and VŽ may be regarded as factors in the demand for gold. + +To accept Professor Laughlin's method does not involve the necessity of +his conclusions. The terms, by this method, do not lend themselves to +exact mathematical statement and statistical proof, so conclusions +cannot be exact and definite. This may be illustrated in a consideration +of demand for gold. Some say that demand has grown step by step with +supply and therefore gold has not been cheapened. Others say that supply +has grown more rapidly than demand, and so gold has been cheapened and +to that extent prices are raised. + +Either statement may be wrong. I do not believe we have yet any reliable +data regarding the demand for gold in the sense of a value-making +factor. Most efforts to measure demand are based on statistics of gold +in use. If one can show that consumption of gold in the arts, in the +circulation, and in greater bank reserves, has increased _pari passu_ +with production, we are told that the value of gold has not been +lowered by the greater supply. + +But statistics of consumption give no clue to demand in the +value-determining sense. We have many staple commodities, such as wheat +and cotton, whose price drops sharply when the supply exceeds a certain +normal volume, even though the whole crop is consumed. Statistically +speaking, the demand for a cotton crop always rises as supply rises, and +falls as supply falls, but that is because demand and supply become +equated through a variation in price. Demand, in this sense of quantity +demanded, is in part a result rather than a cause of value. + +When we can properly speak of demand as potent for the determination of +value, we are thinking of demand from the point of view of _intensity_ +rather than the point of view of _magnitude_. But the demand which makes +for value--demand intensively considered--is only measured by the +purchasing power offered. Applied to gold, I know of no measure of +demand except in the goods and services offered in exchange. To say that +goods and services offered for an ounce of gold in 1910 are less than +are offered for an ounce of gold in 1896, is simply to say that prices +are higher. But it is these prices that we are trying to explain by +giving the effect for the cause, when we say that demand has risen with +supply. + +Those staple commodities whose value falls off abruptly with any +increase of supply beyond a customary stock are said to be subject to an +inelastic demand, and those whose value declines uniformly with +excessive supplies are said to have an elastic demand. Is the demand for +gold elastic, or is it inelastic? And is it possible by independent +analysis to construct the curve of elasticity which properly belongs to +gold, and so avoid circular reasoning from the very prices we are trying +to explain? + +If the demand for gold is inelastic and the demand curve drops off +abruptly after a certain supply is in evidence, the presumption is that +in the conditions of gold production, rather than in the conditions of +commodity production, lies the cause of our high prices. Moreover, if +this be the case, we can readily see the cause of cheapening of gold, +even though the product of a single year bears a small proportion to +the existing stock. + +If on the other hand the demand for gold be very elastic, so that it +expands with growing supplies with no substantial alterations in value, +then we are driven to seek the cause of high prices in influences +directly touching the goods and services rather than in those directly +affecting gold. + +It would seem therefore that both methods of treatment have left +something to be desired. The algebraic analysis, even as verified, +presents the relations between magnitudes without showing the cause of +high prices. The argument directed immediately at the value of gold of +necessity involves consideration of the demand for gold, which, as a +price-making factor, remains an unknown quantity. + + * * * * * + +T. N. Carver[72]: Professor Fisher ... has demonstrated beyond all +question the accuracy of his formula. The question remains, however, +whether his formula supports his own conclusion or Professor Laughlin's. +If, for example, it should be found that P is the cause of M, the +formula would to that extent support Professor Laughlin's position. I +believe that to a certain extent P is actually the cause of M. If the +growing scarcity of agricultural land, or the increase in population and +the increased demand for agricultural products without an increase in +land, should increase the marginal cost of producing agricultural +products to supply this larger demand, that would tend to increase the +exchange value of these products, even according to the formula of +Cairnes as quoted by President Houston.[73] Even without any increase in +the gold supply, this would cause each unit of product to exchange for a +little more gold; then, in order that a given number of exchanges in +agricultural products could be carried on, it would be necessary to have +a larger number of ounces of gold, or a larger number of gold coins, or +some other form of money of given denominations to do the money work. +This, in other words, would necessitate a larger supply of money: and, +if other forms than gold were not forthcoming, it would necessitate that +a larger proportion of the stock of gold should be coined into money in +order to do the work. Thus, without any increase whatever in the world's +total gold supply, there would come to be an increase in the proportion +of that supply used as money, or in the amount of gold coin actually +used in circulation. I believe that this has taken place, and that it is +one of the factors in the problem, although there has also been a very +large increase in the gold supply to still further accentuate the +tendency. + + * * * * * + +F. W. Taussig[74]: I congratulate Professor Fisher on his admirable +paper. I am in accord with him in his method of reasoning and in all his +essential results. His investigation of this subject adds another to the +brilliant studies with which he has enriched economic science. + +It deserves to be said, perhaps, that the term MŽ (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 MŽ. 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 MŽ and T is necessary for the completeness +of Professor Fisher's reasoning. + + * * * * * + +Ralph H. Hess[75]: Professor Fisher's formula (MV + MŽVŽ = PT) +approximately expresses the mathematical equality of purchase and +payment which cannot be questioned. I say _approximately_ because MŽ +(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 MŽ 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 (VŽ). + +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 MŽVŽ, 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 VŽ are determined +by the mechanical circumstances and organization of exchange, and that +the value of M and MŽ, taken collectively, is a spontaneous derivative +of PT. The fundamental determinants of prices and of "price levels," +therefore, are to be found outside of monetary and credit agencies _per +se_. + +As to the nature and order of the price-making process and the actual +forces behind price movements, I am in substantial accord with Professor +Laughlin. That prices, individually and collectively considered, express +the value-proportion of demand for and supply of goods on the market to +demand for and "visible supply" of the standard commodity is +fundamentally logical. Nor is there occasion to quibble over the paradox +of disturbed equilibrium of demand and supply. Physically considered, +the goods which objectify these terms are, of course, identical; but, in +the valuation process, demand and supply denominate, respectively, +_desire_ and _utility_--the generally acknowledged antecedents of value. +Price is the equalizing factor between the effective demand for gold and +the effective demand for other goods, each taken in conventional units; +and price changes are resultants of, and commensurate with, net +variations in the value-factors of the standard and of the objects of +exchange. + +Referring to the nature of credit and the economic qualities of credit +instruments, the somewhat figurative expression "goods coined into a +means of payment" is a striking and accurate characterization. It is +possible that all legitimate market values, under normal trade +conditions, may be liquidized through credit agencies, and the goods in +which they are incorporated be thus rendered immediately and +conveniently exchangeable. This process may be consummated independently +of prices and with slight regard to the actual supply of money. The +truth of this assertion is, in fact, demonstrated daily in the marts of +trade. + + * * * * * + +J. Laurence Laughlin[76]: There is time to answer briefly only a few of +the points raised by several speakers. First, Professor Fisher's +equation of MV + MŽVŽ = 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 MŽ, 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 (MŽ), 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 MŽ 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 (MŽ) 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.: _MŽ_, _V_, _VŽ_, the +_p_'s and the _Q_'s? + +We have seen that normally the effect of doubling money in circulation +(_M_) is to double deposits (_MŽ_) 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 _MŽ_. We propose next to +show that this doubling of _M_ and _MŽ_ does not normally change _V_, +_VŽ_ 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 +_MŽ_ 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 _MŽ_ 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 _MŽ_ 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 _MŽ_, and no changes in _V_, _VŽ_, +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 _MŽ_, and the +non-relation of _M_ to _V_, _VŽ_, 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 _MŽ_. + + +THE TESTIMONY OF RICARDO + +[78]Let us suppose that the circulation of all countries were carried on +by the precious metals only, and that the proportion which England +possessed were one million; let us further suppose, that, at once, half +of the currencies of all countries, excepting that of England, were +suddenly annihilated, would it be possible for England to continue to +retain the million which she before possessed? Would not her currency +become relatively excessive compared with that of other countries? If a +quarter of wheat, for example, had been both in France and England of +the same value as an ounce of coined gold, would not half an ounce now +purchase it in France, whilst in England it continued of the same value +as one ounce? Could we by any laws, under such circumstances, prevent +wheat or some other commodity (for all would be equally affected) from +being imported into England, and gold coin from being exported? If ... +the exportation of bullion were free, gold might rise 100 per cent.; and +for the same reason, if 35 Flemish schillings in Hamburgh had before +been of equal value with a pound sterling, 17-1/2 schillings would now +attain that value. If the currency of England only had been doubled, the +effects would have been precisely the same. + +Suppose, again, the case reversed, and that all other currencies +remained as before, while half that of England was retrenched. If the +coinage of money at the mint was on the present footing, would not the +prices of commodities be so reduced here that cheapness would invite +foreign purchasers, and would not this continue till the relative +proportions in the different currencies were restored? + +If such would be the effects of a diminution of money below its natural +level, and that such would be the consequences the most celebrated +writers on political economy are agreed, how can it be justly contended +that the increase or diminution of money has nothing to do either with +the foreign exchanges, or with the price of bullion? + +Now, a paper circulation, not convertible into specie, differs in its +effects in no respect from a metallic currency, with the law against +exportation strictly executed. + +Supposing, then, the first case to occur whilst our circulation +consisted wholly of paper, would not the exchanges fall, and the price +of bullion rise in the manner which I have been representing; and would +not our currency be depreciated, because it was no longer of the same +value in the markets of the world as the bullion which it professed to +represent? The fact of depreciation could not be denied, however the +Bank Directors might assure the public that they never discounted but +good bills for bona fide transactions; however they might assert that +they never forced a note into circulation; that the quantity of money +was no more than it had always been, and was only adequate to the wants +of commerce, which had increased and not diminished;[79] that the price +of gold, which was here at twice its mint value, was equally high, or +higher, abroad, as might be proved by sending an ounce of bullion to +Hamburgh, and having the produce remitted by bill payable in London +bank notes; and that the increase or diminution of their notes could not +possibly either affect the exchange or the price of bullion. All this, +except the last, might be true, and yet would any man refuse his assent +to the fact of the currency being depreciated? + +Could the symptoms which I have been enumerating proceed from any other +cause but a relative excess in our currency? Could our currency be +restored to its bullion value by any other means than by a reduction in +its quantity, which should raise it to the value of the currencies of +other countries; or by the increase of the precious metals, which lower +the value of theirs to the level of ours? + +FOOTNOTES: + +[43] _The Purchasing Power of Money_, pp. 14-71. The Macmillan Company. +New York. 1911. + +[44] This theory, though often crudely formulated, has been accepted by +Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, +Kemmerer and most writers on the subject. The Roman Julius Paulus, about +200 A. D., stated his belief that the value of money depends on its +quantity. See Zuckerkandl, _Theorie des Preises_: Kemmerer, _Money and +Credit Instruments in their Relation to General Prices_, New York +(Holt), 1909. It is true that many writers still oppose the quantity +theory. See especially, Laughlin, _Principles of Money_, New York +(Scribner). 1903. + +[45] See Scott, "It has been a most fruitful source of false doctrines +regarding monetary matters, and is constantly and successfully employed +in defense of harmful legislation and as a means of preventing needed +monetary reforms." _Money and Banking._ New York, 1903, p. 68. + +[46] [For a method of determining the velocity of the circulation of +money, see Appendix A.] + +[47] It is important to bear in mind that wherever _P_ is used in this +chapter it represents the index number, or scale of prices, at which the +trade, _T_, is conducted.--EDITOR. + +[48] An almost opposite view is that of Laughlin that normal credit +cannot affect prices because it is not an offer of standard money and +cannot affect the value of the standard which alone determines general +prices. See the _Principles of Money_, New York (Scribner), 1903, p. 97. +Both views are inconsistent with that upheld ... [here]. + +[49] This fact is apparently overlooked by Laughlin when he argues that +there is not "any reason for limiting the amount of the deposit +currency, or the assumption of an absolute scarcity of specie reserves." +See _Principles of Money_, p. 127. + +[50] Interesting changes in the magnitudes of the equation of exchange +between 1896 and 1914 are given in the appended diagram, which is taken +from a reprint of Professor Fisher's article, _The Equation of Exchange +for 1914, and the War_, the _American Economic Review_, Vol. V, No. 2, +June, 1915.--EDITOR. + +[51] Adapted from Irving Fisher. _Recent Changes in Price Levels and +Their Causes_, Bulletin of the American Economic Association. Fourth +Series, No. 2, Papers and Discussions of the Twenty-third Annual +Meeting, December, 1910, pp. 43-44. + +[52] Irving Fisher, _The Purchasing Power of Money_, pp. 74-88. + +[53] _Ibid._, pp. 149, 150. + +[54] _Causes of the Changes in Prices since 1896._ Bulletin of the +American Economic Association, Fourth Series, No. 2, Papers and +Discussions of the Twenty-third Annual Meeting, December, 1910, pp. +27-36. + +[55] There is a possible error here of perhaps $500,000,000. + +[56] The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director +of Mint, 1909, p. 80. + +[57] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52. + +[58] _Ibid._, pp. 52-61. + +[59] _Money and Credit Instruments in their Relation to General Prices_, +2d edition, 1909. New York: Henry Holt & Company. + +[60] The passages referred to are omitted.--EDITOR. + +[61] Kemmerer, _Money and Credit Instruments_, pp. 9-18, 74-82. + +[62] _Ibid._, pp. 82-8, 121-6, 145-8. + +[63] _Ibid._, p. 9. [See Fisher: _Purchasing Power of Money_, pp. +175-180.] + +[64] The value of gold bullion deposited at the United States mints and +assay offices increased from $87,924,000 for 1897 to $205,036,000 for +1907. Figures furnished by the Director of the Mint. + +[65] It is noteworthy that the reserves of the New York associated banks +for example are usually kept very close to the legal reserve +requirements. Cf. Sprague, _Crises under the National Banking System_, +p. 222. + +[66] Gold produced before 1492 represents an insignificant part of the +existing supply. + +[67] Useful tables summarizing all of these index numbers, except those +of Canada, are given by Achille Necco, in his article on _La curva dei +prezzi delle merci in Italia negli anni 1881-1909_, in _La Riforma +Sociale_, Sept.-Oct., 1910. + +[68] Comparison is for 1897 and 1906, figures for 1907 not being +available. + +[69] De Launay thinks that the industrial consumption averages somewhere +between 40 and 50 per cent. of the annual output, but believes that for +several years past the industrial uses have been absorbing a decreasing +proportion, though an increasing amount. (_The World's Gold_, pp. +176-7.) + +[70] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61. + +[71] _Ibid._, pp. 61-63. + +[72] _Ibid._, p. 64. + +[73] The quotation here referred to is omitted.--EDITOR. + +[74] _Ibid._, pp. 64-65. + +[75] _Ibid._, pp. 65-67. + +[76] _Ibid._, pp. 67-69. + +[77] Adapted from _The Purchasing Power of Money_, pp. 150-157; and +Bulletin of the American Economic Association, Fourth Series, No. 2. +Papers and Discussions of the Twenty-third Annual Meeting, December, +1910. p. 70. + +[78] David Ricardo, _Reply to Mr. Bosanquet's Practical Observations on +the Report of the Bullion Committee_, Works, pp. 326-328. John Murray. +London. 1888. + +[79] The Bank could not on their own principles, then urge that most +erroneous opinion, that the rate of interest would be affected in the +money market if their issues were excessive, and would therefore cause +their notes to return to them, because, in the case here supposed, the +actual amount of the money of the world being greatly diminished, they +must contend that the rate of interest would generally rise, and they +might therefore increase their issues. If, after the able exposition of +Dr. Smith, any further argument were necessary to prove that the rate of +interest is governed wholly by the relation of the amount of capital +with the means of employing it, and is entirely independent of the +abundance or scarcity of the circulating medium, this illustration would +I think afford it. + + + + +CHAPTER XII + +THE GOLD EXCHANGE STANDARD + + It is an essential feature of the gold exchange standard as + it exists in the Philippines, for example, that premiums + charged by the Government in Manila for exchange on New + York, and in New York for exchange on Manila are fixed at a + point somewhat below the gold export points in each case. + Thus the would-be exporter of gold in the Philippines never + finds it profitable to ship gold to New York. On the other + hand, international bankers in New York never find it + profitable to ship gold or currency to the Philippines, + because the authorised agent of the Philippine government in + New York always stands ready to sell in exchange for United + States currency, drafts drawn upon Manila at a premium less + than the cost of shipping gold or currency. Through a + regulation of the supply of silver pesos in actual + circulation in the Philippines they are maintained at a + definite ratio to--not gold in the Philippines, but--gold, + or its equivalent, in New York. The way in which the supply + of local currency in the gold-exchange country is regulated + will be made clear in what follows. + + The gold exchange standard has not entirely escaped + criticism. Professor J. Shield Nicholson has recently + attacked this standard in India. (_Economic Journal_, June, + 1914.) It is his contention that inflation may occur in + India, if it has not already occurred, on account of the + "impeded convertibility of rupees into gold." After a + certain point is reached in the inflation the decline in the + general purchasing power of the rupee must be followed, he + affirms, by a specific depreciation as regards gold; and + then the main object of the plan would be defeated. He + offers no evidence, however, that prices have risen faster + in India than in gold standard countries. With the exception + of Mexico, where currency conditions have become extremely + chaotic, the historical material here reprinted is in accord + with the recent monetary history of the countries under + discussion. + +[80]When the Government of British India sought, in 1893, to give a +fixed gold value to about £120,000,000 in rupee silver, it undertook an +experiment of great importance to the financial world, and one which was +naturally viewed in many quarters with grave misgivings. The experience +of fifteen years which have followed that experiment has taught many +lessons in monetary science. It may, indeed, be said to have blazed a +new path in the principles of money--at least, in their practical +application. The effort to raise the coins to a fixed gold value by +scarcity alone was not successful, but it led to other devices, which, +imitated or improved upon in Mexico, the Philippines, and the Straits +Settlements, as well as in India, have created a new type of monetary +system which has come to bear the title of the gold exchange standard. + +The gold exchange standard differs in several respects from the limping +standard. It has been the product of definite purpose and plan in the +Philippines and in Mexico and to a certain extent in India. While in +British India it has been, like the limping standard, a compromise with +existing conditions, it has there, as elsewhere, received a definite +form and substance which separated it from the limping standard as +evolved in France and in other countries which found themselves with a +large amount of legal-tender silver on their hands when the metal had +fallen below the official parity. There are two other essential +differences between the limping standard and the gold exchange standard. +One is that the gold exchange standard contemplates a circulation of +token coins of silver without any necessary concurrent circulation of +gold or paper. The other is that the gold exchange standard contemplates +definite and comprehensive measures to maintain the value of token coins +at par with gold instead of relying purely upon custom and scarcity to +give them value. + +The essential principle upon which the exchange standard has been +established is that the value of money is governed by the law of supply +and demand. So long as supply was indefinite and excessive, as under the +system of the free coinage of silver, there was no way of preventing +safely and effectively the decline in the gold value of the coins to the +bullion value of their silver contents. The moment, however, that +Government undertook to limit the supply of coins to the demand for +them, it took an important step to separate their value from that of +their bullion contents and to give them a value based upon the demand +for them as money signs required for carrying on exchanges. Strangely +enough, while this principle had been in operation for many years in the +case of subsidiary coins, its bearing upon the use of silver in +countries where the standard had been depreciating was not clearly +comprehended until within recent years. Those who understood the +principle doubted its sufficiency to give a fixed value to silver coins +as the sole medium of exchange, or they distrusted the ability of any +government to judge accurately the number of coins required. + +Upon the latter point they would have been correct if dependence had +been placed upon guesswork or any empirical method of determining the +amount needed. It remained to find the true solution of the problem by +so regulating the quantity of the coins that it would respond +automatically to the demands of trade. The correct method of doing this +is through the system of exchange funds. As this system is operated in +the Philippines, it is not possible to obtain gold coin for silver +certificates in small quantities; but it is possible always to obtain +drafts upon New York at par, plus the usual charges for exchange between +gold standard countries. These drafts have to be purchased with actual +silver coin or coin certificates. In either case the coins and +certificates are, by the requirements of the coinage law, held in the +Philippine Treasury. The law does not permit their deposit by the +Treasury in current account at a bank, which would turn them back into +the general circulation. + +For practical purposes the volume of currency in circulation is +contracted to the same extent as if a corresponding amount of gold were +taken from the circulation for export. When the current turns and rates +for money become high in the Philippines, Philippine currency can be +released for local circulation by the purchase in New York from the gold +standard fund of bills upon the Philippine Treasury. This rule of +locking up the proceeds of the sale of bills is not rigidly applied to +the funds in New York, because the influence of the Philippine purchases +upon the local circulation there would be insignificant. On the +contrary, the Government obtains a generous interest rate, which has at +times been as high as 4 per cent., upon the deposit of Philippine funds +with New York bankers. During the stress of the autumn of 1907 +considerable transfers of capital were made from Manila to New York by +means of the purchase of New York drafts from the Philippine Treasury. +The process, often repeated even under less serious pressure, clearly +shows that the monetary system of the Philippines is linked to gold, and +that capital can be freely transferred upon a gold basis between Manila +and other markets. + +The experience of fifteen years since the free coinage of rupees was +first suspended in British India, of five years since the new system was +established in the Philippines, and of nearly four years since it was in +operation in Mexico, have settled most of the doubts which were felt +when the experiment was undertaken in India. In the first place, it has +been made clear that the value of the coins in exchange, as fixed by +law, has not been influenced by variations in the price of silver +bullion. This statement, of course, applies only to one side of the +problem--the fall of the gold value of the silver in the coin below its +face value. It would not be possible under any system yet discovered, +except such uneconomic devices as prohibiting exportation, to prevent +the disappearance of silver coins when the [bullion] value of their +contents rises above the legal value in exchange. Both the Philippines +and Mexico have faced this menace to their monetary circulation since +their systems were inaugurated, but both have succeeded in removing it. +In the Philippines the contents of the silver unit--the peso--was +reduced in 1906 from about 371 grains to 247 grains in pure silver. The +amount fixed by the law of 1903 was practically the same as the contents +of the old Mexican dollar. The adoption of a coin of this weight was +caused partly by the desire to avoid the distrust which some feared +might arise from reducing the weight. At the time of the passage of the +law, moreover, the price of silver was nearly at the lowest point in its +history, having touched the minimum of 21-11/16 pence in January, 1903, +and being at an average price of 22-1/2 pence in March. The adoption of +so heavy a coin, however, was not in accordance with the original +recommendation made by the present writer to the War Department in +November, 1901. The weight then recommended was 385 grains, nine-tenths +fine, or about 347 grains of pure silver. + +In Mexico the rise of the silver coins above the legal gold value proved +a blessing in disguise. It enabled Mexico to go almost to an absolute +gold standard by selling her silver at a premium. From May 1st, 1905, to +October 22nd, 1907, the old silver piasters were exported to the amount +of $85,956,202, while gold coinage was executed to the amount of +$71,646,500 (about £7,200,000).[81] The gold has gone chiefly into the +reserves of the banks, which have in circulation about $95,000,000 in +notes. Gold holdings of the banks, which were only $15,832,840 in +January, 1906, were $54,165,483 in October, 1907, while silver holdings +declined over the same period from $49,781,155 to $14,399,924.[82] This +influx of gold came about because silver at 33 pence was above the +Mexican coinage ratio of about 32 to 1, and much of it was sold by the +Commission on Money and Exchange at a direct profit to the Mexican +Treasury. In view of the subsequent fall in silver below 23 pence, at +which rate Mexico is in a position to replenish her supply of subsidiary +coinage, her statesmen may claim the credit of following the great rule +of profit in the commercial world as well as on the stock exchange--to +sell when things are dear and to buy when things are cheap. + +The coincidence in the rise of silver and the adoption of the Mexican +monetary reform in 1905 was in some degree accidental. It facilitated +the reform, not only by introducing gold, but by removing the objections +which would otherwise have been heard from the miners of silver to the +rise in gold wages which would have accompanied a fixing of the exchange +at a point above the value of silver bullion. It was the intention of +the Mexican Government, however, to proceed resolutely, though +deliberately, to a fixed exchange, and they would undoubtedly have +accomplished this result, even if they had not been aided by the rise in +the value of silver. Its subsequent fall has in no wise impaired the +stability of the gold standard. + +Some fears were expressed in the Philippines as to the willingness of +the natives and of Chinese traders to accept a silver coin at a gold +value fixed by law which was obviously above its value as bullion. This +difficulty has proved almost negligible. Silver within less than three +years has been above 33 pence per ounce and below 23 pence. It is +doubtful if the Government officials in India or the Philippines have so +much as taken note of the daily fluctuations since the price dropped +below the legal parity of the coins, and it is certain that the exchange +value of the coins has been in no wise impaired by their fall in bullion +value. When the last reduction was made in the weight and fineness of +the Philippine coins, lowering by almost 30 per cent. their silver +contents, the precaution was taken of advising the public by means of an +official circular, translated into the various languages and dialects of +the Islands, why the change had been made, and that it would not affect +the exchange value of the coins. Provincial and municipal treasurers +were also directed to carry on a campaign of education among the people +by way of explaining the character and effect of the change. The +greatest menace to the value of the new coins lay with the Chinese, for +in China for many hundreds of years local bankers and merchants have +adhered to the rule that a coin derived no value from the stamp, but was +worth just what it would fetch on the scales. The Chinese traders at +first undertook to discriminate in this manner against the new coins of +the Philippines. In some cases they refused to receive them except at a +discount varying from 20 to 40 per cent. They also offered 105 in the +new coins for 100 in the old, evidently in the hope of exporting the old +at a profit while they continued to be worth as bullion more than their +legal gold value. The success of this discrimination was local and +extremely short-lived. The first consignment of the new coins reached +Manila on May 4, 1907, and when the Treasurer of the Islands prepared +his annual report on October 15th, 1907, he was able to make the +following statement of conditions: + + At this time, October 15, the new coin is accepted without + question in every part of the Islands, and no reports or + complaints have been received for the past two months as to + discounting it, and, so far as can be ascertained, no + premium is now paid for the old coin. In fact, the demand + for the new coin for exchange purposes has so far exceeded + the supply that it became necessary to withdraw nearly half + a million of the new pesos from the banks to meet the + requisitions therefor from the provinces. + +The hesitation which prevailed, therefore, in many quarters in regard to +the ability of a government to overcome the conservatism of the East in +its preference for coins of full bullion value has not been warranted by +events. This demonstration is of importance if the exchange standard is +to be considered for China. At present the Government of China is not +perhaps strong enough and sufficiently centralised to assure its +subjects that it can give a definite gold value to a token coin and +maintain it honestly and efficiently. The trial of the system, however, +in the Philippines, in British India, and in the Straits Settlements, in +all of which there are many Chinese, has probably so far cleared the air +upon this point that the Chinese Imperial Government would be able to +establish the gold exchange system if it did so under sufficient +guarantees to the financial world that it would be honestly and +intelligently maintained. + +Next in importance to the settlement of this question of native +willingness to accept the new system may be considered the degree of +difficulty in maintaining it. It is not surprising, perhaps, that when +it was proposed in an incomplete form for British India, it should have +been denounced as a "fair weather" device--"a leap in the dark," which +would not stand the test of business depression, deficient crops, and an +unfavourable balance of trade.[83] + +The most serious difficulty which has been foreseen by critics of the +gold exchange system relates to the sufficiency of the exchange funds. +Up to the period of the general panic of 1907 and the crop failure in +India in the spring of 1908, it might fairly be said, perhaps, that the +system had not been subjected to any but "fair weather" conditions. The +experience of India, however, has thrown striking light upon the +possibilities and limitations of the system in time of stress. The test +in India has been of such magnitude, moreover, that its results are much +more conclusive than any test which might have been afforded in a +smaller country dealing with a less enormous mass of token coins. If the +test had come before the exchange funds had acquired a respectable size, +the system might have been allowed to break down, through timidity and +delay in taking proper measures of protection, and discredit have thus +been cast upon it before it had been fairly tried. + +What happened in India was that the failure of the crops deprived the +country of the usual means of compensating by exports the heavy imports +of foreign goods which had been contracted for. It became necessary, +under the settled principles of exchange, to find gold to fill the gap. +Usually the exchange account substantially balanced itself by the sale +in London of Council drafts upon the Indian Government to obtain gold to +pay the interest on the debt held in England. These drafts were +purchased by importers in London, and used to pay for the Indian crops; +but all through the spring of 1908 purchasers for drafts failed to +appear, because there had been no considerable exports of Indian crops +to be paid for. Hence Council drafts were without a market, and for a +moment it seemed that the link which bound the Indian monetary system to +the gold market of London had been severed, and that the silver rupee +might drop as disastrously as the Mexican dollar before its free coinage +was suspended. This would have added the influence of an appalling +disaster to the burden already imposed upon Indian finance by the +failure of the crops, for it would have compelled the Indian importer of +English goods to find a greatly increased number of rupees to meet his +gold obligations in London. Obviously, it was a disaster which, if it +had occurred, would have invited the bankruptcy of the country, +reflected lasting disgrace upon English financial foresight, and perhaps +even have led to organised revolt. + +The Indian Government had available for meeting the crisis about +£18,500,000, principally invested in securities in London. This fund, +known as the gold standard reserve, was distinct from the currency +reserve, consisting of gold received for currency notes, which amounted +in the spring of 1908 to about £12,000,000. It was against the former +fund that the Indian Government felt compelled to offer to sell exchange +in India. Such offers were made for a time in limited amounts of +£500,000 each, but they proved substantially adequate for meeting the +demand, and by early summer the demand fell below the supply. The offer +of exchange in this form for rupees maintained the value of the rupee +coinage, contracted the amount of rupees in circulation in India, and +enabled the Indian merchants to meet their obligations without the loss +which they must have suffered if the currency had been allowed to +depreciate in gold value. The actual sales of bills upon the exchange +funds in London reached, between March 26th and August 13th, 1908, the +considerable total of £8,058,000. Of this amount about £2,000,000 was +taken from the currency reserve in gold, which was "earmarked" at the +Bank of England, incidentally affording relief to the London money +market which was keenly appreciated. Most of the remainder was obtained +by the sale of securities to an amount which reduced such holdings from +£14,019,676 on March 31st to £9,415,708 on July 31st. + +The test to which the Indian system, as the most important example of +the gold exchange standard, was thus subjected was perhaps of a higher +importance than was realised by those in the thick of the conflict. It +was plainly intimated, however, in the annual report on financial +conditions for 1908 that, if necessary, the Indian Government would have +issued short-dated securities in order to still further replenish the +exchange funds in London. This would have been the true means of meeting +the situation if the existing fund had been unduly impaired. The +argument against it would have been that the demand was indefinite, and +might become so large as to be unmanageable. The fact that the demand +for exchange was met without the issue of new securities and without +trenching upon the reserve funds beyond the amount of £8,000,000 out of +£18,500,000 affords pretty strong evidence that there is a natural limit +to such demands. + +It is in this principle, that there is a natural limit to the possible +drain upon the exchange funds, that the security of the new system +lies.... It is only the supply of local currency on the margin of +possible export demands which needs to be safeguarded. The substratum, +which can never leave the country unless under the influence of an +almost inconceivable economic cataclysm, is analogous in some respects +to the "authorised" circulation of the Bank of England. It represents +the irreducible minimum below which the local need for currency can +never fall. If the supply on the margin of the international exchange +movement is adequately guarded, then the whole system is secure. If it +were conceivable that the demand for exchange would equal the whole +amount of the local currency, or even the half of it, then it would be +necessary to maintain exchange funds equal to the whole amount of token +coins or the half of them in order to insure safety. But obviously this +could never be the case. + +This argument against the exchange standard is only a repetition of the +dilemma sometimes presented by untrained minds in regard to bank-notes: +what would happen if all the notes should be presented at one time for +redemption? That question has been answered by banking experience; the +question in regard to the gold exchange system has been and must be +answered by experience in substantially the same manner. No country can +be subjected to such stress as to consent to part with its entire +monetary circulation, or even the half of it. On the contrary, every +influence which tends to contract the circulation tends to create a +condition which makes further contraction more difficult. Rates for the +loan of money are affected, prices of imported goods are influenced, +imports fall off and exports increase, and inevitably in the modern +money market local equilibrium is restored, often with considerable +strain, but none the less without pulling down the pillars of the +financial temple. + +The experience of last spring in India proves the adequacy of a reserve +of 15 or 20 per cent. of the circulation to maintain the steady parity +of a token coinage. There is apparently no evidence that serious +distrust of the rupee arose, even when the Government was hesitating as +to just what steps should be taken to meet the demand for exchange. Even +if such distrust had arisen, however, it could have expressed itself +through financial channels only by the demand for drafts on London. +These would not have been very valuable to the average local tradesman +except as he was able to sell them back again to the banks for the very +rupees which had aroused his distrust. In this respect the gold exchange +standard may be said to put a brake upon the disposition to export +currency from fear alone, when the exportation is not demanded by the +balance of trade. + +If any mistake was made in the management of the Indian currency, it was +in the investment of too large a proportion of the gold standard reserve +in securities. While investment in securities is naturally attractive +because of the income earned, and while it is not subject to just +criticism while kept within certain limits, the possession of actual +gold to a considerable amount is highly desirable. It would not be +necessary, perhaps, that such gold should be "earmarked." If the Indian +Government had a large deposit account in such an institution as the +Union of London and Smith's Bank, or the London City and Midland, it +would possess for the purposes of the Indian Government the character of +gold. Drafts against such a deposit could be sold without the discount +or delay which might be required in disposing of securities. It seems +highly desirable, therefore, in spite of the prudence with which the +recent pressure was met, that at least 30 or 40 per cent. of the gold +standard reserve should in the future be kept either in "earmarked" gold +or in the form of demand deposits. + +In the case of the Philippine Islands the reserve is not "earmarked," +but is at present entirely in the form of deposits with New York +bankers. The problem in the Philippines is really child's play compared +to that in British India. The entire circulation of the Philippine +Islands is about 40,000,000 pesos (£4,000,000), against which a large +reserve has accumulated as the result of the recoinage at a reduced rate +as well as by the profits on the original coinage. It is hardly +conceivable that an emergency would arise which would impair this +reserve; but if this should occur, the scratch of a pen in Washington +would remedy the situation. This would be accomplished by depositing +gold or its equivalent in the exchange fund in New York to the credit of +the war and navy, and placing an equivalent amount of local currency at +the command of the military forces in the Philippines. Such a deposit +would operate to increase the resources at the command of military +disbursing officers in the Islands without increasing the amount +actually in circulation until the occasion arose to disburse it. The +Panama currency has been steadily maintained at par by friendly +interchanges of this sort, even with a very insignificant official +exchange fund. No Governor of the Philippines, therefore, need have any +fear of his ability to maintain the parity of the Philippine coinage. + +Whether the exchange standard would stand the strain of a great war is +yet to be subjected to practical test.[84] It may be said, however, that +its capacity to meet such a test would run upon all fours with the +capacity of any monetary system which does not consist exclusively of +gold coin. The experience of France in the war with Prussia seemed to +justify the suspension of specie payments for the purpose of husbanding +the national stock of gold. The history of the Spanish exchange, where +the coins have followed the value of the bank-notes instead of that of +silver bullion, is another case in point. Both Russia and Japan, +however, in the war of 1904-5, succeeded in maintaining complete +convertibility of their bank-notes. There is no reason why the gold +exchange standard should not be successfully maintained so long as the +country where it was established retained its national independence and +pursued a sound financial policy. The issue of large amounts of debt +would not in itself impair the stability of the standard, unless the +Government, in order to obtain gold, ravished the exchange funds in +financial centres. The questions involved would be substantially the +same as those involved in maintaining the parity of bank-notes or paper +money: first, the disposition of the Government to maintain its credit; +secondly, the resources which the Government was able to command. +Without either good intentions or monetary resources, the monetary +system, along with the fiscal system, would break down. It is not +apparent, however, that a country operating upon the gold exchange +system would find any greater difficulty in maintaining the system than +the Bank of Japan had in maintaining the convertibility of its notes +during the war with Russia. + +If there were a disposition in time of war to transfer capital abroad by +excessive demands upon the exchange funds, it could be counteracted in +three ways. One would be the automatic influence of the deficiency of +currency which would arise at home. Another would be the issue of loans +abroad, from which exchange demands could be met. A third would be the +deliberate elevation by a small percentage of the charge for exchange. +This would amount to a slight depreciation in the currency, but if kept +within prudent bounds, it would probably permit the maintenance of an +adequate circulation without disturbance to local prices and without +even a theoretical depression below the 2 or 2-1/2 per cent. which +affected the notes of the Bank of France in the war of 1870. + +The gold exchange system may indeed be said to be an extension of the +bank-note system to token coins. The token coin is, in effect, a +metallic bank-note, whose maintenance at gold par is subject to the +rules of sound banking. Its advantages over the bank-note in undeveloped +countries are that it conforms to a strong prejudice in favour of "hard +money," not subject to the vicissitudes of tropical climes, and that the +output can be more safely regulated, where new coins are issued only for +gold, than where a bank may increase its note issues to take over assets +of speculative or doubtful character. In the advanced countries, with a +highly organised credit system, gold, and gold alone, is the proper form +of full legal-tender coin; but in the less advanced countries of the +Orient silver token coins have the advantage that they conform in size +and denominations to the small scale of local transactions, that they +are not so rapidly absorbed by hoarding, and that their very +non-exportability enables the Government to keep in circulation a +quantity of currency which might under a different system be drained +away to richer countries, and leave the community denuded of an adequate +medium for carrying on exchanges. + + +OBJECTIONS TO THE GOLD-EXCHANGE STANDARD FOR THE STRAITS SETTLEMENTS +ANSWERED + +[85]... the establishment of the gold standard in the Straits +Settlements ... in the spring of 1903 ... provided for the recoinage of +the British and Mexican dollars then circulating in the Malay Peninsula +into new Straits Settlements dollars ... of the same weight and fineness +as the British dollar, and for the subsequent raising of the value of +these new dollars to an unannounced gold par by means of limiting the +supply, in accordance with the principle by which India raised the gold +value of the rupee.... + +The objections urged to the adoption of the gold-exchange standard are +[were]: (1) That it would unduly interfere with the [foreign exchange] +business of the banks. (2) That it would encourage banks to work on +dangerously low cash balances, knowing as they would that they could +obtain dollars of the Government on a moment's notice by the purchase of +cable transfers on Singapore from the crown agents for the colonies in +London. (3) That there would be danger of the Government's notes [a part +of the circulating medium] depreciating unless they were redeemable in +gold in the country itself. (4) That the monetary circulation of the +Straits Settlements was too small to make the plan feasible there. (5) +That the plan would require a larger reserve fund than would otherwise +be necessary, because the Government would be compelled to keep a +reserve both in London and Singapore; and that in each place the reserve +would have to be large, because drafts on the fund through the sale of +telegraphic transfers would not give the Government any such warning in +advance of the demands liable to be made as would enable it to replenish +the reserve. + +The above arguments, all of which were urged upon the writer either by +officials or business men in the Straits Settlements, do not appear to +be conclusive for the following reasons, which may conveniently be +stated in the same order as the objections.[86] (1) If the rates for the +sale of government drafts were fixed at the "gold points," as they +presumably would be under the gold-exchange standard, and if only drafts +of large amounts were to be sold by the Government, redemption by the +sale of drafts would not interfere appreciably more with the business of +the banks than would redemption in coin. Under these circumstances the +banks themselves would be the principal purchasers of government drafts, +and such drafts would be purchased and forwarded merely in lieu of the +shipment of sovereigns. (2) The sale of telegraphic transfers, while +desirable in the interest of currency elasticity, is by no means a +necessary feature of the gold-exchange standard. If the Government were +opposed to making a minimum legal reserve requirement of banks, it could +limit its sales of drafts to demand drafts or even, if need be, to +short-time drafts. (3) If government notes were redeemable in silver +dollars on demand, and if the silver dollars were redeemable in gold +exchange on demand, depreciation would be impossible in a country where +the people have the confidence in the Government which they have in the +Straits Settlements. (4) The system of the gold-exchange standard is +better suited to a country with a small circulation than to one with a +large circulation. It is evidently easier to maintain a small reserve +abroad than a large one and the operations with a small reserve are less +disturbing to the money market of the financial center in which the +reserve is located. (5) It is not probable that the Straits Settlements +would require so large a reserve under the gold-exchange standard as it +will under the system to be adopted. Under either system it would need a +sovereign reserve and a dollar reserve. Under the system to be adopted +both reserves will be located in Singapore; under the gold-exchange +standard the dollar reserve would be located in Singapore and the +sovereign reserve in London. The sale of cable transfers is not a +necessary part of the system, as above pointed out; and, even if it +were, the movement of market rates of exchange would ordinarily give +ample warning of a demand for dollar drafts or sovereign drafts. +Emergency cases, if such should arise, could be met through the +temporary transfer of funds to the gold reserve from the security +portion of the note guarantee fund, or through the transfer of dollars +to the credit of the home government in Singapore in exchange for an +equivalent amount of sovereigns placed to the credit of the Straits +government in London.... A prolonged and severe drain upon the reserve +fund, which in a country like the Straits Settlements would be an +extremely improbable contingency if the Government withdrew from +circulation dollars presented in the purchase of government drafts, +could of course always be met by the forward sale on the London silver +market of the redundant dollars piling up in the Government's dollar +reserve in Singapore. The gold-exchange standard would probably enable +the country to get along with a smaller gold reserve than will the +system to be adopted, inasmuch as it would keep gold coins out of +circulation and the demands upon it would be limited to the requirements +of meeting foreign trade balances--the only monetary use to which the +dollars could not be applied. The Straits Settlements, inasmuch as it is +a country for whose trade requirements silver coins are better adapted +than gold, and a country which is anxious to maintain its reserve at as +small an expense as possible, would in fact seem to be a place +peculiarly adapted to the gold-exchange standard. The premiums which the +Government would realize on its sale of exchange, together with the +interest it would obtain on that part of its reserve deposited abroad, +would doubtless yield sufficient profit, as in the Philippines, to pay +the expenses of administering the currency system and to provide in +addition a substantial annual increment to the gold reserve. + +FOOTNOTES: + +[80] Charles A. Conant, _The Gold Exchange Standard in the Light of +Experience, The Economic Journal_, Vol. 19, June, 1909, pp. 190-200. + +[81] _Le Marché Financier en 1907-8_, p. 711. + +[82] These figures are from the annual budget statements of the Minister +of Finance. + +[83] For some of these doubts see _London Bankers' Magazine_, October, +1908, LXXXVI, p. 435. + +[84] Throughout August, 1914, while sterling rates in other countries +rose to unprecedented heights, India succeeded in maintaining rates on +London in the neighborhood of the gold export point--a striking +testimony to the soundness of the Indian arrangements.--EDITOR. + +[85] E. W. Kemmerer, _A Gold Standard for the Straits Settlements II., +Political Science Quarterly_, Vol. XXI, No. 4, p. 663, 678-680. + +[86] The answers given to the objections just stated have been confirmed +and strengthened by the actual operation of the gold-exchange standard +as later adopted by the Straits Settlements.--EDITOR. + + + + +CHAPTER XIII + +A PLAN FOR A COMPENSATED DOLLAR + +[87]In the _Purchasing Power of Money_ (1911) I sketched a plan for +controlling the price level, _i. e._, standardizing the purchasing power +of monetary units. This plan was presented more briefly, but in more +popular language, before the International Congress of Chambers of +Commerce, at Boston, September, 1912. The details were most fully +elaborated in the _Quarterly Journal of Economics_, February, 1913. +Following these and various other presentations of the subject, +especially the discussion at the meeting of the American Economic +Association in December, 1912, the plan was widely criticized by +economists, both favorably and unfavorably, as well as by the general +public. + +On the whole the plan has been received with far more favor than I had +dared to hope and even the adverse criticism has usually been tempered +by a certain degree of approval. + +The object of the present paper is briefly to state the plan and to +answer the more important and technical objections which have been +raised. Answers to the more popular objections, omitted from this +article through lack of space, will appear in a book, _Standardising the +Dollar_, which I hope to publish in 1915. + +I shall begin with a skeleton statement of the plan; space is lacking +for more. In brief, the plan is _virtually_ to vary each month the +weight of the gold dollar, or other unit, and to vary it in such a way +as to enable it always to have substantially the same general purchasing +power. The word "virtually" is emphasized, lest, as has frequently +happened, any one should imagine that the actual gold coins were to be +recoined at a new weight each month. The simplest disposition of +existing gold coins would be to call them in and issue paper +certificates therefor. The virtual gold dollar would then be that +varying quantum of gold _bullion_ in which each dollar of these +certificates could be redeemed. The situation would be only slightly +different from that at present, since very little actual gold now +circulates; instead, the public uses gold certificates, obtained on the +deposit of gold bullion at the Treasury, and redeemable in gold bullion +at the Treasury at the rate of 25.8 grains, nine-tenths fine, per +dollar. The only important change which would be introduced by the plan +is in the redemption bullion; we would substitute for 25.8 a new figure +each month. The gold miner, or other owners of bullion, would, just as +now, deposit gold at the United States Mint or Treasury and receive +paper representatives, while the jeweler, exporter, and other holders of +these certificates would, just as now, present them to the Treasury when +gold bullion was desired. + +There would also be a small fee or "brassage," of, say, 1 per cent. for +"coinage," _i. e._, for depositing the bullion and obtaining its paper +circulating representative. In other words, the Government would buy +gold bullion at 1 per cent less than it sold it. This pair of prices, +for buying and selling, would be shifted in unison, both up or both +down, from month to month, it being provided, however, that no single +shift should exceed 1 per cent., a figure equal to the amount by which +the two differ. The object of this proviso is to prevent speculation in +gold. + +To determine each month what the pair of prices should be, or, what is +practically the same thing, to determine what amount of gold bullion +should be received and paid out in exchange for paper, recourse would be +had to an official index number of prices. If, in any month, the index +number is found to deviate from the initial par, the weight of bullion +in which it shall be redeemable the next month is to be corrected in +proportion to this deviation. Thus, the depreciation of gold would lead +to a heavier virtual dollar; and an appreciation, to a lighter virtual +dollar. + +There are, of course, other details and possible variants of the plan, +some of which will be referred to later when necessary. The objections +to the plan are classified under the following heads: + +1. "_The plan assumes the truth of the quantity theory of money._" There +is nothing whatever in the plan itself which could not be accepted by +those who reject the quantity theory altogether. On the contrary, the +plan will seem simpler, I think, to those who believe a direct +relationship exists between the purchasing power of the dollar and the +bullion from which it is made--without any intermediation of the +quantity of money--than it will seem to quantity theorists. + +2. "_It contradicts the quantity theory._" This objection, the opposite +of that above, is raised by some, who, like Professor Boissevain, +believe in the quantity theory, but imagine that the operation of the +plan could not affect the quantity of money at all (or would not affect +it to the degree needed). But evidently an increase in the weight of the +virtual dollar, _i. e._, a reduction in the price of gold bullion, would +tend to contract the currency, by diverting gold from the mint into the +arts; because its reduced price would cause an increased demand and +consumption. A decrease, of course, would have the opposite effect. + +3. "_It might aggravate the evils it seeks to remedy._" This objection, +raised by Professor Taussig and a few others, is based on the preceding. +It is claimed that an increase in coined money may take place for years +"without visible effect on prices; then comes a flare-up, so to speak." +I doubt if Professor Taussig meant the first half of this statement to +be quite so strong. The evidence only justifies the statement that the +rise is slow at first and rapid later while similarly the effect of a +scarcity of money is slow at first and rapid later. Professor Taussig +then proceeds to apply the same idea to my plan: + + The cumulative consequence would be like the cumulative + consequence of a long continued decline in gold production. + After a season or two of declining bank reserves, tight + money, and so on, a sudden collapse might be occasioned, and + apparently caused, by the announcement of some particular + seigniorage adjustment. Then there might be a decline in + prices much greater than in proportion to the bullion + change. + +But the working of the compensated dollar would not be in the least +analogous to the operation of gold inflation or contraction, even as +Professor Taussig supposes it. The plan always works cumulatively +_toward_ par, never cumulatively _away from_ par. One often sees a wagon +with its wheels on a street-railway track having some difficulty getting +off; the front wheels have to be turned at a large angle before they are +forced out of their grooves; then of a sudden they jump away. This is +analogous to the delayed "flare-up" of prices which Professor Taussig +supposes under the influence of a long continued decline or increase in +the gold supply. But if the driver instead of trying to turn out is +trying to keep the wagon on the track he will pull the horse back at +every tendency to turn to the right or left. The more the horse turns to +the right the harder will the driver endeavor to turn him to the left. +Clearly the effect of the driver's efforts will be to avert or delay, +not to aggravate or hasten, any jumping out of the grooves which other +causes may tend to produce. + +In other words, if it takes as much time as Professor Taussig fears for +a pressure on prices to move them, then so much the more certain is it +that, under the plan, deviations from par, though they may be +persistent, cannot be either rapid or wide. A long continued small +deviation gives plenty of time for the counter pressure exerted by the +compensating device to accumulate and head off any wide deviation. + +Suppose that, following Professor Taussig's ideas, some cause such as an +increase of gold production would, in the absence of the compensated +dollar plan, gradually lift the price level as follows: during the first +year, not at all; during the second year, 1 per cent.; during the third +year, 2 per cent.; after which would come a "flare-up" of 10 per cent. +We may suppose then that, if the plan were in operation during the first +year, there being no deviation visible, there would be no change in the +weight of the dollar. After the first month of the second year when +prices were 1 per cent. above par, the weight of the dollar would +according to the plan be raised 1 per cent. If this were unavailing, so +that in the second month the deviation were still 1 per cent., the +weight of the dollar would be again increased 1 per cent. Every month, +as long as the deviation of 1 per cent. lasts, the weight of the dollar +would receive an _additional_ 1 per cent. Unless some effect were +produced on the supposed original schedule of deviations, the weight of +the dollar of the second year would be increased 12 per cent., and by +the end of the third year by 24 per cent. more, or 36 per cent. in all. +But it is clear that by this time, with so swollen a dollar, the +"flare-up" scheduled for the fourth year could not occur, but that a +counter movement would set in--in fact, would have set in long before +the dollar became so heavily counterpoised. Nor could the result of the +counterpoise, even if so heavy, be to swing suddenly prices far below +par. Prices would, by hypothesis, yield slowly and again give time for +taking the counterpoise off. If the price level sank, say to 1 per cent. +below par for six months, then to 2 per cent. for another six months and +to 3 per cent. in the next six months, evidently the entire 36 per cent. +would be taken off in eighteen months (since 1 × 6 + 2 × 6 + 3 × 6 = +36). The compensating device is thus similar to the governor on a steam +engine. It is the balance wheel that is largest and hardest to move +which is the most easily controlled by the governor. So if the +"flare-up" theory is true, the system will work more perfectly than if +it were not true. + +4. "_It would not work unless every single mint in the world employed +it._" This is an error. Although it could be easily shown to be +politically inadvisable for one nation alone to operate the plan, this +would not be economically impossible. Those who hold the contrary are +deceived by the term "mint price." They reason that our mint price +($18.60 an ounce of gold, 9/10 fine) and England's mint price (£3 17_s._ +10-1/2_d._ for gold 11/12 fine) are now "the same," and that, +consequently, if our price were lowered 1 per cent., _i. e._, to $18.41, +while the English price remained unchanged, _all_ our gold would be +taken to England to take advantage of the "higher" price there. But +these comparisons between English and American prices are based on the +present "par of exchange" ($4.866 of American money for the English +sovereign): which par of exchange is in turn based on the relative +weights of the dollar and the sovereign. As soon as our dollar were made +1 per cent. heavier, not only would the new American mint price go down +1 per cent., but the par of exchange would also go down 1 per cent., to +$4.82. Consequently, the new mint price of $18.41, although in figures +it is lower than the old, yet, being in heavier dollars, would still be +"the same" as the English mint price of £3 17_s._ 10-1/2_d._ This +sameness of mint price as between the two countries means at bottom +merely that an ounce of gold in America is equivalent to an ounce of +gold in England. + +It is true that each increase in the weight of the virtual dollar in +America--in other words, each fall in the official American price of +gold--would at first discourage the minting of gold in America. The +miner would _at first_ send his gold to London, where the mint price was +the same as formerly, and realize by selling exchange on the London +credit thus obtained. But the rate of exchange would soon be affected +through these very operations, by which he attempted to profit, and his +profit would soon be reduced to zero; the export of gold to England +would increase the supply of bills of exchange in America drawn on +London and lower the rate of exchange until there would be no longer any +profit in sending gold from the United States to England and selling +exchange against it. When this happened it would be as profitable to +sell gold to American mints at $18.41 per ounce as to ship it abroad; +and $18.41 in America would be the exact equivalent at the new par of +exchange ($4.82) of the English mint price of £3 17_s._ 10-1/2_d._ + +5. "_The system would be destroyed by war._" Professor Taussig fears +that if money were stabilized, the system would itself be upset by war. +"Any war would put an end to it." To this I would reply: first, that if +war did put an end to it the system would do good so long as it lasted +and its discontinuance would do no more harm than the existence of our +present unscientific system is doing at all times; secondly I do not see +any reason for thinking that war would put an end to it. + +Possibly Professor Taussig has in mind the first form in which I +explained the plan, _viz._, in my book, _The Purchasing Power of Money_. +In that form one country was to serve as a centre and all other +countries were to have the gold exchange standard in terms of gold +reserves in the central country, just as now the Philippines have a gold +exchange standard with reference to the United States and India with +reference to England. Professor Taussig's objection would undoubtedly +apply, to some extent, in cases where the plan was carried out through +the gold exchange mechanism. But where the system was independently +established in each country simply parallel to the systems in other +countries, there would be no more need for its abandonment in case of +war than for the abandonment now by Germany of the gold standard because +England, its enemy, has the gold standard also. We know, of course, that +in time of war, the gold standard is often temporarily abandoned in +favor of a paper standard; and the new proposal would not escape such a +difficulty. This, however, would not be due to the international +character of the plan, but to the exigencies of war. + +6. "_The multiple standard is not ideal. Especially is it faulty when +the cause of price movements is entirely a matter of the abundance or +scarcity of goods in general._" Those who hold this objection point out +that an ideal standard would not be one which always smooths out the +price level but one which discriminates and leaves unchanged such rises +and falls as are due to general scarcity and abundance of goods. There +is much to be said in favor of such discrimination as an ideal. It must +be admitted that the compensated dollar plan would not discriminate +between changes in the price level due to the scarcity or abundance of +goods in general and those due to changes in money and credit. It must +be further admitted that a theoretically ideal standard would take some +account of this distinction. But the compensated dollar plan does not +claim to be ideal. The plan would simply correct the gold standard to +make it conform to a multiple commodity standard. It does not pretend to +correct the multiple commodity standard to make it conform to some +"absolute" standard of value. + +Such an ideal standard is as unattainable as is absolute space. Changes +in relative value indicate change in absolute value, either of goods or +of money; but it is not possible for us to know, except in a general +way, how much of the absolute change is in goods and how much in the +dollar. On general principles we may be assured that the absolute change +is wholly or mostly in the dollar. We economists in our measurements of +value are in much the same predicament as the astronomers. Our +economical "fixed stars" are fixed only in a relative sense. We cannot +measure the empty spaces of absolute value, but can only express values +in terms of visible goods, the general average of which is the nearest +approach to absolute invariability we can, in practice, reach. + +But if it were possible to measure absolute values to our universal +satisfaction, in terms, say, of "marginal utility," or of "disutility of +labor," or of anything else, there are no statistics by which we can +realize such a standard in practice. The only readily available +statistics by which we can correct our present standard are price +statistics from the great markets. We can, by index numbers based on +these price statistics, translate from gold into commodities, but as yet +we cannot translate from commodities into any ideal or absolute +standard. + +If I were treating of the problem of an ideal standard of value, I think +I should be inclined to agree with Professor Marshall that a standard +that represents a gradually descending scale of prices to keep pace with +the "real" cheapening improvements in industrial processes is better +than one which represents an absolute constancy of prices. But it would +be quite impracticable to discover the exact rate of fall of prices +which would correctly register the improvement going on in industry, +and, moreover, it would, I believe, be so small as not to depart much +from the mutiple standard. This I infer is also the opinion of Professor +Marshall. + +Professor Kinley makes the very interesting suggestion that we can +suppose a more ideal standard than the tabular by making our unit a +definite percentage of the national annual dividend. This appeals to me +as a rough and ready way of fixing a unit more nearly ideal than that +fixed by the tabular standard. But it would certainly not be +practicable. It would not even be quite ideal. But if Professor Kinley +will measure his standard, the compensated dollar plan will be able to +take care of it. + +In fact, if we could find a more absolute standard than the tabular +standard and could accurately measure it in statistics, precisely the +same method of compensating the dollar could be employed to keep the +dollar in tune with that standard as with the tabular standard. The only +difference would be that the guiding index would be different. The plan +for compensating the dollar does not in essence consist in selecting the +multiple or any other standard. It consists in a method of making the +monetary unit conform to any standard chosen. But there is convincing +evidence that the multiple standard is usually near enough to the ideal +for all practical purposes and infinitely nearer than the gold standard. +_While individual goods may vary greatly in absolute value, the general +mass of goods will vary comparatively little and seldom._ There may be +some absolute change in the general mass of commodities, but it must +usually be extremely small in comparison with changes in any one +commodity like gold. It is clear from the theory of chances that this +must be the case. The odds are hundreds to one that the variations in +absolute value in several hundred commodities will offset each other to +a large degree. We very seldom have world feasts or world famines. If +the corn crop is short in some places it is abundant in others. If it is +short everywhere the crop of wheat or barley or something else is +practically certain not to be. We cannot expect that everything will +usually move in one and the same direction. If there is a war in Japan, +it is not likely that there will also be a war in India. A world war or +even anything as near to a world war as the present conflict in Europe +is a most unusual thing. + +A standard composed of several hundred commodities must therefore be, in +all human probability, more stable than a standard based, as is our +present gold standard, on one commodity. Bimetallists made much of this +point when claiming that two metals joined together were steadier than +one, just as two tipsy men walk more steadily arm in arm than +separately. Still more steady is the average of a hundred commodities +just as a line of a hundred tipsy men abreast and holding each other's +arms will march even more steadily than two. This is because it is +wholly unlikely that every man in the line will lurch in the same +direction at the same instant. The lurching of some in one direction +can always be depended on to offset almost entirely the lurching of +others in the other direction. This theory of probabilities in its +application to the present rise of prices is, I believe, borne out by +the facts. + +After a careful study of all available evidence, I am convinced that the +present general rise in prices beginning in 1896, cannot be traced to +any simultaneous scarcity of goods. I refer the reader to _Why Is the +Dollar Shrinking?_ where I have given the summary of the evidence. I +think the facts are equally clear that the great fall in prices from +1873 to 1896 can not be laid, wholly at least, to the increasing +plentifulness of goods. + +Finally, even if we could measure and apply an absolute standard, it is +doubtful if, in practice, it would be of any more service in regulating +contracts, than a multiple standard. For after all, as I have tried to +show in _Appreciation and Interest_ what we want in a contract is +something that is _dependable_ rather than something that is absolutely +constant; and the multiple standard gives dependability in terms of the +ordinary staple necessities of life. If we could know that the dollar +always means a definite collection of goods, we could know that the +bondholder or the salaried man who gets a stated income of $100 a month, +would have the same command over actual goods, and such knowledge would +be of great service. This whole subject I have discussed in Chapter X of +my _Purchasing Power of Money_. + +7. "_It would be inadequate to check rapid and large changes of the +price level._" Owing to the narrow limits, _e. g._, 1 per cent. as +stated, imposed on the monthly adjustments, it is quite true that a +sudden and strong tendency of prices to rise or fall could not be +completely checked. If prices were to rise 8 per cent. per annum and the +plan permitted no more rapid shift than 6 per cent. per annum, this +would leave only 2 per cent. per annum uncorrected, or only one-fourth +the rate at which prices would rise if wholly uncorrected. But half (or +in this illustration three-quarters of) a loaf is better than no bread. +Moreover, such extreme cases are rare and when they occur there is all +the keener need for mitigation even if it be somewhat inadequate. +Ultimately, of course, after the rapid spurt has abated, the +counterpoise, in its relentless pursuit, would overtake the escaped +price level and bring it back to par. + +8. "_The correction always comes too late._" It is objected that the +plan does not make any correction until actual deviation has occurred, +and so the remedy always lags behind the disease. It is true that the +corrections follow the deviations. They could not precede them unless we +foreknew what the deviations were to be; and we could not afford to +entrust the work of guessing to government officials. In this respect, +as in others, the plan does not attain perfection; yet it is infinitely +better than the present plan, which leaves the standard haphazard. It is +also pointed out that after the correction is applied it may happen that +prices will take the opposite turn, in which case the remedy actually +aggravates the disease. But, taking the extremely fitful course of +prices since 1896 and correcting it according to the plan, month by +month, as shown in the _Quarterly Journal of Economics_ diagram, we find +that in nine cases out of ten the opposite is true. Even in the few +remaining cases the deflections were very slight and were, of course, +soon corrected immediately after the following adjustments. If the +corrections are sufficiently frequent, it is impossible not to maintain, +in general, an extremely steady adjustment. + +When steering an automobile the chauffeur can only correct the deviation +from its intended course _after_ the deviation has occurred; yet, by +making these corrections sufficiently frequent, he can keep his course +so steady that the aberrations are scarcely perceptible. There seems no +reason why the monetary automobile cannot be driven almost equally +straight. + +9. "_The plan assumes that a 1 per cent. fluctuation can be exactly +corrected by a 1 per cent. adjustment of the dollar's weight._" Owing, I +fear, to my own fault of phrasing, I have found that several people have +acquired the mistaken impression that the plan requires, to be made at +each adjustment, an increase of 1 per cent. in the weight of the dollar +for every 1 per cent. _increase_ of the index number since the last +adjustment; whereas actually the plan requires, to be made at each +adjustment, an increase of 1 per cent. in the weight of the dollar for +every 1 per cent. excess of the index _above par_ then outstanding. + +From this mistaken premise it has naturally been inferred that, in order +that the plan should work correctly, a 1 per cent. loading of the dollar +would always have to exactly correct a 1 per cent. change in the index +number, and, very properly, the critics doubted the truth of this. But +since the premise was mistaken the objection based on it disappears. + +10. "_The plan would be sure to create dissatisfaction and +quarrelling._" This fear is, I believe, wholly imaginary. There would be +some ground for it if the proposal were to adopt the old "tabular +standard" by correcting money payments through the addition to or +subtraction from the debt of a certain number of dollars. Under these +circumstances the extra dollars paid or the dollars from which the +debtors were excused would stand out definitely and would be a subject +for debate and dispute, but if the tabular standard were merged in the +actual money of the country the ordinary debtor and creditor would be as +unaware of how his interests had been affected as he is now unaware of +how his interests are affected by gold appreciation. It would still be +true that to the ordinary man "a dollar is a dollar." + +If we cannot get the ordinary man to-day really excited over the fact +that his monetary standard has affected him to the tune of some 50 per +cent. of his principal of fifteen years ago, it does not seem likely +that he could get excited because some one tells him that the index +number used in the "compensated dollar" plan robbed him of 1 or 5 per +cent. as compared with some other possible system. + +The debtor class favored in large measure bimetallism, or free silver, +as a means of helping them pay debts, while the creditor class opposed +it. But this was a question of changing the standard, not of keeping it +unchanged. If it were proposed to shorten the yardstick, undoubtedly +many who would profit in the outstanding contracts would and ought to +oppose it. But there is and can be no contest over efforts to keep the +yardstick from changing. + +11. "_It has never been tried._" True; but the proposal is, in +mechanism, almost identical with the gold exchange device introduced by +Great Britain to maintain the Indian currency at par with gold. The +system here proposed would really be to-day less of an innovation in +principle than was the Indian system when introduced and developed +between 1893 and 1900, while the evils it would correct are similar to, +but vastly greater than, the evils for which the Indian system was +devised. + +The truth is, unless I am greatly mistaken, that the last named is the +only strong objection to the plan in the minds of most of its critics; +it is the constitutional objection to any change of the _status quo_. It +is simply the temperamental opposition to anything new. As Bunty well +says in the play, "anything new is scandalous." The conservative +temperament dislikes experiment because it is experiment. Accordingly it +is not surprising that we find many of the objectors saying, "let well +enough alone," "let us 'rather bear those ills we have than fly to +others that we know not of.'" These people seldom give assent to untried +experiments; yet after the new plan has been tried and established they +invariably turn about and become its most staunch supporters. This fact +has been often illustrated in our monetary and banking system. Nothing +short of the shock of civil war was required to divert us from a state +system of banking to a national one. In spite of the intolerable evils +of the former, it was easy to find many arguments in its favor. After +the change these arguments never reappeared. The same was true of +slavery. + +But conservatism always yields gradually to pressure. Its resistance is +strong but has no resiliency. It is not like the resistance of a steel +spring (which, when pushed in one direction, will bend back), but a mass +of dough or putty which, though it resists impact strongly, yet when it +is moved stays inert and does not return. Under these circumstances, +even if progress is made an inch at a time, it seems to me worth while +to try to make it. The two steps first necessary have been taken, +namely, the perfecting of the plan and the running the gauntlet of +criticism. + +It is not impossible, judging from the many and authoritative +endorsements of the plan, that it may be pushed rapidly toward +realization. All depends on the opening up of opportunities. After the +present war, for instance, it may be that "internationalism" will come +into a new vogue and that some special opportunity will be afforded to +bring the plan with its endorsements to the serious attention of the +world's administrative officials. + + * * * * * + +[88]It must be admitted at the outset that the plan, if carried out with +iron consistency for a considerable stretch of time, would achieve the +result mainly had in view--the prevention of a long-continued and +considerable rise in prices. It might not achieve that result as +smoothly and evenly as its proposer expects; and the qualifications just +stated--that it must be carried out unflinchingly for a long +period--should be borne in mind. No one who holds to the doctrine that +the general range of prices is determined by the relation between the +quantity of commodities and the volume of the circulating medium, and +that the volume of the circulating medium in the end depends, _ceteris +paribus_, on the amount of coined money, can do otherwise than admit the +logical soundness of the scheme. He who maintains that the rise in +prices during the last fifteen years is due to the greater gold supply +must admit that a restriction of the monetary supply of gold will check +the rise. The plan proposed is in essence one for a regulation in the +monetary supply of gold. Its effects must be the same in kind as those +of a cessation of free coinage, with an apportioned limited coinage.... + +The question arises whether it would be feasible for one country alone +to adopt the plan. It would be feasible, in the same sense that it would +be feasible for all countries together to adopt it. One country alone, +carrying it out with unflinching consistency, might secure the desired +result, subject to the qualifications which have already been indicated. +But that any one country would in fact adopt it alone seems to me in the +highest degree improbable. + +Consider for a moment the mode in which the scheme would work in detail +if adopted by a single country. Though the immediate effect upon general +prices within the country would be unpredictable, the effect upon +certain kinds of prices would be certain, predictable, almost +instantaneous. Exported commodities would feel the effect at once. Their +prices are determined, to use the current expression, by the foreign +market. It would be more accurate to say that their prices are +determined by the total market, domestic as well as foreign. But it is +clear that their prices must be the same (due allowance being made for +transportation charges and the like) within the country as without. Now +the immediate effect of a seigniorage would be, as Professor Fisher +points out, a readjustment of the par of foreign exchange. The exporter +would find the par of exchange lessened, and in terms of domestic money +(compensated dollars) he would receive less than he got before. All +commodities of export would fall in price at once, or fail to rise, to +the extent of the seigniorage. Other commodities probably would be +unaffected for the moment. In the long run, no doubt, these other +commodities (we may call them domestic commodities) would also be +affected. But, to repeat, the rapidity and extent of the change in +general prices is impossible of prediction. The exporters, none the +less, would feel an immediate and unmistakable effect. Beyond question +they would be as hotly indignant with the plan as if an excise tax had +been imposed on their commodities without any possibility of their +raising the price of their products. Consider for a moment what would be +the state of mind in our cotton-exporting South. Is it to be supposed +that any set of legislators could resist the political pressure from the +various exporting sections, and carry out the scheme unflinchingly? Can +we imagine a Congressman telling his constituents that they need only +wait a while, until all money incomes and all prices had adjusted +themselves to the new conditions? that then nobody would be worse off or +better off than before? To ask this sort of question is to answer it. +The very proposal of the scheme in the halls of Congress would invite +the hot opposition of the exporting sections and industries. Its +immediate consequences for them would be seen quickly enough, and no +promise of ultimate adjustment would lessen their hostility.... + +Professor Fisher has predicted that prices will rise further. He is +disposed to believe that there will be not only a rise, but that there +will be a considerable rise. I hesitate very greatly to enter the domain +of prediction. I am inclined to believe that the rise in prices will not +cease for the next decade; but whether it will be considerable or +moderate or negligible in extent, I should not venture to say. +Predictions concerning the output from the mines are to be taken with +the greatest caution. We all recall the predictions which Suess made in +1892. The distinguished geologist believed that the prospects of an +increased production of gold were of the slightest, and that the world +must fall back on the use of both metals. How different the course of +events has been from that which he predicted! There are those who +believe that the output of gold, so far from continuing to increase, has +reached, or is approaching, its maximum. For myself, I should not be +surprised if there were a cessation in growth, and should certainly be +surprised if there were not a relaxation in the rate of growth. + +Further: it deserves to be borne in mind that the total supply of the +precious metals is now so much greater than it was twenty years ago that +the same annual increment will have much less effect on prices. This is +the familiar consequence of the durability of the precious metals.... + +Finally, a circumstance should be borne in mind which bears not only +upon the intrinsic desirability of a regulative plan, but also upon the +attitude of the general public and the consequent political and +industrial possibilities. Economists are familiar with the difference +between the phrase which they use in describing the new conditions, and +that which is current in popular discussion. The economists speak of the +"rise in prices"; the general public speaks of the "high cost of +living." The difference in phraseology is not due simply to variation of +the point of view. It results from the fact that very different +phenomena are had in mind by the two sets of persons. The economist is +thinking and reasoning about the change which has been of special +interest for him--the general rise in prices. The man on the street is +thinking about the exceptional rise in the prices of one important set +of commodities. Any one who will examine with care the index numbers of +our Bureau of Labor will see what a marked rise, much beyond that of the +general index number, has appeared in the prices of farm products, and +especially in the prices of meat. That special advance has taken place +within the last three or four years. It is precisely within this period +that general attention has been turned to rising prices. What the public +has had chiefly in mind has been the commodities of wide consumption. +This, I believe, is the main cause of labor unrest.... + +Whatever be the particular causes that have led to the high prices of +food, economists agree that these causes will operate irrespective of +any compensated dollar plan. This would simply serve, at its best, to +keep general prices where they are, leaving each particular group of +commodities subject to its own particular set of causes. If the +compensated dollar plan were to be adopted, and if the prices of food +should continue to mount, there would be disappointment for the general +public, but nothing to surprise the economist. And conversely, it is +entirely possible that the rise in the cost of living, that is, the +special rise in the prices of foodstuffs, will reach its end +irrespective of any monetary change whatever. The general rise in prices +and money incomes ... is not unwelcome to the great majority of people. +Its incidental consequences are perceived and debated chiefly by the +economists; such as the effects on the creditor class and the slowness +of so-called fixed incomes to rise correspondingly. The general public +is concerned chiefly with the conspicuous rise in the prices of +foodstuffs, which is ascribable to causes very different from those that +bring the general rise, and can be reached only by remedies very +different.... + +FOOTNOTES: + +[87] Adapted from Irving Fisher, _Objections to a Compensated Dollar +Answered_, reprint from _The American Economic Review_, Vol. IV, No. 4, +December, 1914. + +[88] F. W. Taussig, _The Plan for a Compensated Dollar_, _The Quarterly +Journal of Economics_, Vol. 27, May, 1913, pp. 401-416. + + + + +CHAPTER XIV + +MONETARY SYSTEMS OF FOREIGN COUNTRIES + + +ENGLAND[89] + +[90]The monetary unit is the _pound_, or _sovereign_, equal to $4.8665, +divided into 20 _shillings_ of 12 _pence_ each, each penny equal to 4 +_farthings_. Originally the pound was a Troy pound of silver, .925 fine. +Under the law of 1816 gold was made the standard and silver subsidiary. +The coinage of gold is free, and to avoid delay the Bank of England is +required to buy all gold and pay for the same at once at the [minimum] +rate of £3 17_s._ 9_d._ per ounce, a [maximum] charge of 1-1/2_d._ being +imposed for the accommodation. Silver is only coined on government +account and the coinage ratio is 14.29 to one. + +They have the gold _sovereign_ (containing 113.001 grains pure gold), +the unit of their currency, also _half-sovereigns_, _crowns_ (5_s._), +_double florins_, (4_s._), _half-crowns_, _florins_, _shillings_, _six_ +and _three pence_ pieces, _four pence_ (groat), _two pence_ and _penny_, +all in silver, also _penny_, _half-penny_, and _farthing_ in bronze. A +few English banks, operating under old charters, issue notes to a +limited extent, which circulate as money. Otherwise the paper currency +of England and Wales consists wholly of notes of the Bank of England.... + +Extraordinary measures were resorted to by the British government in the +early stages of the European war of 1914; with the close of the war +currency conditions will doubtless go back to normal, as described +above. + +The Government, also, under date of August 6, authorized an issue of +currency notes, in denominations of £1 and 10 shillings.... + +These notes, which were first issued to the public August 7, were +deposited with the Bank of England for account of the British +government, as the practical way of getting them into use; they were +used for various purposes, including advances to banks at 5 per cent. +per annum, up to 20 per cent. of their deposits; the volume outstanding +December 30, 1914, was £38,478,164; the amount outstanding on June 23, +1915, was £46,199,705. These notes were protected in part by securities +and by an increasingly large gold reserve, exceeding 75 per cent. in +March, 1915. + +Postal orders were made legal tender and so remained until February 4, +1915.... + + +CANADA + +In 1857 the legislature of Upper and Lower Canada formally adopted +dollars and cents as the money in which public accounts should be kept. +The Confederation in 1867 adopted the same for the Dominion, retaining, +however, the sovereign. + +In 1871 the Currency Act prescribed the same for all accounts, providing +also that the gold coins of the United States of America should be legal +tender along with British sovereigns, the latter at a rating of $4.86 +2/3. + +The silver and bronze tokens (including pieces of 50, 25, 20, 10, 5, and +1 cents) had been supplied from the London Mint, or from Birmingham on +its behalf, from 1856 to 1907. After the Confederation no more coins +were issued for the separate Provinces. The twenty-cent piece (though +still retained by Newfoundland) has not been struck for Canada since +1864. + +From January 2, 1908, the whole supply of British and Canadian coins was +undertaken by the Ottawa Mint. By the Ottawa Mint Act the Dominion +Parliament undertook the support of a branch of the Royal Mint in +Ottawa, the administration to be in the hands of the British Treasury. +This system (the same as that of the Australian Branch Mints, Sydney, +Melbourne, Perth) was preferred to the plan of an independent Dominion +Mint because that was the only way of procuring the privilege of coining +British sovereigns. + +A royal proclamation published on November 2, 1907, duly established a +branch of the Royal Mint at Ottawa, and authorized the coinage of +British sterling gold coins from dies prepared in England, such coins to +rank with those struck in London. The depositor of gold bullion has the +right to demand British sovereigns in exchange.... + +The British sovereign (or pound) is legal tender in Canada at $4.8666. +The American gold coins are also legal tender. Canadian silver coins are +925 parts fine, and have a slightly less amount of fine silver than +United States of America silver coins of similar circulating values. The +dollar, though sanctioned, has not yet been struck. + +Paper currency consists of legal-tender Dominion notes and bank-notes +issued against the credit of the banks; there were at the end of 1914, +22 banks, with 3,130 branches in the Dominion, 20 in Newfoundland and 72 +in the United States and other foreign countries.... + +On July 31, 1914, just before the war, Dominion notes were issuable +without limit, providing the amount over $30,000,000 was covered by +gold. The volume at that time was $112,821,618.53 and the gold held +amounted to $90,292,833.28. As a consequence of the war the limit beyond +which Dominion notes may not ordinarily be issued without being entirely +covered by gold was by an Act passed in August increased from +$30,000,000 to $50,000,000.... + + +BRITISH COLONIES + +The British West Indies, as also Guiana, make British gold legal tender. +United States gold also circulates freely. There are a few banks with +limited note-issuing power, and minor coins are similar to those of +England. There is a growing use of United States currency. + +British Honduras has a dollar unit, identical with that of the United +States. + +British India has ... adopted the gold [-exchange] standard and India +has for some years been largely absorbing gold; the _pound_ is the +unit--the metallic currency, mainly silver, is maintained at parity with +gold by an arbitrary valuation or rate of exchange. The principal coin +is the _rupee_, equal to $0.3244; by a fixed government rating 15 rupees +equal £1. There is a gold [-exchange] standard reserve for India, +amounting, March 13, 1915, to £25,627,393, about one-half held in India +and one-half in London; it consists of gold and investments.... Paper +money is issued only by the Government and is covered by gold, silver +largely, and securities to some extent. + +The Straits Settlements have a _dollar_ currency, divided into 100 +_cents_; the value of the dollar was fixed by the Government at 2_s._ +4_d._, on January 29, 1909, and has since been maintained at +approximately that rate, a gold [-exchange] standard reserve being +accumulated for that purpose. The system is copied after that of India. + +Hong Kong, silver standard, is the exchange point between gold and +silver countries, and hence important. The British _dollar_ of 416 +grains is the principal coin. It fluctuates in value with the value of +silver bullion. + +Australia and New Zealand have the British system of banking. There are +many banks, some with British charters, and many branches; they issue +notes covered by gold. Gold in large quantities has been produced in +these states since 1851. + +British Africa and other minor Eastern possessions have the British +system, modified in various respects. + +Egypt having recently been formally annexed by Great Britain, her +monetary system will naturally be closely identified with that of +England in the future. The English sovereign has been for many years the +gold coin of common use. + + +LATIN UNION + +The Latin Union consists of France, Italy, Belgium, Switzerland and +Greece; they are bimetallic, both gold and silver being full legal +tender, and the coinage ratio being 15-1/2 to 1; they have identical +systems, and formed a union to maintain the parity of silver and gold, +at the above ratio, by accepting each other's silver coins; while their +systems are bimetallic in law, silver is now coined only in small +denominations and on government account. The general adoption of the +gold standard by other countries has embarrassed the efforts of the +Union to preserve the parity and also the interchangeability of silver +coins between these nations. + + +FRANCE + +France has the _franc_, equal to $0.193, as the monetary unit; the +principal gold coin is the _louis_, equal to 20 francs. The paper +currency of France is issued wholly by the Bank of France, a private +corporation, privately owned, but whose chief officers are appointed by +the Government, which thereby obtains a general control of policy and +administration; the maximum amount of note-issue is fixed by law, +arbitrarily, and by occasional increase is kept well ahead of the +country's necessities; no fixed legal reserve is required, but the total +note-issue must be covered by gold, silver, securities, and commercial +paper; as a matter of fact it carries very large metallic reserves, and +since it may lawfully pay its obligations in either gold or silver, it +can always conserve its gold holdings by requiring a premium for the +same, or withhold gold payment altogether. + +It has over 400 branches and the same rate of discount obtains in all +branches on the same day; it thus regulates and controls the interest +rate throughout France, in the interest of uniformity and fairness; it +may do business with banks or individuals and has many very small loans; +its notes are a legal tender; the power to issue currency is one of its +chief elements of banking power.... + + +BELGIUM + +Belgium is bimetallic and its coins are the same as those of France and +have unlimited lawful currency; bank-notes are issued only by one bank, +privately owned; the Government receives a share of the dividends in +excess of 6 per cent., and imposes a tax upon the note-issues; demand +liabilities, including notes, must be protected by a coin reserve of +33-1/3 per cent. and the notes must be covered by cash, commercial paper +and securities. + + +ITALY + +Italy has the _lira_, equal to $0.193, and divided into 100 _centesimi_; +her coins correspond to those of France; the Bank of Italy largely, and +two other banks to a lesser extent, issue notes against their credit, +limited, however, to three times their capital, unless covered by gold; +the issue may be increased, but comes in for a tax of 1 per cent. per +annum and must be protected by a 33-1/3 per cent. reserve in coin and +foreign exchange.... + + +SWITZERLAND + +Switzerland's coinage system duplicates that of France, and her Federal +Bank is very similar to the Bank of France.... + + +GREECE + +Greece ... has for its monetary unit the _drachma_, equal to $0.193. Her +coinage follows the Latin Union agreement. Paper currency is issued both +by the Government and by banks, and both are depreciated. Greece had to +resort to emergency measures during the Balkan War, which may have an +influence upon her currency for some time. + + +SPAIN + +Spain ... has the _peseta_, equal to $0.193 United States, as her unit. +The Bank of Spain has the sole right to issue notes, which may equal +five times its capital and must be protected by a 25 per cent. coin +reserve. Gold commands a premium. Silver is coined only on Government +account.... + + +GERMANY + +Germany, gold standard, has for her currency unit the _mark_, of 100 +_pfennig_, equal to $0.238; the 5-mark piece contains the same amount of +pure silver as the 5-franc piece and two United States half-dollars.... +Silver is legal tender to the amount of 20 marks. The coins for her +colonies are varied to suit local needs. + + +AUSTRIA-HUNGARY + +Austria-Hungary, gold standard, has as its unit the _krone_, equal to +$0.2026; 20-krone and 10-krone pieces are coined in gold, also gold +ducats, worth $2.288; silver coins are of various fineness.... + + +PORTUGAL + +The Portuguese Government, by decree of May 22, 1911, adopted a new +monetary system and the coins will be placed in circulation as soon as +possible. The unit of the system, excepting for her possessions in +India, is the gold _escudo_,... equal to $1.08 American gold. The escudo +is divided into 100 equal parts called _centavos_.... Multiples are 2, +5, and 10 escudos. Divisions of the escudo are of silver, with values of +50, 20, and 10 centavos; subsidiary coins consist of bronze and nickel +pieces. Her currency is not maintained at a parity with gold. + + +NETHERLANDS + +... The unit is the _florin_ or _guilder_ of 100 cents, equal to $0.402. +The 10-florin piece is the principal gold coin; the _ryksdaalder_ (2-1/2 +florins), the florin and half-florin in silver are legal tender, as well +as all gold coins; silver is maintained at parity with gold by law; +coinage of silver is only on Government account; paper money is issued +by a central bank and 40 per cent. metallic (gold and silver) reserve is +required against deposits as well as notes; the balance of the notes are +covered by negotiable instruments. The central bank was organized in +1814. Banking in the Netherlands is excellently managed. + + +SWEDEN--NORWAY--DENMARK (SCANDINAVIAN UNION) + +These have the gold standard and have for their unit the _krone_, equal +to $0.268 United States currency; their subsidiary silver has various +fineness; paper currency of Sweden is issued by the Royal Bank, owned by +the Government; notes are legal tender and may be issued to a fixed +amount in excess of gold on hand or in foreign banks, but must at all +times have gold to the extent of at least 10,000,000 _kroner_. + +Norway has a single bank of issue, controlled by the State, which owns a +majority of the stock; notes are legal tender and may be issued to twice +the amount of gold on hand and in foreign banks. + +Denmark's paper money is issued by a privately owned bank, but under +strict control by the Government; the notes are legal tender and may be +issued to a sum 30,000,000 kroner in excess of the gold on hand. + + +RUSSIA + +Russia is on a gold basis and has for its unit the _ruble_, of 100 +_kopecks_, equal to $0.51456 in United States currency; the silver coins +in common use are the ruble, one-half and one-fourth ruble; paper money +is issued by the Imperial Bank, which is owned by the Government and +managed as part of its finance department; the law requires the coin +reserve to equal two-thirds of the note issue.... + + +JAPAN + +Japan maintains the gold standard and its unit is the _yen_, equal to +$0.498; the yen is divided into 100 _sen_, the sen into 10 _rin_. The +yen equals 11.574 grains of pure gold. + +The Bank of Japan may issue notes to the extent of $120,000,000 upon +securities, any amount upon specie, and also may issue further sums in +excess of specie, subject to a tax of 5 per cent. The stock of the bank +is all privately owned. Japan first copied the national banking system +of the United States and after trial abandoned the same for a central +bank. She has managed her finances and her banking with wonderful +ability and great success. Besides the Bank of Japan, there are many +strong private banks, notably the Yokohama Specie Bank. + + +CHINA + +China, silver basis, had for its unit the _tael_, divided into 1000 +_cash_; there are said to be sixteen different kinds of tael in the +different states of China; the most valuable is the "Haikwan," or +"_customs tael_," the one in which customs dues are reckoned, and this +equalled $0.664 United States currency, October 1, 1914. The cash is of +base metal, with a square hole punched in the centre and is worth less +than a mill in our currency. + +In the last years of the Empire a new system of coinage was established +and since continued by the Republic. The unit is the _yuan_ of silver, +worth $0.477, but varies with the price of silver; one-half, one-fifth, +and one-tenth yuan are also coined in silver and smaller coins in copper +and brass.... + + +PHILIPPINES + +The unit of value is the _peso_, equal to $0.50 in United States +currency. The fiscal affairs are administered by the United States and +the currency is safe and maintained on [essentially] a gold basis. + + +ARGENTINA + +At a time when the cultivation and development of trade relations with +South America seem most alluring, we find a principal embarrassment in +the currency and credit conditions which obtain in most South American +States, but Argentina, one of the most favored of South American States, +has a stable and sound currency system. Her unit is the _peso_, of 100 +_centavos_. The gold peso is equal to $0.9647 in United States money. In +1889 the Government took measures to acquire gold and fixed the relation +of paper to gold at 227.27 per cent., and it has since been maintained +at that level without fluctuation. This made the paper peso equal to +about $0.44 gold. They have a very large gold reserve in their _caja de +conversion_, 262,000,000 pesos gold, which protects the paper money and +gives it stability. Gold payments were suspended temporarily at the +commencement of the European war (1914), but paper money seems to have +remained at par.... + + +BRAZIL + +Brazil was formerly a colony of Portugal, and naturally copies the +parent country in her currency system. Her unit is the _milreis_, of +1000 _reis_. Nominally the gold standard prevails, but depreciated paper +is the currency of her commerce. The milreis contains 12.686 grains of +pure gold and is worth in United States currency $0.546. + +In 1898 the Government assumed the sole power to issue paper money, and +strove to bring the same to a parity with gold; the arbitrary valuation +put upon the milreis by the Government was 15_d._ or $0.30. + +On December 20, 1910, the value of a milreis was raised to 16_d._ The +Government accumulated a conversion fund, understood to be $60,000,000 +to $70,000,000, but owing to crises at home and abroad it has not yet +been able to make gold and paper notes interconvertible. + +Brazil possesses an enormous area, and is wonderfully rich in +undeveloped resources. Her coffee and rubber are especially valuable and +should take care of her international trade balances. In the near future +her currency should become stable and free from fluctuation. Brazilians +receive important service from foreign banks and bankers. + + +CHILI + +Chili has the gold standard, but her paper currency is not maintained at +a parity with gold; her unit is the _peso_, of 100 _centavos_, of the +value of 18_d._... + +FOOTNOTES: + +[89] The following table, from _The Monetary Systems of the Principal +Countries of the World_, compiled in the office of the Director of the +Mint, Washington, 1912, gives the weight, fineness, etc., of the coins +of Great Britain: + + GOLD +-----------------+-------+------------+-------+--------+--------+-------- + | | | | | Pure |Value in +Denominations. |Weight.| Fineness. | Fine | Weight.|gold or | United + | | |weight.| |silver. |States + |Grams. |Thousandths.|Grams. |Grains. |Grains. | money. +-----------------+-------+------------+-------+--------+--------+-------- +5 pounds |39.9410| 916-2/3 |36.6125|616.3720|565.0080|$24.3325 +2 pounds |15.9764| 916-2/3 |14.6450|246.5488|226.0032| 9.7330 +Sovereign | 7.9881| 916-2/3 | 7.3225|123.2744|113.0016| 4.8665 +Half sovereign | 3.9941| 916-2/3 | 3.6612| 61.6372| 56.5008| 2.4332 +-----------------+-------+------------+-------+--------+--------+-------- + SILVER +-----------------+-------+------------+-------+--------+--------+-------- +Half crown |14.1379| 925 |13.0775|218.1760|201.8119| $0.6083 +Florin |11.3103| 925 |10.4620|174.5405|161.4495| .4866 +Shilling | 5.6551| 925 | 5.2309| 87.2695| 80.7232| .2433 +Sixpence | 2.8275| 925 | 2.6154| 43.6339| 40.3008| .1216 +Fourpence (groat)| 1.8850| 925 | 1.7436| 29.0893| 26.9071| .0811 +Threepence | 1.4137| 925 | 1.3076| 21.8162| 20.1788| .0608 +Twopence | .9425| 925 | .8718| 14.5446| 13.4536| .0405 +Penny | .4712| 925 | .4358| 7.2715| 6.7252| .0202 +-----------------+-------+------------+-------+--------+--------+-------- + + +[90] A. Barton Hepburn, _A History of Currency in the United States_, +pp. 450-473. The Macmillan Company. New York. 1915. + + + + +CHAPTER XV + +THE NATURE AND FUNCTIONS OF TRUST COMPANIES + +[91]The trust company supplements the bank. Through a long process of +evolution the bank has developed as a means of facilitating the exchange +of commodities. The trust company is a still further step in the same +process, and, in a highly organized society, it meets needs which the +bank is not able to supply. + +In a new community the general store forms the centre of the business +life of the place. With growth and increasing trade, the private banker +sees room for the profitable employment of his funds. The state or +national bank meets the needs of further growth. Success and the +accumulation of wealth pave the way for the trust company. The bank is +organized primarily to serve the needs of active commercial life; the +trust company handles funds in less active circulation. + +It is customary for the courts to designate or approve certain trust +companies as depositories for funds paid into court, and the effect of +such designation or approval would be to relieve executors, trustees, or +others acting in a fiduciary capacity and depositing with these +companies from liability for loss through their failure. A person +charged with due care in the selection of a depository could not be held +to have been wanting in such care in choosing as a depository a trust +company which the court has itself approved. + +The powers of trust companies vary in different states, and when they +are created by special legislation, local companies are found with +different charter privileges. The capital and surplus of these +institutions are liable for their acts in fiduciary capacities, and in +some states they are required to deposit with one of the state +departments a fund as a special guarantee. The liability assumed is +generally accepted by the courts in lieu of the bonds which individuals +acting in similar capacities are required to give. + +The development of trust companies in the United States has been +remarkably rapid. Since 1882, when the first legal authority was given +for the exercise by corporations of fiduciary powers, they have steadily +grown in number until there are now more than fifteen hundred, +distributed as follows: + + Alabama 30 + Arizona 9 + Arkansas 38 + California 24 + Colorado 16 + Connecticut 31 + Delaware 12 + District of Columbia 5 + Florida 9 + Georgia 25 + Idaho 10 + Illinois 75 + Indiana 108 + Iowa 29 + Kansas 4 + Kentucky 42 + Louisiana 22 + Maine 39 + Maryland 21 + Massachusetts 56 + Michigan 6 + Minnesota 4 + Mississippi 19 + Missouri 49 + Montana 7 + Nebraska 13 + Nevada 1 + New Hampshire 4 + New Jersey 86 + New Mexico 10 + New York 78 + North Carolina 38 + North Dakota 5 + Ohio 60 + Oklahoma 10 + Oregon 20 + Pennsylvania 260 + Rhode Island 11 + South Carolina 17 + South Dakota 12 + Tennessee 73 + Texas 52 + Utah 9 + Vermont 26 + Virginia 19 + Washington 20 + West Virginia 22 + Wisconsin 9 + Wyoming 5 + Hawaii 5 + ---- + Total 1555 + +Their business in all departments has shown a steady increase, and the +trust companies of the United States to-day carry deposits amounting to +over $3,858,300,000. Net deposits in the 7397 national banks aggregate +$5,891,670,000. + +In some states commercial banking and trust powers are exercised by the +same companies. In such cases, separate departments are maintained for +the various classes of business. Another method is for the same +individuals to organize a national bank and a trust company, the former +under national and the latter under state laws. + +The securities company or trust company organized under state laws and +controlled by a national bank with the stock interest in the former +distributed among the owners of the stock of the bank and evidenced by +indorsement on its certificates is still another expedient which has +been resorted to in order to enable a closely affiliated and controlled +organization to exercise legitimate functions which are, however, +outside the province of a national bank. + +The earning power of trust companies has equalled and even exceeded that +of the banks, and the stock of those companies which are well +established and doing a flourishing business sells at such a premium +that investment in it at its market value gives a very low return. + +Trust company failures have been few and far between, and where they +have occurred they can be traced to a disregard of sound banking +principles and to the assumption of unwarranted risks. Even in the case +of companies which have failed there is no record of any impairment of +trust funds, whatever loss there was having been borne by the +stockholders and, to a less degree, by the depositors. This fact, the +result of the absolute separation of trust assets from assets belonging +to the company, is the strongest argument for the employment of trust +companies in fiduciary capacities, and explains their rapid growth in +popular favor. + +The literature put out by these institutions invariably recites the +advantages to be gained by dealing with them instead of with +individuals. The following is a good example of such reasoning: + + +THE ADVANTAGES OF A TRUST COMPANY AS TRUSTEE + +A trust company is preferable to individual trustees, because it +possesses every quality of desirability which the individual lacks, to +wit:-- + + (1) Its permanency: it does not die. + + (2) It does not go abroad. + + (3) It does not become insane. + + (4) It does not imperil the trust by failure or dishonesty. + + (5) Its experience and judgment in trust matters are beyond + dispute. + + (6) It never neglects its work or hands it over to + untrustworthy people. + + (7) It does not refuse to act from caprice or on the ground + of inexperience. + + (8) It is invariably on hand during business hours and can + be consulted at all times. + + (9) Its wide experience of trust business and trust + securities is invaluable to the estate. + + (10) It is absolutely confidential. + + (11) It has no sympathies or antipathies and no politics. + + (12) It can be relied upon to act up to its instructions. + + (13) It does not resign. + + (14) All new investments of value suitable for trust estates + are offered in the first instance to trust companies, and in + that way it has a choice of valuable security; and as its + purchases are on a scale of magnitude, it can usually buy at + a rate which is lower than that at which the individual + trustee can purchase. + +The most common objection to the appointment of corporate trustees is +thus stated by Augustus Peabody Loring, Esq.: + + The trust companies, which have of late years become so + numerous, to a considerable extent do away with the element + of personal risk attaching to an individual trustee; but + they lack the advantages of personal management. These + companies sometimes fail from improper management as utterly + as individuals do, and as a rule the lack of personal + management results in securing the minimum return only on + the amount invested, and lacks the great advantages often + secured by the able personal oversight of individual + trustees. + +The question, after all, comes back to the personal qualifications of +corporate officers and individuals. If the former are less capable than +the latter, the fault is with the particular company--not the system, +and if interest returns are sometimes less under corporate management, +this fact is more than equalized by the added safety to the corpus of +the estate. + +A "Trustee Company" has been suggested as a proper title for the company +doing a legitimate trust business, and is the name used in Australia and +in New Zealand. In some states the use of the word "trust" in corporate +titles is now regulated by law. Confusion has arisen in the popular mind +between the trust company and the trusts or industrial combinations. + +The usual functions of a trust company are: banking in a more or less +limited form, execution of corporate trusts, execution of individual +trusts, care of securities and valuables. In addition, other functions +are sometimes exercised, such as life, title, and fidelity insurance, +and the business of becoming surety. The earlier companies in the United +States were chartered to manage individual estates only and to act in +certain fiduciary capacities; the recent development of the trust +company has been in the direction of banking functions and corporate +trust business. + +It is worthy to note that the life insurance companies which originally +secured trust powers have, with but few exceptions, given up their life +insurance business, and that most of the fidelity insurance and surety +business is given over to companies which now make a specialty of such +risks. The fact is being recognized that the assumption of vast risks +contingent on future occurrences is not compatible with the absolute +security which is essential in the transaction of legitimate trust +business. + + +BANKING + +The banking functions of trust companies may include any or all of the +following: + +The receipt of money deposits payable on demand and subject to check, or +payable at a fixed date, or according to special agreement. Interest is +usually allowed on all deposits above a fixed maximum amount or on the +total sum. + +Money advances secured by the hypothecation of stocks, bonds, life +insurance policies, bonds and mortgages, or other personal property. + +Real estate loans, secured by bond and mortgage. It is customary to loan +not over two-thirds of the value of improved property; when the property +is unimproved, not more than half. + +Discounting paper is engaged in principally by companies transacting a +commercial banking business. The purchase of unsecured paper is +permitted in some states where discounting is not allowed. + +The purchase and sale of securities. + +Trust companies sometimes guarantee issues of bonds, or at least set +their stamp of approval upon them. + +The issue or guarantee of letters of credit, and the transaction of a +foreign exchange business. + +The care of savings deposits. For this purpose a separate department is +usually maintained. + + +CORPORATE TRUSTS + +Among the most important functions of a trust company are those relative +to the business of other corporations: + + Of late years the trust companies in the Eastern cities have + been selected as trustees instead of individuals whenever + the law of the State where the property was situated allowed + such selection. Trust companies have manifold advantages + over individuals in such a relationship; they do not die; + the large amount of financial business which they daily + transact provides them with the machinery for such purposes; + while their well-known names stand as evidence to the + purchasing public that at least the necessary formalities + have been complied with. Beyond that responsibility the + trustees of corporation mortgages usually assume none. + + In recent years the trust companies have shown a tendency, + when acting as mortgage trustees, to recognize a greater + moral responsibility than they at first were willing to + bear. Trust companies did not, of course, intend to appear + as in any way guaranteeing the bonds to which they + certified, though that seems often to have been the + erroneous opinion of the unthinking; but trustees now + acknowledge themselves bound within the limits of the + mortgage to use their influence to protect the interest of + the bondholders. A trust company which should now allow the + issue of unsecured bonds because of some glaring defect in + the language of the mortgage, would not longer be morally + excused by financial opinion, though perhaps held + technically innocent.[92] + +As trustee under corporate mortgages and trust deeds, the trust company +acts for the bondholders. It is customary for it to authenticate each +bond issued subject to the provisions of the mortgage, to represent the +bondholders in case of default, and to exercise such other functions as +may be provided in the mortgage. + +A generation ago it was customary for a railroad to name one or more +individuals as trustees of the mortgages executed to secure bond issues. +The development of trust companies and their manifest advantages over +individuals in such a capacity has resulted in their absorbing almost +all this business. Trust companies are now generally appointed as +trustees in corporation mortgages, and are also often named to succeed +individuals who have died or resigned. The appointment is one of the +most important and far reaching which the trust company can accept. Its +name and reputation serve as an assurance that the transaction is a +regular one, and entered into in good faith. Although the modern +corporation mortgage is usually explicit in its terms to the effect that +the trustee in no way guarantees the value of the security and assumes +no liability except for its own negligence, yet the intimate connection +between the trustee and the borrowing corporation in the minds of +investors makes it necessary that care be taken not to assume +trusteeships which may lead to a wrong use of the name and credit of the +trust company. + +As trustee under mortgages securing bond issues, the title to the +mortgaged property is vested in the trust company for the benefit of the +security holders. The corporation owning the mortgaged property retains +physical possession of it so long as the terms of the obligation are +complied with, except in the case of securities pledged, which are +usually lodged with the trustee. In case of default, however, it +devolves upon the trustee to protect the interests of the bondholders, +and this may necessitate the foreclosure of the mortgage and sale of the +property. + +As fiscal agent it dispenses coupon and interest payments on bond +issues, and dividends on stock. It receives sums set aside as sinking +funds to provide for the retirement of obligations at maturity, or when +bonds are subject to redemption, draws the specified amount by lot and +pays the principal. + +As registrar the trust company authenticates certificates of stock and +bonds in order to prevent an over-issue, and to reduce the chance of +loss or theft. As transfer agent, the company attends to perfecting +transfers of ownership for stock and bond issues or parts thereof. + +The New York Stock Exchange, like most other stock exchanges, in its +constitution requires that all active listed stocks must be registered. +This Exchange also requires that a trust company or other agency shall +not at the same time act as registrar and transfer agent of the same +corporation. In the popular mind, and even in the minds of some trust +company officers, the difference between the duties of the two positions +has been more or less confused. Both have been created to safeguard and +facilitate the passing of title to shares of stock, but the duties of a +transfer agent and a registrar are not synonymous; they are distinctive. +One is called upon to examine and give clear titles to property +transfers, and the other is merely to record such transfers. + +As manager of underwriting syndicates, the trust company issues the +prospectus and markets the securities of corporations which are being +launched, or of established companies which are putting out new +securities. + +In railroad and other reorganizations, the trust company takes a +prominent part, acting both as a depositary for, and as a representative +of, the committees which formulate and execute the plans of +reorganization. Its officers often have a large share in the preparation +of such plans. + +As assignee and receiver, the trust company acts in the same capacity +for corporations as for individuals and firms or partnerships, assisting +in winding up insolvent businesses and in conducting embarrassed ones. + + +INDIVIDUAL TRUSTS + +The execution of individual trusts is the function originally assumed by +trust companies. The various other forms of business which are now +engaged in, have, with the exception of life insurance, been later +developments of the trust company idea. The earliest power granted these +companies was to receive moneys or other property, real or personal, in +trust. The trust company now also acts as executor and administrator of +the estates of decedents. + +As executor appointed by the will of a decedent, it takes out letters +testamentary upon probate of the will, advertises, files inventory and +appraisement, pays debts, collects claims, makes the requisite +accounting to the probate or orphans' court, and makes distribution of +the estate in accordance with the terms of the will and the court's +decree. + +As administrator acting under appointment of the register of wills or +probate court, it performs similar duties, distributing the estate in +accordance with decedent's will if there is one, or if there is none, in +accordance with the intestate laws of the state, which specify the +order of succession and distributive shares in the case of estates of +decedents leaving no wills. There are different kinds of administrators, +in any of which capacities a trust company may be called upon to act. + +As trustee under will, the trust company carries out the provisions of +the will, investing and managing the estate or particular fund in +accordance with the directions of the testator. As such it may hold real +and personal property. + +As trustee under deed or private agreement, a contract is entered into +between the company and the owner of the property, by which the title to +the property is vested in the corporation subject to the terms recited +in the instrument. Such deeds of trust may be revocable or irrevocable. +Marriage settlements are frequently made in this way. + +The trustee's duty in investing the funds is a double one; namely, to +invest them securely so that the principal shall be preserved intact, +and to invest them as productively as possible under his powers, so that +they shall yield the best rate of interest obtainable for the benefit of +the person or persons entitled to the income. He must hold the scales +evenly, regarding scrupulously his duties to all beneficiaries. The +popular idea that security is the only consideration is erroneous, as +the trustee is equally bound to invest the funds as profitably as +possible and cannot neglect one duty more than the other. The mistaken +impression that the corporate trustee, even more than the individual, is +mindful only of the safety of the principal and entirely loses sight of +the question of income, has arisen from the restrictions as to +investments imposed by law, and frequently also by the will or trust +deed, and from the fact that the individual executor or trustee, rightly +or wrongly, sometimes assumes risks and personal liability which the +proper rules of a trust company would not permit it to assume. + +The executor or trustee is governed, as to the kinds of investments, by +the directions of the will or deed of trust. This may require the +purchase of "legal investments" only, or state that the trustee is not +to be confined to securities prescribed by law, or give specific +directions as to the classes of securities which are to be bought. The +terms of such documents are always strictly construed by the courts; if +no directions are given, the trustee is expected to buy only "legal" +securities, and when he exceeds his powers he is held responsible for +any loss. Administrators and guardians without broader powers given by +will are obliged to invest, except at their personal risk, in such +securities as are sanctioned by law or directed by the court. + +Some states prescribe by statute the securities in which a trustee may +invest. "Where there is no statute or decision of the highest court +fixing the class of securities in which a trustee may invest, he can +safely follow the rule prescribed for the investment of the funds of +savings banks." In general, city, State, and United States bonds, first +mortgages secured on improved real estate with ample margin, are among +the investments sanctioned by law. As to real estate, stocks, and first +mortgage bonds of railroad, manufacturing, and other corporations, the +practice varies in the different states. Loans on personal property, +second mortgages, and other investments subject to prior liens or of a +speculative character are excluded. All investments must possess +"intrinsic" value; the courts hold trustees liable for any losses from +speculative risks--but any gains accrue to the trust estate. + + +OTHER FUNCTIONS + +The trust company acts as guardian, curator, or committee of the +estates, and in some states, of the persons of minors, those who are +insane or mentally incompetent, spendthrifts, drunkards, and any other +persons not legally qualified to take charge of their own affairs. In +the case of a minor, the trust terminates on the ward's becoming of age; +in other cases, when the disability is removed, or in accordance with a +decree of court. These appointments are frequently made by order of +court, and to it accounting must be made. In some states the company is +styled "conservator" when caring for the estates of persons of unsound +mind. + +When acting as attorney in fact, the company obtains its authority by +virtue of a letter of attorney which usually is or can be recorded, +conveying certain definitely specified powers. This may be either to +perform a single act--such as to satisfy a mortgage--or may be broader +and continuing, granting authority to sell and transfer securities and +collect income. A general power of attorney, as the term indicates, is a +delegation to another of the general powers of the person appointing--as +to payments, collections, transfers of property, and all transactions of +a business nature. + +As agent merely, the company takes charge of property, real or personal, +for its owner, but such agency does not imply nor ordinarily include +authority to sell or convey title. Moreover, trust companies as agent +often take up lines of business which they either cannot or would not +engage in on their own account. Thus, a trust company can act as agent +for fire or life insurance companies, for water, gas, and other public +service corporations. In new communities and where it is difficult to +find responsible representatives, the trust company can often render +efficient service and secure a steady income without risk by assuming +agencies of various sorts. + +As assignee the trust company takes possession of the property assigned +for the purpose of carrying out the terms of the deed of assignment in +the interest both of the assignor and the creditors of the assignor. The +deed of assignment is an acknowledgment of an embarrassed or insolvent +condition, and the efforts of the assignee are directed to realizing as +much as possible from the assets intrusted to its management. + +As receiver, the duties may be very similar to those of assignee, +although they are usually broader in scope. The business may not be +insolvent, and the application for the appointment of a receiver may be +due to temporary difficulties only. By such an appointment the property +is preserved intact and equal treatment is afforded creditors. An able +receivership often results in the adjustment of difficulties and the +return of the property to its owners on a paying basis. While in the +case of assignee the appointment is by the individual, partnership, or +corporation executing the deed of assignment which specifies the powers +and duties of the assignee, in the case of receiver the appointment is +by a court and the company so appointed acts as an appointee or +ministerial officer of the court, and as such is directly subject to the +court's orders. + +A trust company acting as receiver is better able than an individual to +furnish additional capital, if amply secured, and thus successfully to +meet the difficulties which withdrawal of credit and restricted capital +have temporarily brought upon an otherwise prosperous business. The +courts authorize the issue of receivers' certificates to provide funds +for purchase of equipment and the proper maintenance of the property and +conduct of the business when the creditors are benefited by such +expenditures. Such certificates may be made a first lien on all assets, +taking precedence even of mortgages and other secured obligations. The +receiver thus secures the capital necessary to make the property more +productive and to secure the largest return from the business. + +As custodian or depositary, the trust company sometimes holds property +the title to which is in dispute, delivering the same when the ownership +is legally determined. + +In taking charge of escrows or conditional instruments or deeds +delivered to a third party until the condition is performed, the trust +company acts in a similar capacity, as the joint representative of both +parties. + +The trust company acts as the representative of both the living and the +dead in practically every legal relation in which an individual is +qualified to act. Its function is not only to keep intact the estate of +which it has charge, but to look to and safeguard the interest of every +beneficiary. + + +CARE OF SECURITIES AND VALUABLES + +The functions already recited have resulted in the assumption of the +duty of caring for property other than that of the estates held in the +trust department. In the safe deposit department, individual safes are +rented, bulky packages--not containing stocks or bonds--are received on +storage, certificates of deposit covering securities are issued, and +provision is made for access to, and examination of, the property so +deposited. For personal property received on storage, the charges are +either according to bulk or value. Wills are usually receipted for and +kept without charge. + + +INSURANCE + +The examination and insurance of real estate titles is a later +development often found in connection with the usual trust functions. + +Fidelity insurance and suretyship providing against loss by reason of +the dishonesty of individuals and the non-performance of obligations, +contracts, etc., have often been combined with the various forms of +trust company activity. They are, however, largely passing into the +hands of corporations especially organized for the transaction of such +business. + + +COMPENSATION + +When acting as trustee under corporation mortgages, a definite charge +may be made for accepting the trust, and a fixed amount per annum +thereafter for paying coupons and performing other duties. For the +certification of bonds it is usual to charge fifty cents per bond in the +case of large issues, and one dollar for small issues. The figures, +however, vary in different places. The charge for certifying the bonds +may be the only one, although an additional charge is usually made for +counsel fees. In case of default and consequent foreclosure of the +mortgage, extra payment is made to the trustee covering all services +incident to the foreclosure. + +For the disbursement of sinking funds, interest, or coupons, the +temporary use of the money may be considered adequate compensation, if +the amount involved is large. A commission on the sum distributed or a +fixed amount is charged when acting as fiscal agent, apart from duties +in other capacities. For acting as registrar or as transfer agent it is +usual to make a fixed charge per annum, based on the amount of labor +involved. The transfer agent is usually paid about twice as much as the +registrar. Compensation for acting as manager of an underwriting +syndicate may be a fixed sum or a commission, according to the +provisions of the underwriting agreement. For acting as depositary under +plans of reorganization, assignee, or receiver, a lump sum is usually +paid covering all services. Agency work of various sorts is paid for in +accordance with the usual practice in the business which is undertaken; +a fixed sum, or a fixed sum and a commission, or a commission only, may +be received. + +The trust company is in a position to render valuable, and often +indispensable, aid to its corporate clients. Large amounts being +involved, the great railroad and industrial corporations are willing to +pay well for such services. Corporate trust business has, consequently, +been a profitable field for the trust companies. + + +GOVERNMENT REGULATION + +An examination of the laws of the various states is interesting as +showing the attempts which are being made at regulation. Most of these +laws have been enacted within recent years and to-day there are but few +States which do not have such statutes on their books. + +The step which Massachusetts first took in requiring a legal reserve to +secure deposits has been followed by similar action in other states. In +general, the wisdom of prohibiting companies which engage in the care of +estates from assuming excessive risks is becoming better recognized. The +promotion and underwriting of commercial ventures and the assumption of +unknown risks are functions not compatible with the proper exercise of +the duties of trustee or executor. + +The supervision of trust companies by the separate states provides an +elastic system to supplement the rigidly guarded powers of the national +banks, and can adapt itself to changing conditions and enlarging needs, +leaving for solution according to the requirements of each section of +the country such questions as proper functions, reserves, and the +authority to establish branch offices. + +FOOTNOTES: + +[91] Adapted from Kirkbride and Sterrett, _The Modern Trust Company_, +pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company. +1913. + +[92] Thomas L. Greene, _Corporation Finance_, p. 59. + + + + +CHAPTER XVI + +SAVINGS BANKS + +[93]The savings bank works with those unacquainted with the ways of +business and who could not single handed take good care of their money, +or invest it safely or profitably. The bank of discount is generally +managed by business men versed in the ways of business, acquainted with +monetary affairs, and able to conduct financial operations with +intelligence. They combine their _capital_ in order to make it +effective; the savings bank combines _savings_ in order to make them +_capital_, and as such to acquire a power impossible to the scattered +savings. + +The savings bank is for the saver; its funds are invested permanently, +while the business bank opens its doors to business men and loans rather +than invests its funds, and for a short time only. The latter deals with +borrowers rather than savers, and serves for hire. The one serves best +by keeping--the other by lending. One _aims_ at profit, while the other +_never_ makes (or should make) profit an end. The savings bank is the +receiving reservoir for the little springs, the bank of discount is the +distributing reservoir for accumulated capital. + +We must get the last idea clearly in mind or we get a misconception of +the savings bank. However much the element of interest may figure in the +management, and whether we pay depositors 4 per cent. or 3 per cent., or +no interest at all, the accumulation of interest is not to be compared +in importance with the _accumulation of principal_. + +No man ever acquired riches at 4 per cent. In fact, 4 per cent. upon +small deposits is so trifling a matter that it may be ignored in +considering the greater value of the increase of capital. However +desirable the accumulation of interest may be (and this in the course +of years is considerable), the chief end and aim of the savings bank +should be the _accumulation of principal_. + + +CLASSIFICATION OF SAVINGS BANKS + +We may roughly classify savings institutions into: First, mutual +(trustee), or philanthropic; second, stock (including "savings and trust +companies"); third, co-operative, or democratic, as exemplified in the +co-operative banks of Europe. The first are usually managed by a +self-perpetuating body of trustees, who do not share the earnings; the +second are managed by the directors elected by the stockholders; the +third are managed by officials elected by the members. + +A second classification may be made into public and private +institutions; the first includes the postal and municipal banks; the +private embraces the mutual, stock, and co-operative. A third +classification may still be made into the "unit" and the chain system. +In the unit system the bank is an independent entity and has no +connection (aside from a managerial standpoint) with any other bank. The +banks of the United States are all, excepting the Postal Savings Banks +and a few branch savings banks, of this character. In the second, the +bank is but a part of a chain, as in the postal system, the municipal +banks of Germany, and the co-operative credit banks of Europe. We shall +briefly review each system. + + +TRUSTEE SAVINGS BANKS + +The _original_ savings bank is the trustee bank. As Hamilton says, "It +stands for the attempt on the part of the well-to-do to improve the +condition of the poorer classes, and involves a self-sacrificing service +on the part of a few in the interest of the many." While many of the +early savings banks partook of this character, others were organised +from purely selfish motives and were characterised by bad management and +bad faith from the start. A study of savings bank frauds will amply bear +out this statement. + +The "spirit of commercialism" hereafter spoken of has invaded the +domain of the mutual savings bank and it cannot in truth be said that +some of the newer banks were organised from any spirit of philanthropy, +although the management as a whole may be above suspicion and honorable +in the highest degree. + +But, however this may be, the mutual savings bank is a product of the +East and promises to remain so in spite of the fact that some of the +Western states have very good, if not excellent, savings bank laws. + +The distinguishing characteristic of the trustee savings bank is +_mutuality_. _All_ the earnings of the bank, less reasonable +administrative expenses and the apportionment to surplus or guaranty +fund, are divided among the depositors in the form of interest. + +One or two features of the mutual bank may be mentioned. First, the +investments of such institutions are usually carefully restricted, +looking primarily to the element of safety; and as long as the trustees +keep their funds so invested they cannot be held, either in law or +morals, responsible for losses. Second, the predominancy of the mortgage +loan. The nature of the deposits being more or less permanent, +investments of a permanent character may be made without fear of a +sudden demand for their return on the part of depositors; and to +safeguard the banks from such unexpected calls, quite generally trustee +banks are permitted by law to require notice, the usual time being +either sixty or ninety days. The third distinguishing feature is the +self-perpetuation of the board of managers. No amount of money can _buy_ +a man's way into a mutual savings bank. He cannot, as in stock concerns, +buy enough stock to _vote himself_ into office--he can only gain office +as the other men advocate his cause. And, on the contrary, he cannot be +voted _out_ of office. Only an act, such as bankruptcy (which voids his +office), can affect him, and, like a Supreme Court judge, he is +appointed during good behavior. + +The greatest weakness of the trustee bank is this: Lacking the +"essential element" that prompts men to undertake such ventures +(profit), it does not appeal to the average man of means unless he is +sentimentally inclined; and not being indispensable to trade and +commerce, like a bank of discount, it does not come to be a commercial +necessity. Even in a great State like New York we find twenty-eight +counties with no savings banks. And in many of these counties there are +large and thriving towns and cities. Thus the city of Jamestown, with +over 30,000 population, has no savings banks; while Elmira, with over +35,000 population, has but one, and that with but half a million assets. + +From the viewpoint of intensive results, as tested by the volume of +patronage accorded these institutions, a perusal of the statistics will +demonstrate that in some places the trustee bank has had a remarkable +record. For instance, in Maine, a sparsely-settled State, and largely of +a rural nature, we find one savings account to every 3 of the +population. More remarkable is Vermont, the "Green Mountain State," +where natural conditions would seem to be much more hostile to such +development, we find 30 per cent. of the population having savings bank +accounts. New Hampshire has an account for every 2-1/2 of the +population, while Massachusetts heads the list, with seventy-five out of +every hundred. New York has one to every three. + +"In seeking an explanation of this remarkable success of the trustee +system," says Hamilton, "we are reminded that New England is singularly +separate and distinct in its customs, habits and ideals from the rest of +the country. Notwithstanding the large foreign population, the dominant +type is more homogeneous and more Anglo-Saxon than it is in any other +section, and therefore fixed customs have been more rigid and +controlling. Among the ideals behind the customs and institutions must +be noted a stern, Puritanical sense of simple living, industry and +providence, and this spirit is so strong as to be well calculated to +give color and direction to the philanthropic impulse. There is also an +unusual amount of public spirit, of collective rather than a neighborly +character, as seen in the institution of the town meeting." + + +STOCK SAVINGS BANKS + +The stock savings bank, where it is a savings bank, and not a bank of +discount under a savings title, differs in no essential degree from the +mutual institution. The mutual bank belongs to the depositors; the stock +bank to the stockholders. The mutual bank pays dividends to depositors +only; the stock bank pays dividends to both stockholders and depositors. +The stock bank does not pretend to be philanthropic in its management. +It is purely a business proposition, and where the investments are of +the accepted savings bank type, it can justly claim to be on a par with +its mutual friends, provided, of course, that it measures up to the +standard in its management. + +As is implied in the term "stock," it issues capital shares and pays +dividends thereon. It has, therefore, the added protection of the +stockholder's liability, which, together with the accumulated surplus, +affords the element of strength so necessary in all financial concerns. +It usually pays the depositors a stipulated rate of interest, and the +profits beyond this belong to and are distributed to the stockholders as +dividends. The partnership idea is entirely lacking, and the depositors +get what they bargain for, while the surplus goes to those who invest, +not necessarily their savings, but their _capital_, and assume all risks +of the business. It could not in law or equity "scale down" its deposits +to make good any losses--a feature peculiar to the mutual institution. + +In this respect one thing is certain: In so far as safety is concerned, +especially in a young bank, the stock bank with the stockholders' +liability is surely superior to the mutual, unless the trustees of the +latter are of such high order and of such financial worth as to be able +and _willing_ to assume the burden of any losses that may accrue until +the surplus or guaranty fund affords ample protection. This was the +trouble in the early days of the mutual savings banks in England. + + +GUARANTY SAVINGS BANKS + +New Hampshire is the only state in which "guaranty savings banks" are +found. These are a combination of mutual and stock--a cross between the +two. They do not transact a commercial business, being strictly savings +banks in their functions, yet having "special deposits," which to all +intents and purposes are capital stock. "The guaranty savings bank +differs from the ordinary mutual savings bank in that it has capital +stock or _special deposits_, as they are called. It pays a certain +stipulated rate of interest to its _general_ depositors and _any surplus +of earnings above this dividend is available for dividends on the +capital stock or special deposits. These special deposits constitute a +guaranty fund for the general depositors, and the charter ordinarily +stipulates that the special deposits shall always equal 10 per cent. of +the deposits._" + +Such institutions are savings banks in every sense of the word, but the +strictly mutual feature is lacking in the specialising of part of the +deposits and paying a higher rate of interest on these deposits. In New +York State savings banks cannot take a "special deposit," but in New +Hampshire, in return for the higher interest rate, the special +depositors assume all the risk of loss or depreciation, and, as in the +case of stock concerns, they would be the first to suffer in the event +of insolvency. + + +MUNICIPAL SAVINGS BANKS + +This form of savings banks properly belongs to a strong class of +municipalities. They can only thrive in places where the local spirit is +strong, the local government pure, and where the local officials are +accustomed to wield a large measure of authority. Accordingly, they have +come into being and met with success in those countries where the early +history of the town made a large measure of local autonomy a necessity. +Towns of this class possess the public spirit and the intelligent +administration required for the success of such a public venture. They +also possess a fund of gratuitous public service among the citizens +which may be drawn upon when occasion requires. + +Such banks are found in Austria, France, Italy, Denmark, Sweden, and +Japan. The best examples are to be found in Germany, where they have +been in operation for a long period of years. Savings institutions exist +here at present in great variety and number, including State or Province +Savings Banks, City Savings Banks, Township Savings Banks, County +Savings Banks, _Bezirk_ (District) Savings Banks, Private Savings Banks, +and Co-operative Savings Banks. + +These banks have some 19,000,000 pass books out and their deposits +amount to 13,500,000,000 marks ($3,213,000,000). These deposits are +practically all guaranteed by the various municipalities of the Empire, +which condition forms a bulwark of confidence in the security of private +wealth and earnings that cannot be shaken by hard times, panics, bank +failures, etc. + + +PEOPLE'S BANKS + +The co-operative banks of Europe, otherwise called "People's Banks," are +essentially savings banks, in that they depend for their working capital +upon the accumulated savings of their members. The aims of these banks +are first _economic_, to enable the economically weak to make themselves +financially strong by the power of combination; second, _moral_, to +bring the members together in a unity of interests and to develop +character by making thrift and good habits the groundwork of their +operations; third, educational, to train in business methods and in the +handling of money those whose scope has been narrow and whose +experiences have been few in this regard. + +In the establishment of these banks, the cardinal rules have been: +Maximum of responsibility, minimum of risk, maximum of publicity. To +secure the maximum of responsibility, unlimited liability has been +accepted by the members in many cases; that is, each one pledging his +all for the good of all; and, second, to secure the minimum of risk, +character is made the basis of membership and good habits the prime +requisite for membership. No investments are made in speculative +enterprises, and the purposes for which the money is borrowed are +closely inquired into and due care taken that the funds shall be applied +for such purposes only. To secure the maximum of publicity the action of +the bank in all matters is given the widest publicity possible in order +that the work may have public inspection. + +The result of these simple rules has been that the poor have proven as +good, if not better, creditors than the rich; for once losing credit +they can never regain it except by the slow process of years of good +behavior. + +The great pioneers in the "People's Banks" were Raiffeisen and +Schulze-Delitzsch. They fully appreciated that any system that would +succeed must descend to the level of its beneficiaries and they have +admirably adapted the co-operative idea of banking. + + +THE LOCALIZATION OF SAVINGS BANKS IN THE UNITED STATES + +The home of the mutual savings bank is in the East, where it began +operations in 1816, and may even be said to be in the Eastern States; +for west of Buffalo and south of Baltimore, we find only 21 savings +banks of the mutual character. Out of 647 savings banks of the mutual +type found in the United States, 593 are found in New England, New York, +and New Jersey; and over one-half, or 334, are found in the two States +of New York and Massachusetts. Maine, Vermont, Connecticut and New +Hampshire have 215, the total of which accounts for all but 100 of the +mutual savings banks in this country. + +The dearth of savings banks in Pennsylvania is notable. It would seem +strange that in a state of such character, where the mutual savings bank +had its first test, and where in individual instances it has been +extremely popular and successful, the failure of such an institution has +been so pronounced; but Pennsylvania is the home of the building and +loan association (there are over 1,400 in operation), which seems in a +measure at least, to fulfill the same purpose. From a pamphlet issued by +the Dollar Savings Bank of Pittsburgh in 1905, the striking sentence is +gathered, that to-day at the end of half a century the Dollar Savings +Bank stands as the _only_ institution of its kind in Western +Pennsylvania. + +As we go south and west the banks take on a more commercial aspect, and +the savings bank as we know it in the East is a rarity, and the word +"savings" in their title is a misnomer. This is particularly true of +Iowa, where we find practically all state banks using this word, and yet +very few of them are other than banks of discount. The reason for the +large number may be in the economic conditions of that State, and also +the fact that banks may organise with as low as $10,000 in capital, +making it possible to establish a bank in even the smallest place. + +In Illinois, for instance, we find no distinctively savings banks, and +in a city like Chicago, where if the same success had attended the +savings banks as it has in New York, upwards of a billion dollars would +be on deposit, we find no strictly savings institution other than banks +of discount and trust companies operating savings departments. + +The reasons for the absence of mutual savings banks in the West and +South lie, no doubt, as Hamilton suggests, in the fact that these +sections were not settled from religious, but commercial motives; and +the "spirit of New England" being lacking, the savings bank which +requires a peculiar spirit of philanthropy, and age, as well, has not +become a factor in the development of the country. In fact, the +eleemosynary institution, such as the college, the hospital, or the +savings bank, the former requiring endowments of money to become +successful, and the latter the endowment of gratuitous management to +become possible, is last to follow in the economic development of a +community. Another reason may be in the pre-ponderance of agriculture +among the employments, which does not, until the country becomes highly +prosperous, afford much in the way of idle funds which would go into the +savings banks. The mutual savings bank is a product of the East and +promises to remain so in spite of the fact that some of the Western +states have very good, if not excellent, savings banks laws. + +The dearth of savings banks in the South is, no doubt, due to the +prostration following the Civil War, which left the country drained of +its resources; the general ignorance of banking functions, and the +improvidence of the Negro. + + +POSTAL SAVINGS BANKS + +The postal savings bank is not a bank, or a banking system, so much as +it is an adjunct of the Government; for the fundamental idea is that +through the post office the Government holds itself out as willing to +accept the savings deposits of the people, invest them in its own +securities and become absolutely responsible for the safe return of the +funds when called for, with a nominal rate of interest. All the leading +countries of the world except Germany and Switzerland now operate the +postal savings banks. While the rules may differ in the details, the +general scheme is the same, and a review in brief of the system of Great +Britain will serve to illustrate the methods of operation of such an +institution. + +The present system was established in England in 1861. The deposits, at +whatever office they may be made, can be withdrawn from any other office +which transacts a savings bank business. The accounts are kept in London +and all moneys are remitted to the headquarters, where it is handed over +to the Commissioners for the Reduction of the National Debt, who invest +the funds in public securities. + +Deposits may be made as low as one shilling or multiples thereof, and +the limit of deposits for an individual is $150 during one year or $650 +in all. Charitable societies may deposit without limit. For the benefit +of youthful depositors, who have not a shilling to deposit, cards are +issued upon which stamps are placed as purchased, and when filled +represent one shilling, and may be turned in as cash. School managers +are urged to bring this plan to the attention of the pupils, and it has +been productive of good results, over 5,000 schools having adopted this +system. The interest rate is fixed at 2-1/2 per cent. and never varies. + + +AMERICAN POSTAL SAVINGS BANKS + +ARGUMENTS FOR AND AGAINST THE ESTABLISHMENT OF POSTAL SAVINGS BANKS IN +THE UNITED STATES. + +[94]In spite of the numerous differences in the postal savings bank +system of the forty-odd countries possessing them, there are certain +fundamental features common to all. Whatever else a postal savings bank +may be, it is without exception an institution working principally +through the post offices, and its primary object is the encouragement of +thrift among the poorer classes by providing safe and convenient places +for the deposit of savings at a comparatively low rate of interest. In +the discussion of the postal savings bank proposition in this country, +no one questioned the desirability of encouraging habits of economy and +thrift on the part of the public, nor was there any question that +adequate savings bank facilities should be provided for this purpose; +the debate hinged very largely upon the question whether adequate +facilities of this character were not already provided by private +initiative. + +The advocates of a postal savings bank claimed that adequate savings +facilities were not and could not be provided by private enterprise, +because of the expense of conducting savings banks in small communities, +and also in larger communities where the people were not yet educated to +the saving habit; and they pointed particularly to the lack of savings +facilities in the southern and western states.... + +... The country is not nearly so well provided with banks receiving +savings accounts as with post offices. In the United States there are +270 square miles of territory to each bank carrying savings accounts and +50 square miles to each post office; there is a population of 8,370 to +each such bank and of 1,542 to each post office; and there are 5.4 post +offices to each bank carrying savings accounts. A comparison of the +figures for the different sections and states shows that it is in the +southern, western, and Pacific states that savings bank facilities are +most lacking.... The New England, eastern, and middle western states are +much better provided with banking facilities than are the other +sections; but even in these states post office facilities are much more +ample than savings bank facilities.... + +An objection repeatedly urged against the establishment of a postal +savings bank was that it would prove a competitor to existing banks. The +fear of such competition appears to have been the chief cause of the +opposition of most members of the banking fraternity to all postal +savings banks proposals. Senator Cummins of Iowa said in the Senate: + + The banks of the United States are opposed unanimously to + the institution of a postal savings system.... I venture the + assertion that during the nearly two years that I have been + a member of this body ... I have received the protests of + nearly every bank in my state against any such scheme, and + those protests have usually been accompanied by a very + large number of petitions, secured, I have no doubt, through + the industry and energy of the bank officers. + +It was argued that postal savings banks would have an undue advantage +over private institutions because of the great confidence in the +Government entertained by working people; and it was asserted that funds +would be withdrawn from existing banks and deposited in the postal +savings banks.... In reply, the advocates of postal savings banks +claimed that existing banks had nothing to fear from governmental +competition; that they had the advantages of an established clientele, +higher interest rates, higher limits, if any, in the amounts that could +be kept on deposit, and of the close personal and advisory relation +which so often exists between a bank and its customers. They further +argued that postal savings banks would be a help rather than a hindrance +to other banks. They would educate the people to habits of thrift and +would draw money out of hoards; and the deposits which they received +would for the most part be transferred to other banks as soon as the +limit fixed for postal savings banks deposits should be reached, or even +before, as the depositor began to appreciate the safety of other banks +and the advantage of their higher rate of interest.... + +The immediate occasion of the last active movement for a postal savings +bank system in the United States was ... the losses and inconveniences +arising from bank failures and from the suspension of cash payments in +the panic of 1907. Naturally, therefore, the demand for great safety of +savings deposits played an important part in the discussion. + +The advocates of postal savings banks cited figures showing the number +of national bank failures and the losses involved, and similar figures +for savings bank failures in certain states. They made much of the large +amounts involved and of the hardships in individual cases. On the other +hand, the opponents of the postal savings bank scheme quite generally +dealt with percentage figures rather than with absolute amounts and +showed that for recent years the average losses, in terms of percentage +of the amounts on deposit, were almost infinitesimal. + +The figures cited for bank failures, so far as they relate to savings +deposits, are so incomplete as to be of doubtful value in measuring the +extent of the losses.... + +After all, such figures give us no adequate measure for losses of this +kind. "Among the experiences of working people none is more demoralizing +and few are more cruel than loss of savings through failure of banks or +absconding of individuals intrusted with funds." To such people there is +cold comfort in the assurance that the average loss of savings bank +depositors over a long period of years is but a fraction of a mill on a +dollar. The loss is theirs: it is not distributed among all depositors. + +In urging that a postal savings bank would draw money from hoards into +circulation, the advocates of the scheme claimed also that such a bank +would keep in the United States money that would otherwise be sent +abroad by foreigners.... Much was made of the fact that every year many +millions of dollars in money orders payable to self are bought for +savings purposes.... In such cases the purchaser not only failed to +receive any interest on his savings but was required to pay the money +order fee. Many immigrants, moreover, distrust American banks, and, +being familiar with postal savings banks in their home countries and +having great confidence in government institutions, remit their savings +to these home banks. How extensively this is done we have no figures to +show.... + + +THE MAIN FEATURES OF THE SYSTEM + +[95]The Postal Savings Bank System of the United States, which began +operations January 3, 1911, by the opening of a postal savings bank in +each state, is under the control of a board of trustees, consisting of +the Postmaster-General, the Secretary of the Treasury, and the +Attorney-General. + +Depositories for the receipt of such moneys are designated by the Board. +An initial appropriation of $100,000 was made to cover the cost of +putting the law in operation, which was supplemented by another +appropriation of $500,000 in the session of 1911. + +Any person over ten years of age may deposit, but no person shall have +more than one postal savings bank account in his or her own right. Upon +making the first deposit, a _certificate of deposit_ is issued, which is +to be surrendered when paid, and cancelled; or in the event of making a +subsequent deposit is to be surrendered for one calling for a higher +amount. The lowest deposit permitted is one dollar, the limit being $100 +in a calendar month; but to provide for small deposits, a postal savings +card is issued for ten cents, to which may be attached postal savings +stamps, which when filled will be accepted in lieu of one dollar. + +The interest rate allowed is 2 per cent., credited once a year, and the +highest balance permitted is $500 to one person. Withdrawals may be made +on demand. + +The funds so received are to be deposited in national and state banks at +2-1/4 per cent. interest. Five per cent. of these deposits may be +withdrawn and kept in the Treasury of the United States as reserve. +Before becoming a depository, the bank must furnish as security +government, state, or municipal bonds, the limit of deposits being an +amount equal to the paid-up capital and one-half the surplus.... Not +over 30 per cent. of the amount of such funds may be withdrawn by the +trustees for investment in United States bonds, and it is the intent of +the act that the residue of such funds amounting to 65 per cent., shall +remain on deposit in the banks in each state and territory willing to +receive the same under the terms of the act, but may be withdrawn for +investment in bonds under the direction of the President, "when in his +judgment, the general welfare and interests of the United States so +require." Provision is also made for the conversion of savings bank +deposits into United States bonds, at the request of depositors. + + +"POSTAL SAVINGS BEHIND THE SCENES" + + Speech of Hon. Carter B. Keene, Director of the United + States Postal Savings System at the Banquet of the + Investment Bankers Association of America at Denver, + Colorado, Tuesday evening, September 21, 1915. + +_Mr. Toastmaster and Gentlemen:_ + +I appreciate very highly your invitation to speak here to-night, also +the words of commendation from your presiding officer. I have often +wondered whether the fact that I am the only director of a big savings +institution has anything to do with the ability of that institution to +pay every depositor his money on demand. (Laughter and applause.)... + +The toastmaster was wrong when he said that postal savings has nothing +to do with investment bankers. We have a great deal to do with them. +Indirectly, we are one of their best customers. More than ninety-four +million dollars in bonds are now with the Treasurer of the United States +as security for postal savings funds, and you gentlemen have largely +supplied the banks with these bonds. Sixteen million dollars are in +State and Territory bonds; city, town, and village bonds amount to +forty-six millions; county bonds nine; miscellaneous bonds ten; and +bonds of the United States Government and its dependencies thirteen.... + +Since I have been here this week I have heard billions and billions +talked about.... I can hardly comprehend what a million is. But I want +to tell you that in four and a half years the postal savings system of +the United States has become custodian of sixty-eight million dollars, +in cash, of the people's savings. Let me lay emphasis on the _cash_, +because big figures do not always mean cash. Sixty-five million dollars +of this money is on deposit in six thousand banks scattered throughout +the country. In other words, practically all of the money we have +collected has been released through the banks to channels of trade in +the very localities where it originated. I am sure you will agree with +me that this is a very creditable showing so far as dollars and cents +are concerned. + +The Federal Reserve Act, which went into effect on the 16th of November +last, provided that postal savings funds should not be deposited in +non-member banks. The Attorney General for the United States has held +that the prohibition relates to funds received on and after November +16th. Therefore, postal savings on deposit in state institutions when +the act became effective have been allowed to remain, except as it has +been necessary to withdraw it to pay depositors. + +The Post Office Department has made frequent investigations to determine +where postal savings deposits come from; with the invariable result that +they are found to come from chimney corners, mattresses, bootlegs, +etc., but until very recently no effort has been made to ascertain where +postal savings go when withdrawn. And this recent inquiry has been both +gratifying and entertaining. It was found that in a vast majority of +cases savings were withdrawn for very substantial reasons, prominent +among them being payments on homes and the launching of small business +enterprises. Occasionally a hospital bill was paid. Some depositors sent +money to the old country to bring over a parent or a brother; a wedding +trousseau here and there; and in Colorado we have record of a withdrawal +to buy an automobile. (Laughter.) + +I am glad to say that there has been a very great change in the attitude +of the banks toward postal savings in the last few years. At the outset, +many bankers thought that postal savings was an unwarranted invasion of +the domain of private enterprise and that the service would prove a +severe drain on their established business. The opposite has been the +result. The tarnished coins and soiled currency that come into our +postal depositories represent hidden savings--money that is beyond the +reach of any corporate banking institution no matter how sound it may be +or how conservatively managed. This newly discovered money has been made +available for commercial purposes in the very cities and localities from +which it was withdrawn, so instead of being a drain on corporate banking +institutions postal savings has added to the deposits of some six +thousand banks more than sixty-five millions. The bankers now freely +admit that postal savings has been a help to them, and it is no uncommon +thing for banks, especially in the mining regions of the West, to urge +the Post Office Department to extend postal savings facilities in order +that more money may be made available for local uses. + +Among our 540,000 depositors every nation on the face of the earth is +represented, also every conceivable occupation. The fisherman, the +miner, the shoemaker, the preacher, the bank teller, the butcher, the +baker, the candle-stick maker, all have accounts, but the great bulk of +our deposits come from the men and women who work with their hands for a +daily wage. + +The foreign born are our most numerous and liberal patrons. An +interesting poll of depositors has just been made by the Post Office +Department and it was found that 59 per cent. of all postal savings +depositors were born outside the United States, while the American born +comprise 41 per cent. A still more surprising fact is that the foreign +born own 72 per cent. of all the deposits. The Russians lead with +$14,000,000 to their credit, or 20.7 per cent. Then follow the Italians +with $9,650,000, or 14.2 per cent.; natives of Great Britain and her +colonies with $6,000,000, or 8.8 per cent.; the Austrians with +$5,900,000, or 8.7 per cent.; Hungarians, $2,900,000, or 4.3 per cent.; +Germans, $2,800,000, or 4.1 per cent.; Swedes, $1,500,000, or 2.2 per +cent.; and Greeks, $1,200,000, or 1.8 per cent. + +What a splendid vote of confidence on the part of our foreign-born +citizens in the good faith of the United States. And in these figures +also is a high testimonial to the industry and frugality of our newly +acquired citizens. That they should take most kindly to postal savings +is not remarkable when we consider that they were accustomed to a +similar service in their native countries.... + +Another thing that has induced foreigners to become postal savings +depositors is the disastrous experiences many of them have had with +so-called "private banks," usually operated by people of their own +tongue. It is difficult to conceive of a more heinous crime than some of +these so-called "bankers"--slick and persuasive--have committed in +alluring credulous, hard-working men and women, to entrust their humble +savings with them for the deliberate purpose of theft. I am glad to see +that prosecuting officers have recently been aroused to the "private +bank swindle" and that their promoters are getting the punishment they +deserve. + +When Europe got on fire last year, our postal savings receipts began to +increase by leaps and bounds. During the fiscal year 1915, the deposits +jumped from $43,440,000 to $65,680,000 and more than 140,000 new +accounts were opened. The war still has an influence upon postal savings +deposits, but the more immediate cause of large deposits at this time is +the remarkable revival of commercial activities. Seven cities now have +more than a million dollars on deposit, namely. New York, Brooklyn, +Chicago, Boston, Detroit, San Francisco, and Portland, Oregon. Greater +New York, including Brooklyn and several other offices in the +municipality, now have over one-fourth of all the money in the Postal +Savings System. During the past fiscal year New York City gained 200 per +cent.; Bridgeport, Connecticut, 188 per cent.; Brooklyn, New York, 167 +per cent.; Paterson, New Jersey, 162 per cent.; Jersey City, New Jersey, +122 per cent.; Detroit, Michigan, 112 per cent.; Newark, New Jersey, 100 +per cent.; Akron, Ohio, 77 per cent.; Gary, Indiana, 66 per cent.; +Pueblo, Colorado, 52 per cent. + +Now, my friends, I come to a point that I hope will make an impression +on your minds--a lasting impression--and that point is that the Postal +Savings System from the first has been seriously handicapped by +statutory restrictions on the amount that may be accepted. The law +permits the acceptance of only one hundred dollars a month and five +hundred dollars in all from a depositor. It has been shown that the +foreign born are the largest patrons of our savings service and if this +service is to reach its full measure of success we must recognize and +respect the habits of the foreigner, and one of his habits is to save +his money until he gets several hundred dollars together and then take +the entire amount to the post office, just as he did in the old country. +Because the postmaster cannot accept all that is offered, the intending +depositor very frequently goes away in resentment and disappointment +without depositing a dollar.... + +It is the testimony of postmasters from all over the country that they +are rejecting about as much money as they are taking in. The Postmaster +General last year recommended to Congress that one thousand dollars be +accepted with interest and that another thousand dollars be accepted +without interest, but for safekeeping. That was a practical and +reasonable recommendation--one which would meet all requirements in +ninety-five per cent. of the cases. Unfortunately the recommendation +failed.... The Postmaster General has indicated that he will repeat the +recommendation in his forthcoming annual report and I sincerely hope +that Congress will promptly recognize the urgent need of the +legislation. Millions of dollars, my friends, are spent every year by +uplift societies for the betterment of the foreigners. These foreigners, +these begrimed, hard-working foreigners, come to our post offices and +ask us to take their humble savings. How unfortunate that we cannot +accept what they offer, within reasonable bounds. What an effective +agency this would be in bettering in a most practical and permanent way +the conditions of the very people we want to Americanize as speedily as +possible. + +... We have five hundred and forty thousand depositors in the United +States to-day and postal savings has a new and different story for each +of them. It is not always the big things in life that change or fix our +course. Can't you remember when a few dollars or the want of a few +dollars tipped you one way or the other in some important matter. Who +can estimate the happiness and prosperity that the starting of a postal +savings account may lead to. It is a step, and an important one, in the +right direction. Some one has well said that the immigrant who opens a +postal savings account steps unconsciously on a moving platform; one +thing leads to another, and his deposit might lead him into local +investment and investment into business and into citizenship. + +There is a very interesting human-interest side to postal savings in +which every phase of good fortune and disaster is reflected. An aged +couple at Norfolk without the knowledge of each other had been carrying +$100 on their persons as a guaranty of respectable burial. They are now +postal savings depositors. Two sisters died in each other's arms in the +_Eastland_ disaster in Chicago a few weeks ago--two working girls--and +they had postal savings accounts for like amounts. Their savings went to +pay for their burial. One of Uncle Sam's bluejackets who went down on +the ill-fated submarine _F-4_ was the owner of a substantial postal +savings account. Gentlemen, the Postal Savings System means something +more than a cold array of assets and liabilities, a balance sheet. Way +off in an isolated spot in Russia a money order went not long ago to the +home of a humble peasant. That money order represented the savings of a +son who was drowned in the Susquehanna River. A few weeks back, a +thrifty Mexican girl withdrew her savings from the post office at San +Diego, California, to buy a trousseau. After the honeymoon she returned +to the office with her new husband and both opened postal savings +accounts. + +Last year Leadville, Colorado, struck a thrift note that was new in this +country, so far as I know, and reference to it is particularly timely as +Christmas is approaching. A mining company in that city struck the note +and I hope it will be heard from one end of this country to the other. +It was this: Last December an officer of the company went to the post +office and opened a postal savings account for every employee--ninety in +all--as a Christmas present. He placed to the credit of each 2 per cent. +of what he had earned during the year. These Christmas remembrances +amounted to over fifteen hundred dollars. Out of the ninety employees +only five had previously opened postal savings accounts. Now, I count +that substantial charity; I call that well-directed charity. We have +kept track of these particular deposits and the workmen who get their +start through that Christmas bounty are adding to their savings weekly +by their own personal efforts. (Applause.) + +Gentlemen, as a rule, we in official life swing back and forth in a +measured arc, and the little one can do is so small when compared with +the mass of Government activity that we feel insignificant and lost. But +I feel, my friends, that in the Postal Savings System my associates and +I are doing a positive good for humanity. I believe that we are making +people better and happier because postal savings points the way from the +sweat shop to the school--it stands for clean homes and empty alleys. +Each of you is a stockholder in the Postal Savings System and its +success is your success. Your dividends are in the better and happier +American citizenship which it encourages and promotes. (Applause.) + +FOOTNOTES: + +[93] Adapted from W. H. Kniffin, _The Savings Bank and Its Practical +Work_, pp. 54-75. The Bankers Publishing Company. New York, 1912. + +[94] E. W. Kemmerer, _The United States Postal Savings Bank_, _Political +Science Quarterly_, Vol. XXVI, No. 3, September, 1911, pp. 465-77. + +[95] W. H. Kniffin, _The Savings Bank and Its Practical Work_, pp. 75, +76. The Bankers Publishing Company, New York. 1912. + + + + +CHAPTER XVII + +DOMESTIC EXCHANGE + +[96]The banker has become the bookkeeper and settling agent of the +business world. The products of a locality, let us say the State of +Georgia, move out to the markets of the world and create credits in +favor of that locality on the books of banking institutions in the +commercial centers, while at the same time a counter movement of +commodities is under way from other localities into Georgia, in like +manner creating credits for those localities which are debits against +Georgia. The practical effect is that the commodities moving between +these communities are exchanged and pay for themselves, the running +accounts being kept and settlements effected in the banks. + +To illustrate the details: A dealer in cotton in Atlanta makes a sale to +a mill in Fall River and receives in payment a check or draft drawn on a +New York bank, which he deposits for the credit of his account in an +Atlanta bank, and which the latter forwards for the credit of its bank +account in New York. Meanwhile an Atlanta merchant has bought goods in +New York and in order to pay for them buys from the Atlanta bank an +order for the New York credit, and this when forwarded completes the +circle of payments for cotton and goods. + +If we would extend the investigation to include the bank accounts of the +Fall River mill and the Atlanta dealer we would find, first, that the +mill account was built up constantly by deposits of checks and drafts +received in payment for goods sold in all parts of the country and +perhaps all over the world, with almost no deposits of cash, and that it +was drawn down by checks for raw cotton, and supplies and large amounts +of cash for the pay-rolls; second, that the cotton dealer's account was +built up entirely by deposits of checks or drafts received for cotton +shipments and drawn down by checks and cash payments to farmers for +cotton. + +For payments at a distance bank credit in the form of a check or draft +is [commonly] used.... + +The foregoing illustrates the movement of the exchanges constantly +proceeding ... between ... different communities.... There is a network +of relationship between banks through which each local community and +market is connected with all other communities and markets.... No +locality is so remote as to be outside of the circle and no community's +sales and purchases are so scattered but that they can be brought +together in the settlements. Each bank is the center of a circle of +which it is the clearing agent; all payments between its own customers +may be made by a transfer of credit upon its books. If there are two +banks or more banks in a town, all payments between their customers are +resolved into offsets between these banks, and in like manner all +payments between localities are resolved into offsets between banks, and +if not settled in local centers are passed up to larger and larger +clearing centers.... + +But while the cross-payments of trade may be depended upon in the long +run to balance and settle themselves, it does not follow that they will +do so from day to day, or that they coincide so closely that payments in +money are never required. An individual's sales and purchases are seldom +made at the same time, and the sales and purchases of communities are +not constantly balanced. The trade of a one-crop farming district will +not be so evenly balanced as one of a district in which mixed farming +prevails, and in every industry there are periods, usually recurring +every year, when the payments exceed the current income, and +corresponding periods when income exceeds outgo.... + +A region like the cotton states, whose products move quickly to market, +may have large credit balances at one season and at another be wanting +to borrow.... + +The banker is an equalizing agency in the situation. He stands in the +breach: he must either supply the missing offsets of credit, or, as a +last resort, make the payments in money.... + +The entire system of settlements, with transfers and offsets and +advances and interchange of capital and credit, is exceedingly +interesting and wonderfully simple and effective, but depends for its +effectiveness upon a scrupulous observance of the principle upon which +it is based. That principle is the natural reciprocity of trade.... + +While there are balances from time to time in the exchanges ... between +different localities ... which cannot be settled without shipments of +money, they are usually met without inconvenience unless there is a +disturbance of credit. + + +EXCHANGE RELATIONS BETWEEN CHICAGO AND NEW YORK + +[97]... It should always be borne in mind that the fact that New York +City is the country's dominating financial market results in making New +York funds acceptable everywhere as a means of payment, and in making a +ready market for New York exchange throughout the country for a large +part of the year. + +Throughout January money in Chicago relative to that in New York City is +cheap. Exchange rates on New York are high and there is a considerable +movement of cash from Chicago to the Eastern States--particularly to New +York City.... + +Just prior to January 1 there is normally a large demand in Chicago for +New York exchange with which to meet dividend and interest payments due +in New York, and the high rates thus created continue somewhat into the +new year. The crop-moving and holiday demand, however, being over, money +becomes relatively cheap in Chicago and flows to New York City, where it +can at least earn the 2 per cent. paid by banks on bankers' balances, +and where it is absorbed somewhat in speculative activity and in the +higher security prices, which normally rule the latter part of January +and the fore part of February. + +From the last of January to the fore part of March the demand for money +in Chicago relative to that in New York rapidly rises. Exchange rates on +New York fall to a low point, and shipments of cash to the Eastern +States are very small.... + +... There is, however, no evidence of a movement of cash from the East +to Chicago in February, although there is something of a westward +movement in March. + +During this period the relative demand for money in Chicago is increased +by the anticipated opening of navigation on the Great Lakes, for the +opening of navigation gives rise to a large amount of New York exchange +received in payment of grain bills. There is also a demand on the part +of western bankers for currency to meet the spring needs of the western +farmers. The first of March in many sections of the Middle West is the +commonest time for making settlements of interest and principal on farm +mortgages. It is also a common date for paying farm rents. + +This spring advance in the value of money in Chicago as compared with +New York reaches its maximum early in March. The demand then falls off +rapidly and with only temporary interruptions (the most noteworthy being +about the first of May) until it reaches the low level of the early +summer, the latter part of May. It continues at a low level until early +in July, when the crop-moving advance begins.... + +About the first of July the relative demand for money in Chicago and +vicinity begins to increase, advancing rapidly, with minor +interruptions, until early in September, and then maintaining a high +level until the fore part of November. During this period exchange rates +rule low and money moves in large quantities from the Eastern States to +Chicago.... + +The primary cause for this increasing and large demand for money in +Chicago is of course the anticipated and actual crop-moving demand, +there being no sufficiently strong Eastern demand for money at the time +to hold it back.... + +It has been found ... that during the last six to eight weeks of the +year, after the crop-moving demand has to a large extent subsided, the +relative demand for moneyed capital in both New York City and Chicago is +maintained until the time of January settlements at nearly the high +level of the crop-moving period. A study of domestic exchange rates and +of currency shipments shows that the relative demand for money is +stronger during this period in New York City than in Chicago, that +exchange rates in Chicago on New York rise, and that cash moves +eastward.... + +Money becomes relatively cheap in Chicago and vicinity during these last +six to eight weeks of the year, principally because of the return flow +of currency previously shipped to the country districts for crop-moving +purposes. There is also considerable demand at this time for New York +exchange to meet payments in certain lines of goods, such as hardware +and dry goods, that are due New York and New England houses by Western +establishments, and to make purchases for the holiday trade.... +Comparatively high exchange rates... [near] the end of the year are +largely due to preparations for the January disbursements, which Western +concerns are called upon to make in New York City....[98] + + +EXCHANGE RELATIONS BETWEEN ST. LOUIS AND NEW YORK + +[99]... General seasonal movements in the relative demand for money in +St. Louis (as compared with New York City), ... are fairly regular in +their occurrence. + +From the beginning of the year until the fore part of May the demand +appears to be moderate, exchange rates rule near par, and there is a +moderate tendency for cash to move from St. Louis to the Eastern States, +with almost no tendency to move in the opposite direction.... + +The first eighteen weeks of the year, St. Louis bankers say, are a +period of comparative inactivity in the local money market. Concerning +this period, a prominent St. Louis banker writes: "For the first +eighteen weeks in the year... there is comparatively no New York +exchange making and also a nominal demand for it, and likewise an easy, +quiet money market."... + +The second noticeable movement in the St. Louis money market is the +sharp decline in the relative demand for money from the fore part of May +to about the first of June. Exchange on New York rises rapidly at this +time, and May is the month of heaviest shipments of cash to the East.... + +The high exchange rates in May, and the resulting eastward movement of +money, are due largely to the fact that at about this time in St. Louis +the bills of boot, shoe, hardware, and dry goods merchants mature, and +as their paper is held largely in the East, exchange is required in +large amounts. The result is large payments to St. Louis banks, the +building up of their reserves, and resulting reduction of their credit +balances in New York City. + +From the first of June to the first of November the demand for money in +St. Louis relative to that in New York City increases rapidly, advancing +from the cheapest money in the year (twenty-first week) to the dearest +money (forty-fourth week).... + +This greatly increasing relative demand for money in St. Louis is, of +course, attributable to the crop-moving requirements.... The cashier of +a St. Louis bank writes: "New York exchange... always goes to a discount +here in the fall of the year, and this is caused by the large cotton +drafts drawn in payment of cotton shipped out from the Southwest. The +banks down there either send us drafts drawn on New England points or +New York, or else they send drafts drawn on the two large cotton buyers +here, who, in turn, draw their drafts on Eastern points. The result is a +great deal of exchange comes in, for which there is a demand for +currency." The resulting low rates of exchange continue as long as the +cotton season lasts. During this crop-moving season there are heavy +shipments of cash from St. Louis to the Southern States.... + +After about the first week in November the relative demand for money in +St. Louis falls off rapidly until about the first of December, and then +fluctuates at a moderate level until the end of the year.... + +The rise in exchange and easing up of the St. Louis money market in the +latter part of November and in December is due to the decline in the +crop-moving demand for cash, particularly in the South, and the return +movement of cash from that section,... which begins the latter part of +November. Southern banks in settling their St. Louis bills first use +their eastern exchange and then ship currency. The upward movement of +exchange is hastened shortly after the first of November by heavy +purchases, for about four weeks, of New York exchange by dry goods, +hardware, and boot-and-shoe houses for the purpose of settling their +eastern accounts.... + + +DOMESTIC EXCHANGE IN SAN FRANCISCO ON NEW YORK CITY + +[100]... Before taking up the subject of seasonal variations in San +Francisco domestic exchange rates on New York City, it may be well to +observe that in a number of respects the San Francisco domestic exchange +market is a peculiar one. + +In the first place the principal kind of money in circulation is gold +coin and this fact materially influences the range of domestic exchange +fluctuations, _i. e._, the shipping points. Concerning this matter I can +do no better than quote from letters of Mr. F. L. Lipman of the Wells +Fargo Nevada National Bank. Mr. Lipman writes (under date of February 7, +1908): "In the East the medium of exchange is paper or new gold by +weight. In California it is current gold coin by tale, with a mingling +of paper and new gold. The first effect of an upward movement of +exchange, there, is that at about 40 cents per $1,000 the currency +shipping point is reached, which in due course, drains off our paper +money. At approximately $1.10 per $1,000 the gold shipping point is +reached. Of course the only gold that can be economically shipped is new +gold. Now it not infrequently happens that the demand for remittance +will be so great as to exhaust (1st) the currency and (2d) the new +gold, leaving only our current gold, for which there is practically no +shipping point, the discount on worn coin being practically +prohibitory." + +A second peculiarity of the San Francisco exchange market arises from +the fact that San Francisco, being the chief port city of the Pacific +coast and the seat of one of the United States mints and subtreasury +offices, is the recipient of large quantities of gold from +gold-producing regions, _i. e._, California, Alaska, and Australia. The +United States mint will issue without any charge its transfer drafts on +the subtreasury in New York in return for deposits of gold, the new +product of mines, or for deposits of imported gold. "Frequently," writes +Mr. Lipman, "this usage is without influence on our local market, as +when large importations of Australian gold are received for New York on +London account. At other times this practice of the Treasury has a +decided effect on our exchange market as, for instance, when the early +gold shipments come down from Alaska. These shipments command the +service of the Treasury Department to the full amount thereof, while a +portion at least of the proceeds is used in payment of local bills for +supplies to Alaska from this city. This throws on the market an +additional supply of exchange when such exchange is desired. The owners +of the gold, however, have the privilege of taking gold coin instead of +eastern exchange from the Treasury, and this alternative tends to bring +exchange to about par. The Government also influences exchange from the +other side, by its willingness to transmit money by telegraph from New +York and Chicago to this city."... + +Professor Carl C. Plehn of the University of California, suggests three +other characteristics of the San Francisco domestic exchange market, _i. +e._, (1) the close exchange relations with the Orient, (2) the fact that +in San Francisco, New York bills very frequently represent merely steps +in a general arbitrage transaction, and (3) the appreciable interest +element involved in demand transactions because of the distance between +San Francisco and New York.... + +From the beginning of January to about the first of March there is a +rapid decline in the relative demand for money in San Francisco, +resulting in the lowest level of the year during February. + +The average rate of exchange rose from 30 cents discount in the first +week to $1.05 premium in the seventh.... + +... Among the principal factors cheapening money in San Francisco at +this time and forcing up exchange may be mentioned: (1) the fact that +advances which have been made for the movement of general crops up and +down the Pacific coast are being repaid very rapidly; (2) the demand for +eastern exchange with which to pay bills incurred for holiday purchases; +and, finally (3), the latter part of February, the desire of taxpayers +to discharge eastern obligations and get movable funds out of the State +before the tax returns of the first Monday in March are made to the +assessor. + +From the fore part of March to the fore part of June the demand for +money in San Francisco relative to New York City tends to increase.... + +Among the causes at work in reducing exchange rates at this time may be +mentioned: (1) the readjustment after the heavy demands for exchange +which were made anticipatory of assessment day: (2) preparation for the +second installment of taxes which become delinquent the last Monday in +April; (3) demand for funds by the large fruit canneries with which to +buy sugar and tin in preparation for the annual fruit pack which begins +in May; (4) by May the shipping trade in green fruits has begun, giving +rise to many eastern bills; (5) demand for funds for equipping fishing +companies going on long trips.... + +From about the 1st of July to the fore part of September there is an +almost continuous increase in the relative demand for money in San +Francisco.... + +... During August and September, particularly the latter month, +substantial transfers of cash [are made] to San Francisco by the United +States subtreasury at New York. + +This decline in exchange is principally due to the large amount of +eastern credits available locally at this time from the shipment of +California products, especially green fruits, to eastern points; the +returns for such shipments being usually available in either Chicago or +New York exchange.... The California hay and grain harvests cause +considerable demand for funds by the middle of July, while the ships +returning from the fisheries in August and September require large sums +with which to pay their crews. + +From about the middle of September (thirty-fourth week) to the latter +part of October (thirty-ninth week) New York exchange tends to rule at +near par.... + +During these weeks the outward movements of grain, green fruit, and fish +tend to force exchange down, while the fact that this is the quarter of +large receipts of gold ... from Alaska, making it a period of large +receipts of gold bullion at the Mint, and that the San Francisco Mint +makes returns for this gold in gold coin or New York exchange, at the +option of the owner of the bullion, tends to keep New York exchange at +par. + +The demand for money in San Francisco relative to New York City +increases rapidly from the latter part of October to about the 1st of +December when it reaches its highest point in the year.... November and +December are the months of largest transfers of cash to San Francisco by +the United States subtreasury in New York. The fall in exchange during +this period appears to be due primarily to the outward movement of dried +fruits, such as raisins, prunes, and apricots. The banks pay out large +amounts of actual coin which goes to the country, and receive in return +drafts on eastern points which build up their eastern balances. This +also represents the most active part of the northern grain season. The +low point of the year for exchange is about the last week in November +when the tax collector for the city and county of San Francisco +withdraws large sums of actual coin from circulation and locks much of +it up in the vaults of the city hall. + +December is a month in which the relative demand for money in San +Francisco lightens considerably as the result of the rapid falling off +of the crop-moving demand.... The demand for remittances to the East for +January 1st settlements tends to force up exchange rates at the end of +the year.... + + +CURRENCY MOVEMENTS BETWEEN NEW ENGLAND AND THE EASTERN STATES + +[101]... The distance between New York City and the principal New +England cities is very small, and there is a great community of +financial interest among these cities and New York. Between New York +City and Boston the currency shipping points are only about 25 cents +premium and 25 cents discount. Single financial deals between New York +City and Boston are frequently of sufficient moment to lead to +considerable shipments of currency, although exchange rates previously +were only moderate. The relations among the clearing-house banks of +Boston and among those of other New England cities are close, so that +when one bank is in need of New York funds it is liable to obtain them +from another which may have more than it needs. For this reason, it is +said, much less money is now received from New York City and shipped +there than was the case a few years ago.... + + +THE DOMESTIC EXCHANGES DURING THE CRISIS OF 1907[102] + +There is no part of our banking machinery which has received so little +elucidation as that of the domestic exchanges. Even for normal times the +subject is obscure, and the writer therefore ventures upon an +explanation of its course during a period of crisis with hesitation, and +he is by no means confident that important considerations may not have +been overlooked. + +As in the case of foreign exchange, domestic exchange rates fluctuate +within limits fixed by the cost of shipping money, and also, in the case +of cities distant from New York, by the loss of interest while currency +is in transit. The quoted rates apply principally to business between +banks, the rates being determined by demand and supply. A Boston bank, +for example, receives from its customers New York drafts and also checks +drawn on banks in New York and its vicinity. All these items will serve +to build up its balances in that city. On the other hand, its depositors +have been sending out checks, many of which will in the course of time +reach New York and reduce its balances there. The Boston bank will also +have received from banks of New York and from banks elsewhere items for +collection in its vicinity, and remittance in ordinary course will be +made by it in New York funds. Similarly it has sent away items for +collection to banks in other cities upon which it expects a like +remittance. As a result of all these various influences the balances of +the Boston bank may either increase or decrease. If they increase it may +be ready to sell exchange to other Boston banks whose balances are +running low. It may also happen that the bank is desirous of reducing +its New York balances, and in that case it will also appear as a seller +of exchange in the market. + +Now, if in the course of a crisis clearing-house loan certificates +become the principal or sole medium of payment between banks, it may +well happen that a bank will be unwilling to sell exchange unless it is +unusually well supplied with New York funds. By the sale of exchange it +can at best only secure a favorable clearing-house balance, which will +be settled in loan certificates, and if this balance should be +unfavorable it can meet it by taking out certificates on its own +account. Each bank, therefore, to a greater extent than in normal times, +is obliged to rely upon itself for means of payment in New York. The +loan certificate does indeed yield a return or involve an expense of 6 +or 7 per cent., while the return on New York balances is only 2 per +cent. This advantage does not, however, seem to have induced the banks +to sell exchange as freely as in normal times. + +This is, however, not the only disturbing influence. The Boston bank may +have remitted to New York upon items collected by it for other +banks--let us say those of Philadelphia--but it may happen that the +Philadelphia banks delay or even discontinue remitting to New York upon +items sent to them for collection by banks of Boston and other cities. +The Boston bank can then no longer rely upon what would normally serve +to build up its own New York balances. It will be simply acquiring a +mass of unavailable credits at scattered points throughout the country. +The supply of New York exchange which it might have been willing to sell +is consequently diminished, and the premium on exchange must rise to a +point at which it will tempt some of the banks to sell exchange, even +though it intrenches upon their balances with agents which are available +for reserve. + +The premium would naturally be especially high in those cities where the +banks were most unwilling to reduce their New York balances. +Philadelphia seems a case in point, as its deposits with reserve agents, +which were $30,995,000 on August 22, were reduced to only $29,389,000 on +December 3. At that time the premium on currency in Philadelphia ranged +from $1.50 to $3 per $1,000. It is, therefore, a reasonable conclusion +that the banks were strongly disinclined to make use of their New York +balances. In a few cities it is probable that the premium reached a high +level because the banks had exhausted their New York balances. St. Louis +may be mentioned as a probable example. Being a central reserve city, +its banks would naturally have only such balances in New York as normal +business requirements made necessary. The dislocation of exchange +elsewhere or the course of payments between New York and St. Louis may +have combined to produce such a balance of payments as would have +required currency shipments if the St. Louis banks had remitted promptly +to New York. + +The extent to which banks in different cities delayed or refused to +remit to New York on items collected by them for other banks cannot be +determined. Banks in one city, very naturally and honestly, were +inclined to lay the blame upon banks elsewhere. The banks in other +places, however, may not have been able to secure payment of the items +sent to them for collection from other banks in their locality with the +usual promptness. When every allowance has been made, however, there can +be no question that banks in certain cities, in these as well as in +other matters, adopted a policy wholly designed to strengthen themselves +regardless of consequences. + +The general prevalence of the premium on New York exchange is, as we +have seen, accounted for in part by the use of clearing-house loan +certificates in settling balances between banks and by the delay in +remitting in New York funds upon items collected for other banks. It +seems probable, however, that, taking the country as a whole, the course +of payments was favorable to the New York banks. At the beginning of +November withdrawals for crop-moving purposes have in recent years begun +to diminish, except to the South, and movements of money from eastern +centers are distinctly in favor of New York at that season of the year. +If this were indeed the case in 1907, it affords still another reason +for thinking that the New York banks might have met the crisis +successfully without restricting payments. They would probably have been +obliged to meet only withdrawals arising from lack of confidence and not +real needs for crop-moving purposes, such as would have increased the +difficulties of the situation had the crisis begun at the beginning of +September. + +Finally, it should be noted that the restriction of cash payments to +depositors and the currency premium seem to have increased the demand +for New York exchange. Only in that city was it possible to buy any +considerable quantity of money. Many banks in various parts of the +country purchased gold and currency at a premium in New York and, +instead of drawing on their own balances, then entered their home market +as purchasers of exchange which was remitted in payment. + +In the few instances where exchange was below par the currency premium +was a more direct influence; but exchange could not have dropped to the +low figures recorded in 1893 in the case of Chicago [$30 discount per +$1,000], because the Chicago banks in 1907 did not maintain payments +among themselves as they had done on previous occasions. Exchange was at +a discount only in those cities where the course of payments was so +strongly against New York that practically all the banks found their +balances in that city increasing. Chicago might have been expected to +belong to this group, but its banks made extensive use of bills derived +from grain exports to secure gold which was shipped directly to them. In +general, exchange was at a discount, or at par only, in the Southern +States, the banks of which, by means of cotton sales, are normally in +position to draw money from the northeastern part of the country during +the late autumn. + +In conclusion, it should perhaps be pointed out that the quoted rates of +exchange were often without much significance. The ordinary course of +dealings was so completely disorganized in many places that the rates +were purely nominal, representing little or no actual transactions. + +FOOTNOTES: + +[96] Frank A. Vanderlip, _Modern Banking_, Three Addresses delivered at +Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. +New York. 1911 [?]. + +[97] E. W. Kemmerer, _Seasonal Variations in the Relative Demand for +Money and Capital in the United States_. Publication of the National +Monetary Commission, Senate Document No. 588, 61st Congress, _2d +Session_, pp. 96-100. + +[98] [Owing to the growth of deposit banking among the farming classes, +the increasing diversification of industry in the agricultural States, +_Sub-treasury operations_, and the offer of remunerative rates of +interest on loans in New York during the fall, the net autumnal currency +movement since 1907 has frequently been to New York. See E. M. +Patterson, _Certain Changes in New York's Position as a Financial +Center_, _Journal of Political Economy_. Vol. XXI, June, 1913, pp. +523-539.] + +[99] E. W. Kemmerer, _op. cit._, pp. 101-105. + +[100] _Ibid._, pp. 118-121. + +[101] _Ibid._, 54. 55. + +[102] O. M. W. Sprague, _History of Crises under the National Banking +System_, Publications of the National Monetary Commission, Senate +Document No. 538, 61st Congress, _2d Session_, pp. 293-297. + + + + +CHAPTER XVIII + +FOREIGN EXCHANGE + + +THE NATURE OF FOREIGN EXCHANGE + +[103]The bill, or order to pay money in a foreign centre, is the +commodity that is actually bought and sold by dealers in foreign +exchange, but it is better for the moment to leave bills out of +consideration. They are only the tangible expression of the claim for +money in another centre, and at this early stage of our inquiry it is +better to keep our minds fixed on what is at the back of the bill, +namely, the money in a foreign centre to which it gives its holder a +claim. The French buyer of a bill on London buys it, as a rule, because +by sending it to his English correspondent he can discharge a debt to +him in English money. What he really buys with his francs is so many +English pounds, and the labyrinth of the foreign exchanges is much +easier to thread if, before we complicate the question by talking about +bills, we keep our eye on the comparatively simple problem which is the +key to the puzzle, namely, the exchange of one country's money for +another's. + +Thus stripped to its naked simplicity, the problem begins to look as if +it were not a problem at all, and a critical inquirer may be excused for +thinking that at least in the case of countries that use currencies +based on the same metal, there ought to be no need for daily quotations +of rates of exchange, because the relative value of their moneys ought +to be constant. It is a natural question to ask, why should there be +these daily fluctuations, and, since they are evidently there, what is +the sense or purport of them? The answer is, that money in France and +money in England are two different things, and the relative value of two +different things is almost certain to fluctuate. Quite apart from any +differences in the fineness of gold coined by two different countries, +or the ease or difficulty with which a credit instrument can be turned +into gold, mere distance is quite enough to make the difference that +will create fluctuation in price. New York and Chicago use exactly the +same currencies, but money in New York differs from money in Chicago by +being nearly a thousand miles away, and consequently there are frequent +variations in their relative value. The English and Australian +sovereigns are identical in weight and fineness, but there is constant +fluctuation in the buying power of the English sovereign as expressed in +its brother that is circulating in the Antipodes. + +These fluctuations are based on the same influence that sways the +movements in the prices of all goods and services that are bought and +sold, that is, the influence of supply and demand. Just as the price of +boots, Consols, medical advice, football professionals, or anything else +that can be the subject of a bargain, will depend in the end upon the +number of people who want to buy them compared with that of those who +want to sell them, at or near a certain figure, so the price of English +pounds, when expressed in francs, guilders, milreis, or Australian +sovereigns, depends on the number of people abroad who have to buy money +in England as compared with the number of those who have money in +England to sell. People abroad have to buy money in England when they +owe money to Englishmen and want to pay it; and they have money in +England to sell when Englishmen owe them money. + +Jacques Bonhomme in Paris has been selling shiploads of Christmas +kickshaws to John Robinson in London, and so has thousands of English +pounds due to him by the said Robinson. But English pounds, as such, are +not wanted by M. Bonhomme. He wants to sell them, to turn them into +francs, the currency of his own country, with which he makes his daily +payments at home. On the other hand, there are always plenty of +Frenchmen who have imported English goods or have had services rendered +by English bankers, or shipowners, or insurance companies, and so want +to buy English money wherewith to pay their English creditors. So it +follows that the price that M. Bonhomme will get for his English pounds +will depend on the value of goods and services that other Frenchmen have +been selling to England, so producing English pounds to be sold in +Paris, as compared with the value of the claims that have to be met in +London, for the satisfaction of which English pounds have to be bought. +If the amount of English money on offer is bigger than the amount +wanted, down will go the price of the English pound as expressed in +francs, and the seller in francs will get less in francs for his pound. +If the amount of English money wanted is the bigger, the price will go +up, and the seller will get more for his pound. When the price goes +down, the exchange is said to move against London, because there is a +depreciation in the value of the sovereign as expressed in francs. When +it goes up the exchange moves in favour of London, because the buying +power of the sovereign is enhanced. + +The process is exactly the same, and is even more simple and easy to +understand when we take away the complication of the exchange of the +moneys of two different nations, and look at it at work between two +distant towns of the same country. If in the course of trade New York +has large payments to make in Chicago, money in Chicago will be wanted +in New York, and competition there will send up the price of it, so that +a dollar in Chicago will be worth more for the time being to New Yorkers +than a dollar in New York, and any New York bank or firm that has a +balance or a credit in Chicago will be able to dispose of it at a +premium. The extent of this premium, however, will obviously be limited +by the expense involved in sending lawful money, as the Americans call +it, from New York to Chicago. If we suppose, for the sake of simplicity, +that the cost of sending a dollar and insuring it is covered by a cent, +no one in New York will pay much more than one dollar and a cent for a +dollar in Chicago. Rather than do so he will send his dollar. He will +probably pay a small fraction more to save himself the trouble and time +involved by sending and insuring money, and this minute fraction that he +will sacrifice is the opportunity of the exchange dealer, who will send +money to Chicago, and put himself in funds there, and so be able to +supply money in Chicago to any one in New York who will pay for it at +the rate of one dollar and one cent plus any profit that the exchange +dealer can squeeze out of him. + +Viewed in this simple example the problem of exchange has few terrors. +It is merely a question of the price of money in one place, as expressed +in the same money in another, with fluctuations governed by supply and +demand and limited by the cost of sending money from place to place. +This limitation does not mean that supply and demand cease to govern the +market, but merely that at a point supply can be increased to meet any +demand by the despatch of currency. + + +"FAVOURABLE" AND "UNFAVOURABLE" EXCHANGES + +[104]The general feeling with regard to the function of the exchanges, +as giving evidence of the mercantile (or rather monetary) situation of +any country, is indicated by the usual phrase of a "favourable or +unfavourable state of the exchanges." A phrase which occurs so +frequently in all banking discussions that it cannot be passed over +without remark. It may originally have implied the erroneous theory that +the object of commerce is to attract gold, and that that country towards +which the tide of bullion sets with the greatest force is _ipso facto_ +the most prosperous. Political economists, from their point of view, are +correct in their statement that, as regards the country at large and the +interchange of commodities, exports and imports are always balanced, and +that both the words "unfavourable balance of trade" and "unfavourable +exchanges" involve fallacy. But merchants and bankers are influenced by +the feeling, that at any given moment they may be under greater +liabilities for imports than they can temporarily meet, owing to the +system of credit which disturbs the coincidence of payments for exports +and imports, though their value may actually be equal; and further, by +the anxiety as to the possibility of meeting these liabilities in that +specific mode of payment to which they are pledged, namely, in gold or +convertible notes. When, therefore, in banking treatises, it is said +that the exchanges are favourable to any particular country, it should +be understood that the intention is simply to state the fact that bills +of that country upon foreign cities are difficult of sale, whilst bills +drawn upon it from abroad are at a premium, indicating an eventual +influx of specie. So, when it is said that the exchanges are +unfavorable, a situation is described in which foreign bills are in +great demand, and when, consequently, their value seems likely to be so +enhanced as to render the export of bullion an unavoidable alternative. + + +THE ORIGIN AND SUPPLY OF FOREIGN EXCHANGE + +[105]Underlying the whole business of foreign exchange is the way in +which obligations between creditors in one country and debtors in +another have come to be settled--by having the creditor draw a draft +directly upon the debtor or upon some bank designated by him. John Smith +in London owes me money. I draw on him for 100 pounds, take the draft +around to my bank and sell it at, say, 4.86, getting for it a check for +$486.00. I have my money, and I am out of the transaction. + +The fact that the gold in a new British sovereign (or pound sterling) is +worth $4.8665 in our money by no means proves, however, that drafts +payable in pounds in London can always be bought or sold for $4.8665 per +pound. To reduce the case to a unit basis, suppose that you owed one +pound in London, and that, finding it difficult to buy a draft to send +in payment, you elected to send actual gold. The amount of gold +necessary to settle your debt would cost $4.8665, in addition to which +you would have to pay all the expenses of remitting. It would be +cheaper, therefore, to pay considerably more than $4.8665 for a +one-pound draft, and you would probably bid up until somebody consented +to sell you the draft you wanted. + +Which goes to show that the mint par is not what governs the price at +which drafts in pounds sterling can be bought, but that demand and +supply are the controlling factors. There are exporters who have been +shipping merchandise and selling foreign exchange against the shipments +all their lives who have never even heard of a mint par of exchange. +All they know is, that when exports are running large and bills in great +quantity are being offered, bankers are willing to pay them only low +rates--$4.83 or $4.84, perhaps, for the commercial bills they want to +sell for dollars. Conversely, when exports are running light and bills +drawn against shipments are scarce, bankers may be willing to pay 4.87 +or 4.88 for them. + +For a clear understanding of the mechanics of the exchange market there +is necessary a clear understanding of what the various forms of +obligations are which bring foreign exchange into existence. Practically +all bills originate from one of the following causes: + + 1. Merchandise has been shipped and the shipper draws his + draft on the buyer or on a bank abroad designated by him. + + 2. Securities have been sold abroad and the seller is + drawing on the buyer for the purchase price. + + 3. Foreign money is being loaned in this market, the + operation necessitating the drawing of drafts on the lender. + + 4. Finance-bills are being drawn, _i. e._, a banker abroad + is allowing a banker here to draw on him in pounds sterling + at 60 or 90 days' sight in order that the drawer of the + drafts may sell them (for dollars) and use the proceeds + until the drafts come due and have to be paid. + +1. Looking at these sources of supply in the order in which they are +given, it is apparent, first, that a vast amount of foreign exchange +originates from the direct export of merchandise from this country. + +Not all merchandise is drawn against; in some cases the buyer abroad +chooses rather to secure a dollar draft on some American bank and to +send that in payment. But in the vast majority of cases the regular +course is followed and the seller here draws on the buyer there. + +2. The second source of supply is in the sale abroad of stocks and +bonds. + +Origin of bills from this source is apt to exert an important influence +on rates, in that it is often sudden and often concentrated on a +comparatively short period of time. The announcement of a single big +bond issue, often, where it is an assured fact that a large part of it +will be placed abroad, is enough to seriously depress the exchange +market. Bankers know that when the shipping abroad of the bonds begins, +large amounts of bills drawn against them will be offered and that rates +will in all probability be driven down. + +3. The third great source of supply is in the draft which bankers in one +country draw upon bankers in another in the operation of making +international loans. The mechanism of such transactions will be treated +in greater detail later on, but without any knowledge of the subject +whatever, it is plain that the transfer of banking capital, say from +England to the United States, can best be effected by having the +American house draw upon the English bank which wants to lend the money. +The arranging of these loans means the continuous creation of very large +amounts of foreign exchange. + +4. Drawing of so-called "finance-bills," is the fourth source whence +foreign exchange originates. Whenever money rates become decidedly +higher in one of the great markets than in the others, bankers at that +point who have the requisite facilities and credit, arrange with bankers +in other markets to allow them (the bankers at the point where money is +high) to draw 60 or 90 days' sight bills. These bills can then be +disposed of in the exchange market, dollars being realized on them, +which can then be loaned out during the whole life of the bills. + +These are the principal sources from which foreign exchange +originates--shipments of merchandise, sales abroad of securities, +transfer of foreign banking capital to this side, sale of finance-bills. +Other causes of less importance--interest and profits on American +capital invested in Europe, for instance--are responsible for the +existence of some quantity of exchange, but the great bulk of it +originates from one of the four sources above set forth. + + +THE SOURCES OF THE DEMAND FOR FOREIGN EXCHANGE[106] + +Turning now to consideration of the various sources from which spring +the demand for foreign exchange, it appears that they can be divided +about as follows: + + 1. The need for exchange with which to pay for imports of + merchandise. + + 2. The need for exchange with which to pay for securities + (American or foreign) purchased by us in Europe. + + 3. The necessity of remitting abroad the interest and + dividends on the huge sums of foreign capital invested here, + and the money which foreigners domiciled in this country are + continually sending home. + + 4. The necessity of remitting abroad freight and insurance + money earned here by foreign companies. + + 5. Money to cover American tourists' disbursements and + expenses of wealthy Americans living abroad. + + 6. The need of exchange with which to pay off maturing + foreign short-loans and finance-bills. + +1. Payment for merchandise imported constitutes probably the most +important source of demand for foreign exchange. Practically the whole +amount of our huge importations has had to be paid for with bills of +exchange. Whether the merchandise in question is cutlery manufactured in +England or coffee grown in Brazil, the chances are it will be paid for +by a bill of exchange drawn on London or some other great European +financial centre. + +2. The second great source of demand originates out of the necessity of +making payment for securities purchased abroad. So far as the American +participation in foreign bond issues is concerned, the past few years +have seen very great developments. + +Security operations involving a demand for foreign exchange are, +however, by no means confined to American participation in foreign bond +issues. Accumulated during the course of the past half century, there is +a perfectly immense amount of American securities held all over Europe. +The greater part of this investment is in bonds and remains untouched +for years at a stretch. But then there come times when, for one reason +or another, waves of selling pass over the European holdings of +"Americans," and we are required to take back millions of dollars' worth +of our stock and bonds. Such selling movements do not really get very +far below the surface--they do not, for instance, disturb the great +blocks of American bonds in which so large a proportion of many of the +big foreign fortunes are invested. The same thing is true with stocks, +though in that case the selling movements are more frequent and less +important. + +3. So great is the foreign investment of capital in this country that +the necessity of remitting the interest and dividends alone means +another continuous demand for very large amounts of foreign exchange. +Estimates of how much European money is invested here are little better +than guesses. The only sure thing about it is that the figures run well +up into the billions and that several hundred millions of dollars' worth +of interest and dividends must be sent across the water each year. At +the interest periods at the beginning and middle of each year it becomes +apparent how large a proportion of our bonds are held in Europe and how +great is the demand for exchange with which to make the remittances of +accrued interest. At such times the incoming mails of the international +banking houses bulge with great quantities of coupons sent over here for +collection. For several weeks on either side of the two important +interest periods, the exchange market feels the stimulus of the demand +for exchange with which the proceeds of these masses of coupons are to +be sent abroad. + +4. Freights and insurance are responsible for a fourth important source +of demand for foreign exchange. A walk along William Street in New York +is all that is necessary to give a good idea of the number and +importance of the foreign companies doing business in the United States. +In some form or other all the premiums paid have to be sent to the other +side. Times come, of course, like the year of the Baltimore fire, when +losses by these foreign companies greatly outbalance premiums received, +the business they do thus resulting in the actual creation of great +amounts of foreign exchange, but in the long run--year in, year out--the +remitting abroad of the premiums earned means a steady demand for +exchange. + +With freights it is the same proposition, except that the proportion of +American shipping business done by foreign companies is much greater +than the proportion of insurance business done by foreign companies. An +estimate that the yearly freight bill amounts to $150,000,000 is +probably not too high. That means that in the course of every year there +is a demand for that amount of exchange with which to remit back what +has been earned from us. + +5. Tourists' expenditures abroad are responsible for a further heavy +demand for exchange. The sums spent by American tourists in foreign +lands annually aggregate a very large amount--possibly as much as +$175,000,000--all of which has eventually to be covered by remittances +of exchange from this side. + +Then again there must be considered the expenditures of wealthy +Americans who either live abroad entirely or else spend a large part of +their time on the other side. By these expatriates money is spent +extremely freely, their drafts on London and Paris requiring the +frequent replenishment, by remittances of exchange from this side, of +their bank balances at those points. Furthermore, there must be +considered the great amounts of American capital transferred abroad by +the marriage of wealthy American women with titled foreigners. Such +alliances mean not only the transfer of large amounts of capital _en +bloc_, but mean as well, usually, an annual remittance of a very large +sum of money. No account of the money drained out of the country in this +way is kept, of course, but it is an item which certainly runs up into +the tens of millions. + +6. Lastly, there is the demand for exchange originating from the paying +off of the short-term loans which European bankers so continuously make +in the American market. + +These loaning operations, it must be understood, both originate exchange +and create a demand for it. They were mentioned as one of the sources +from which exchange originates, and now as one of the sources from +which, during the course of every year, springs a demand for a very +great quantity of exchange. + +In a general way, it may be pointed out, the sources of demand for +exchange conform with influences which cause exchange to go up, and the +sources of supply of exchange constitute causes which make for low +rates. + +It is to be noted, however, that money rates are a great factor +influencing foreign exchange. Whenever money is cheap at any given +centre, and borrowers are bidding only low rates for its use, lenders +seek a more profitable field for the employment of their capital. + +Money rates in the New York market are not often less attractive than +those in London, so that American floating capital is not generally +employed in the English market, but it does occasionally come about that +rates become abnormally low here and that bankers send away their +balances to be loaned out at other points. Such a time was the long +period of stagnant money conditions following the 1907 panic. Trust +companies and banks who were paying interest on large deposits at that +time sent very large amounts of money to the other side and kept big +balances running with their correspondents at such points as Amsterdam, +Copenhagen, St. Petersburg, etc.--anywhere, in fact, where some little +demand for money actually existed. Demand for exchange with which to +send this money abroad was a big factor in keeping exchange rates at +their high level during all that long period. + +High money rates at some given foreign point as a factor in elevating +exchange rates on that point might almost be considered as a corollary +of low money here, but special considerations often govern such a +condition and make it worth while to note its effect. Suppose, for +instance, that at a time when money market conditions all over the world +are about normal, rates, for any given reason, begin to rise at some +point, say London. Instantly a flow of capital begins in that direction. +In New York, Paris, Berlin, and other centres it is realized that London +is bidding better rates for money than are obtainable locally, and +bankers forthwith make preparations to increase the sterling balances +they are employing in London. Exchange on that particular point being in +such demand, rates begin to rise, and continue to rise, according to the +urgency of the demand. + +The international money markets are a most decidedly complex +proposition, and there is literally never a time when several influences +tending to put exchange rates up are not conflicting with several +influences tending to put rates down. The actual movement of the rate +represents the relative strength of the two sets of influences. To be +able to "size up" the influences present and to gauge what movement of +rates they will result in, is an operation requiring, first, knowledge, +then judgment. The former qualification can perhaps be derived, in small +degree, from study of the foregoing pages. The latter is a matter of +mental calibre and experience. + + +METHODS OF FINANCING IMPORTS AND EXPORTS[107] + +The foreign trade of the United States has increased during the last +forty years about 370 per cent.... This increase ... reflected not alone +our own marvellous development, but as well the wonderful growth of +trade throughout the world. The United States stands third among the +countries of the world, its foreign trade being exceeded only by that of +the United Kingdom ... and Germany.... + +Our imports and exports[108] are being financed more and more by means +of what are known as commercial letters of credit.... An explanation of +the operation of the commercial letter of credit will ... disclose the +methods and conditions under which our imports are financed. + +The commercial letter of credit is an authorization, say of an American +bank to its London correspondent, to honor drafts for its account drawn +at various tenors by foreign shippers or others against shipments of +merchandise to this country. These credits are of two kinds, documentary +and clean. Under the documentary credit the London bank is authorized to +accept drafts for the account of the American bank only when the bill of +exchange is accompanied by certain documents described in the letter of +credit. These documents may be the bills of lading for the goods, +consular invoices, insurance certificates and possibly other papers. +Probably a large proportion of such credits requires that drafts be +drawn at sixty or ninety days' sight. So many elements of danger are +involved in financing commodities under commercial letters of credit, +even where the control of the goods is given to the bank issuing the +credit or its agents, that the financial standing of those asking for +credits must be the first consideration in their issuance. Dishonesty on +the part of the shipper, resulting in a drawing under the credit against +forged documents or against shipments of inferior merchandise, is always +possible, and the financial responsibility of the buyer of the credit is +all that stands between the banker issuing the credit and a loss in such +cases. + +In order to obtain a clear understanding of the working of a commercial +letter of credit, we will take a concrete example and follow its every +transaction. An importer of coffee (A) in New York purchases a certain +number of bags of coffee from an exporter (B) in Brazil. A agrees to +furnish B with a commercial letter of credit. B is not in position, we +will say, to await the arrival of the coffee in New York and the return +of a remittance before receiving his pay. A on the other hand is unable +to remit B for the coffee before its receipt and sale to his customers. +A goes to his banker in New York and requests him to authorize B to draw +upon the New York banker's London correspondent at ninety days' sight +with bills of lading for coffee to the amount of the purchase attached +to the draft, consular invoice and insurance certificate, if B is to +furnish insurance. If A's banker is willing to extend the credit he +writes a letter (or uses a printed form), requesting his London banker +to accept B's drafts upon presentation under the conditions already +mentioned and others of minor importance. This letter is issued in +duplicate, one copy going to the London banker, the other being +delivered to A. A then mails the copy received by him to B. B thereupon +arranges to ship the coffee, obtains the bill of lading, invoice, etc., +and takes them with the copy of the credit to his banker in Brazil. A +draft is then drawn on the London bank under the terms of the credit at +ninety days' sight and is discounted by the Brazilian banker, the +proceeds being placed to the credit of B's account or given to him in +the form of a check or cash. The Brazilian banker then forwards the +draft and documents, except such documents as the instructions may +require to be forwarded direct to New York, to his London banker. He +may secure discount of the bill at once by cable or await its arrival in +London before doing so, or he may request his London banker to have the +bill accepted and hold it for maturity. If the bill is discounted the +Brazilian banker may draw against it immediately and thus put himself in +funds to purchase other coffee bills. Upon receipt of the bill by the +London correspondent it is presented to the London banker on whom it is +drawn for acceptance. The acceptor bank examines the documents and if +they are drawn according to the terms of the credit accepts the draft +and returns it to the correspondent of the Brazilian bank, retaining the +documents, which it then forwards to the New York bank which opened the +credit. In accepting the draft the London bank has in effect agreed to +pay it at the end of ninety days, or, figuring grace, ninety-three days. +Upon maturity payment is made and the amount is charged to the account +of the issuing New York bank. Upon receipt of the documents the New York +bank delivers them to its customer under a trust receipt or against +collateral, and the latter is then in position to obtain the goods. Ten +days before the bill of exchange is due in London the New York bank +collects the amount from A, together with the commission agreed upon +when the credit was opened, and remits the amount to its London banker +to meet the draft. On all such transactions the London banker, while not +himself advancing any money, is extending a credit for which he charges +the New York bank a commission. The result is that we are paying tribute +to European bankers amounting to an immense sum annually for the purpose +of financing our imports. + +The fact that London exchange is more marketable generally throughout +the world than New York exchange is one of the principal reasons why it +is necessary for us to issue credits upon London instead of upon New +York. + +Our imports are distributed generally throughout the United States. The +importers, however, are mostly situated at the ports of entry. A very +large proportion of them obtain their credits through New York +institutions, although some of them deal direct with foreign bankers. + +Probably a smaller proportion of our exports is financed by means of +commercial letters of credit than of our imports. Different commodities +are handled in accordance with special customs which have grown up +around them, due partly to trade conditions and partly to the nature of +the products. Sellers of grain usually draw at sixty days' sight upon +the foreign buyer instead of under a bank credit. These bills, under the +customs prevailing in most foreign countries, may be rebated by the +foreign buyer whenever he desires to obtain the goods at the "bank rate" +or 1 per cent. under the bank rate, or such other rate as custom in the +country on which the drafts are drawn requires. Such drafts, with bills +of lading and such other documents as are necessary, are purchased by +American banks and are forwarded by them to their European +correspondents. The American banker is obliged to advance the money on +such paper, unless he draws his own time bills against them, until such +time as they are rebated. In the case of grain bills the average time +rebated is probably around fifty-six days, which places the American +bank in possession of demand foreign exchange, against which it can draw +in order to reimburse itself with the loss of a very few days' interest. + +Flour bills, which are financed in the same manner as grain bills, +usually run nearly to maturity before they are rebated, although the +condition of the discount market sometimes influences the purchaser, and +causes him to take the bills up more promptly. Many foreign shipments +are made under three-day sight bills, which uses the money of the +American banks making the advance from four to seven days or more, +depending upon whether the laws of the country on which the bills are +drawn allow grace or not and whether the bills are purchased with +intervening days before the sailing of steamers. Other classes of bills +are drawn at sight. This includes a portion of our lumber shipments and +miscellaneous articles. Where shipments are made on sailing vessels, +drafts are frequently drawn at four or six months' sight, and many other +transactions go through against cable payments. + +As nearly 40 per cent. of our exports consist of cotton, the method +under which it is financed is worthy of special consideration. Cotton +bills are ordinarily of two kinds: documentary payment bills and bills +drawn upon bankers. Documentary payment bills, which are drawn upon +cotton merchants or spinners at sixty or ninety days' sight or other +tenors, are handled in the same manner as flour bills. The cotton +merchant accepts the draft upon presentation and rebates it when the +goods arrive, or when he desires to obtain the cotton. A small +percentage of cotton is handled in this way. Most of the commodity is +financed by means of credits opened by the foreign buyer through his +banker. Various abuses have developed under this system, which have +caused losses running into millions of dollars to all of the various +parties engaged in carrying the transactions to their close. These +losses have only been possible because of the turning over of credits by +the foreign buyers to irresponsible concerns in America in their +endeavor to obtain cotton at lower prices than their competitors. A +foreign buyer makes arrangements with certain American concerns to cable +him offers of cotton. The American firms whose offers are accepted +receive cablegrams from the buyer advising them of the acceptance of +their offers and giving them the names of the foreign bankers on whom +the drafts in payment of the cotton are to be drawn. The American +sellers thereupon ship the cotton to the buyer under bills of lading +drawn to the shipper's order and endorsed in blank. The bills of lading +are then attached to drafts drawn upon the bankers designated by the +buyer at the given tenor, which is usually sixty or ninety days. This +exchange is then sold in the market to the highest bidder or it is +forwarded to New York to be sold in the same manner upon arrival. The +American exchange buyers have no means whatever of designating whose +bills shall be upon the market, as the sellers are all agents of the +European buyers. The American exchange houses in their need for exchange +to meet the demands of their importers have accepted the bills offered +in the market, each exchange man endeavoring to keep his "water line" on +weak names as low as possible. If the European buyers only dealt with +first-class houses only first-class bills would be offered, but when +they deal with second- or third-rate houses, or houses with no standing +whatever, such bills drawn upon prime European banks come upon the +market. + +The American exchange buyers having the cotton as collateral while the +drafts are on the water, and then having the acceptance of a prime +European bank for the sixty or ninety days following before maturity of +the draft, have accepted these risks, although unwillingly, for want of +better bills. They endeavor to protect themselves as far as possible by +trying to buy bills only of those in whose honesty they have reason to +believe, whether they have any capital back of them or not. If the +cotton were actually shipped under a bona fide order, any fluctuation in +the value of the cotton which they accepted as collateral, although +taken entirely without margin, would probably cause them neither loss +nor friction. They have run the risk, however, of having forged +documents forced upon them which did not represent goods, or exchange +that was drawn without authority. Lines which exchange buyers are +willing to take from each cotton shipper before acceptance, and before +the name of a prime European banker is added to the paper, have to be +based upon this consideration. + +The old form of the cotton bill of lading which has been signed by +freight agents or their assistants or others has been an instrument not +possible to authenticate. This was particularly dangerous, due to the +manner in which bills of lading were issued. They were formerly given +out to the shippers, who filled them in and returned them to the +railroad agent, who in turn often signed them without having any +knowledge as to whether the goods called for by the bill of lading were +in his possession or not. Under a new system bills of lading are not to +be given up until the goods are actually in possession of the railroads. +This system, which calls for validation certificates, numbered and +printed upon a specially protected water-mark paper, to be attached to +the bills of lading in such manner as to make it practically impossible +to remove them without detection, went into effect September 1, 1910, +and it is confidently hoped that it will give sufficient added safety to +the bills of lading of American railroads to satisfy the foreign +bankers. + +The very act of guaranteeing such bills is recognized by foreign bankers +as being wrong in principle, and while they are requesting that American +exchange buyers guarantee bills of lading for exports yet on the other +hand they particularly call attention to the fact that no bills of +lading which pass through their hands for imports to the United States +are guaranteed by them in any way, shape, or manner. + + +CREDIT RISKS OF DRAFTS DRAWN ON BUYERS ABROAD + +[109]Many American manufacturers do not realize the essential "credit" +element of transactions on the basis of drafts drawn on _foreign +customers_.... The exporter has received an order; he purchases the +goods covered by this order from the manufacturer, and should the +customer change his mind the exporter may suffer a loss. Or the customer +refuses to accept the goods, and the exporter may again suffer a loss. +Or the customer may accept the goods and the draft, but fail to pay, and +the exporter once more is the loser.... + +... The turning over of the bill of lading vests the property right to +the goods in the customer. The customer either pays the value of the +draft in cash ("documents against payment," abbreviated d/p) or accepts +the draft for payment at some future date, which is the more customary +course ("documents against acceptance," d/a). Even in the case of d/p +drafts, payment by the customer may be postponed; instead of paying cash +he accepts the draft at one to three months, but neither the documents +nor the goods are turned over to him. He may want to wait until he has +sold the goods, on the basis of samples, perhaps, and the goods are +warehoused until he can pay the amount of the draft into the bank or to +the forwarding agency. This is frequently done in the Far East. Here the +banks maintain so-called "godowns" for this purpose. The goods are +occasionally turned over to the customer for warehousing purposes +against the so-called "trust receipt." One important feature of +"acceptance" of the draft by the customer is the fact that it forms an +acknowledgment of indebtedness, which it is then unnecessary to prove +item by item in case of litigation. In most countries acceptances are +far simpler to collect judicially than open accounts. When an accepted +draft is unpaid it is "protested," and the debtors may be proceeded +against without further trouble. + +Frequently open accounts may be neglected by a customer who may find +himself for some reason short of immediately available funds, but to +neglect the payment of an accepted draft is regarded in the trade and by +banks as so serious a matter that the drawee would lose caste with the +banks; oversea buyers endeavor in most cases to honor accepted +drafts.... + + +ENGLAND DRAWS FEW BILLS, BUT ACCEPTS MANY--THE REASON AND THE RESULT + +[110]It has been shown that, if two countries buy of each other to the +same amount, their transactions need not give rise to two separate sets +of bills, but that on the contrary, if the foreigner draws on us to the +full value of his exports, the bills so created will be sent as +remittances to the exporter on this side and will pay him for his sales. +Conversely, if the British exporter draws, there is no necessity for the +other side to do so. + +What, then, are the facts? Does the United Kingdom, generally speaking, +draw on abroad, or does the foreigner take the initiative by drawing on +London? + +As a matter of fact, both sides draw; but, as all who are acquainted +with the customs of trade are well aware, the bills drawn by Great +Britain on abroad are vastly outnumbered by those drawn from abroad on +London. + +Owing chiefly to the magnitude of our trade, but also to several +contributory causes--such as the stability of our currency; the +certainty that a bill on London means gold and nothing but gold; the +facility with which those who deserve credit can obtain it here; our +freedom from invasion, etc.--London has become to a great extent the +settling-place of Europe and the world, and the seller, wherever he may +be, of a good bill on London can always be sure of finding a buyer and +of realizing a fair price. As the sale of a bill, moreover, carries the +valuable advantage of ready money and a speedy turnover of capital, it +is invariably preferred by the foreign exporter, who has consigned or +sold produce to us, to the alternative plan of awaiting remittances from +this side. The foreign importer, too, who has to pay for the goods he +has bought, would rather do so by remitting to London than by allowing +us to draw upon him. In the former case, the rate he has to pay depends +upon his own success in higgling; in the latter, it is fixed by a London +bill-broker, who has not the same interest in the matter. + +If the same considerations held good on this side also, our merchants +and manufacturers might perhaps object to letting the foreigner have it +all his own way; but, on the contrary, it appears to suit both buyers +and sellers very well--the former, because in the majority of cases they +would scarcely know how or where to buy suitable bills, and the latter, +because the drawing and negotiation of a foreign bill requires a certain +amount of knowledge of the exchanges, which they do not always possess, +and entails a certain amount of trouble, which they would gladly be +spared. There is also more risk of loss in drawing. In the latter case +they have only their correspondent to look to, while on a London +remittance they have the additional security of the other parties to the +bill. + +Practically speaking, therefore, the settlement of our foreign trade is +effected by means of bills of exchange which are drawn and negotiated +abroad, and are accepted and paid in London. + +To the student of the exchanges this fact is of considerable importance, +for, as the rate of exchange between two countries--the price at which +bills on the one are sold in the other--must be _fixed by the one that +draws and negotiates the bill_, it follows that the exchanges between +England and most other countries are controlled from the other side, and +that we in London have scarcely part or say in the matter. The rate of +exchange, for example, between England and the United States is fixed in +New York; between England and Brazil, in Rio; between England and +Turkey, in Constantinople; and so on. There may be exceptions, of which +the Indian exchange is the most notable, but that is the general rule, +and it is one that should be carefully borne in mind. + +The same fact also supplies a reason for the solicitude with which the +foreign trader watches the fluctuations of the exchange, and for the +utter indifference with which they are regarded by the British trader. +To the former, who intends maybe to draw a few hundred pounds on London +in a day or two against the shipment he is preparing, the difference +between selling his draft next week instead of this may mean, if the +rate should move in his favor, the gain of an additional half per cent.; +but to our home manufacturers, who sell their wares in sterling and +stipulate for payment in bills on London, the see-saw of rates is but of +academic interest. They pay attention to the _course of discount_, +because they may have to melt some of their paper before pay-day comes +round; but the course of the exchange--the question of the rate rising +or falling--hardly concerns them at all. + +It is not sought to detract from the influence of the English-drawn +foreign bill, or, as might be imagined, to explain it away altogether. +On the contrary, paper to a considerable amount is, and will continue to +be, negotiated on the Royal Exchange (though the total, if compared with +that of the paper on London negotiated abroad, would appear quite +insignificant).[111] The object in view is merely to bring into +prominence, and to impress on the reader, the essential principle that, +while the position of every rate of exchange is the outcome of the +market conditions _in the two countries combined_, the predominant mass +of the dealings take place on the other side, so that, as a consequence, +the real significance of the fluctuations can only be grasped by viewing +them from the foreign [_e. g._, American] standpoint. + + +THE RECENT RISE OF THE AMERICAN ACCEPTANCE MARKET + +[112]Probably the most important effect at this time [1915] of the +Federal Reserve Act is the establishment of the American acceptance +market. It may well be said that heretofore America has had no real +money market. The only semblance of a money market previously existing +in this country was the call loan market of New York City. That, +however, did not truly reflect money conditions in this country, as it +has more often reflected the secondary effect of some movement of the +stock market. + +The development of a real money market in this country was greatly +hampered by the lack of a standardized credit instrument. In every other +country the bank acceptance in which the element of credit risk has been +practically eliminated is the standard instrument of credit, and the +discount rate of such paper marks the level of the money market. + +Bank acceptances were not known in this country prior to the operation +of the Federal Reserve Act. For the benefit of those who may not be +familiar with bank acceptances, I will briefly describe an operation +giving rise to such acceptances. Jones, an importer of coffee in New +York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes +to his bank in New York and arranges with them to finance the deal. +Smith, the grower of the coffee in Brazil, makes the shipment to New +York and draws a ninety days' sight draft on the New York bank for the +amount of his invoice. This draft he then sells to some Brazilian +bank.... The Brazilian bank then sends the draft to New York. It is +there presented to the New York bank for acceptance. The New York bank +accepts the draft by writing the word "accepted" across the face of the +draft and affixing its official signature thereto. The draft now becomes +the primary obligation of the New York bank. Of course, Jones, for whose +account the New York bank accepted the draft, has obligated himself to +provide the New York bank with funds to meet the draft, but if he +should fail to do so the New York bank must pay the acceptance +nevertheless. It is, therefore, the direct obligation of the New York +bank, and as such it commands the best discount rates current. This +briefly is what is known as a bank acceptance, _i. e._, a draft drawn on +and accepted by a prime bank or banker. + +Although this business is still in its infancy, it has reached important +proportions and there is an active market for them in New York City. A +number of brokers have taken up the business of buying and selling +acceptances. Every morning they make the rounds of the various banks +with the list of the acceptances they have for sale and the rates at +which they are willing to sell them. Incidentally, they also learn +whether the banks have any acceptances for sale and at what rates. As +the credit risk is practically eliminated, acceptances are a very +attractive form of secondary reserve; they are, as a London banker once +expressed it, a means of enabling the banker to eat his cake and have it +too--the banker by investing his money in acceptances earns the discount +and at the same time he knows that his money is instantly available in +case of need, so that they are almost as available as cash. This +explains why the discount rate on acceptances ranges so low. Ninety +days' sight acceptances sold in New York City at one time as low as 2 +per cent. per annum and to-day prime acceptances command the excellent +rate of 2-3/8 per cent. + + +THE ECONOMIES AND ADVANTAGES OF "DOLLAR CREDITS"[113] + +Many radical changes in the mechanism of international finance have +occurred during the past fifteen months, since the beginning of the +European war. Not the least important among these changes, viewed from +the standpoint of the American importer, is the evolution in the methods +of financing our importations. + +Our imports in the way of commodities such as hides, coffee, rubber, +wool, etc., etc., run into hundreds of millions of dollars annually, and +these are financed generally through the medium of commercial credits +established by the purchaser in favor of the vendor of the merchandise. +Commercial credits, so called, are in effect a bank guarantee to the +seller that his drafts covering certain merchandise, when drawn in +accordance with the conditions prescribed in the credit, will meet with +due honor on presentation to the accepting bank named in the credit +instrument. + +In order merely to gain an idea as to the importance and volume of such +transactions, it is only necessary to glance at the totals of a few of +our principal imports. In the year 1914 we imported, among other +commodities, the following: + + Hides and skins $120,289,781.00 + Coffee 110,725,392.00 + Rubber 131,995,742.00 + Wool (unmanufactured) 53,190,767.00 + +Prior to the outbreak of the war in Europe, it is safe to assume that +fully 95 per cent. of the credits issued to cover these importations +were passed through London in the form of sterling credits; that is to +say, credits available by drafts drawn in pounds sterling on London. +Requests for the issuance of credits available by drafts drawn in United +States dollars on New York were extremely rare, and they were issued +only in exceptional cases. + +Conditions have changed materially in this respect. The Federal Reserve +Act grants to national banks the privilege of accepting drafts or bills +of exchange growing out of transactions involving the importation or +exportation of goods. This acceptance privilege was accorded to national +banks only a short time before the commencement of hostilities abroad, +and this fact in conjunction with the resulting dislocation in the +delicate machinery of international credit brought about by the war, +together with the coincidental establishment of American branch banks in +South America, has contributed in a large measure to bring about the use +of what is known now as "Dollar Credits." + +As a factor in creating the existing demand for Dollar Credits, the +establishment of American branch banks abroad cannot be emphasized too +strongly. Through these branch banks, a new and adequate medium for the +liquidation of transactions as between the United States and certain +South American countries, especially the Argentine, Brazil, and Uruguay, +has been placed at the disposal of our merchants. A direct channel is +now open to the ebb and flow of credit transfer between the United +States and the countries mentioned, and, as a natural sequence, the +former disparity existing against the dollar, as compared with pounds +sterling and the principal continental exchanges, has disappeared. The +resulting equalization in the rates of exchange benefits the American +merchant to the extent of relieving him of the tribute formerly paid to +the indirect channels of liquidation, or, in other words, to the foreign +banker. + +The Dollar Credit is of capital importance to every American merchant +who is interested either directly or indirectly in the importation of +commodities of any character. A study of the advantages accruing from +this form of credit will demonstrate the desirability of its general +employment as the vehicle for financing not only our own imports but +also those of other countries. Primarily, it is more economical than the +Sterling or Continental Credit, for the initial commission cost of +issuance is lower. Secondly, it is based on a known quantity, the +dollar, a factor of supreme importance in these days of extreme and +violent fluctuations in the exchange rates, and therefore all exchange +risk is eliminated from the operation as far as the importer is +concerned. Maturities drawn under Dollar Credits are due and payable in +dollars on a given date, and no question arises as to what the exchange +rate on London may be ninety days after acceptance of the bill. + +Under existing conditions in the New York money market, and considering +the present low rates of interest actually in effect, the use of Dollar +Credits is proving to be particularly attractive to the American +importer as the medium for financing his importations. The rate of +discount in New York for prime bank acceptances is 2-1/8@2-1/4 per cent. +per annum, and a broad, well-developed discount market now exists, with +an ever-increasing demand in evidence for this class of paper. On the +other hand, the rate of discount in London for prime ninety-day bills +is 4-3/4 per cent. per annum, with operations restricted in a far from +normal market. A comparison of these two discount rates will show a +difference in favor of New York of 2-1/2@2-5/8 per cent. per annum. In +addition to this difference in interest, there is also a difference in +the initial cost in the form of commission for issuance, as between +credits available by ninety-day drafts drawn on New York in dollars and +those available by ninety-day drafts drawn on London in pounds sterling. +This difference in commission in favor of New York will average 1/2 per +cent. per annum, and when added to the saving in discount or interest +already noted, will show a net saving on the Dollar Credit of 3@3-1/8 +per cent. per annum, which accrues to the importer through the use of +Dollar Credits in his operations. + +Quite apart from the direct economy to the individual resulting from the +use of Dollar Credits, is the broader question of the economic value +accruing to the nation as a whole through the designation of the dollar +as the basis of value in our credit transactions with the rest of the +world. Since 1903, when the total of our imports amounted to +$1,025,719,237, the volume of our imports has increased rapidly, and in +1914, the total imports reached the enormous sum of $1,893,925,657. +These figures cover products from all parts of the world shipped direct +to our own shores, and while no nation enjoys higher international +credit than the United States, yet it is a fact that in order to finance +the movement of our imports we have been compelled to have recourse to +indirect channels and call on foreign money centers to furnish us with +the necessary credit facilities to take care of a large part of our +importations. Naturally, we have been obliged to pay for this +accommodation, and the service has cost us millions of dollars annually +in interest, commissions, etc. + +These charges can be saved and an important economy effected, thus +benefiting our commerce as a whole by the general designation of dollars +in our foreign credit transactions. The purchasing power of the dollar +in foreign markets is much greater to-day than it is in normal times +because of the varying premium which the dollar commands at present +practically throughout the world. The time is unquestionably opportune +to increase the prestige of the dollar and to standardize its use in the +liquidation of our direct purchases abroad. Co-operation and concerted +action on the part of our merchants to the end of generalizing the use +of Dollar Credits is therefore a duty, which will bring about lasting +benefit to the economic fabric of our commerce. + + +THE NEW YORK FOREIGN EXCHANGE MARKET[114] + +A market may be defined as the coming together of buyers and sellers. It +therefore involves all the mechanism necessary to facilitate their +intercourse. One may speak of a general market or of a local market, of +a market in one or in another place. Thus, there is the New York market +for the buying and selling of exchange on London. A bank in New Haven, +Connecticut, may be a part of that market if it buys from and sells to +it. That market includes, besides the commercial and industrial +organizations which buy or sell drafts, all middlemen of whatever class +who engage in the trade. + +The middlemen may be divided roughly into three classes. First may be +mentioned banks which do a regular foreign exchange business, buying +bills from those who have them to sell and selling their own drafts on +foreign correspondents to persons desiring to remit. Much of this +business is done by foreign exchange banks which carry on little or no +other business. Some of it is done by ordinary commercial banks, such as +United States National Banks, in addition to their other banking +business. Second, we may call attention to those exchange dealers whose +principal business is to buy commercial and bankers' bills, and to +resell them, chiefly to banks. Third are the independent brokers who +make small commissions by bringing buyers and sellers together. These do +not invest their own capital, do not, that is, buy bills of exchange in +the market, but assist those desiring to sell bills to find buyers, and +_vice versa_.... + + +NEW YORK CITY PRACTICALLY ABSORBS BY PURCHASE ALL AMERICAN FOREIGN +EXCHANGE + +[115]There is, perhaps, no feature pertaining to banking throughout the +country so dependent upon New York financiers, as foreign exchange. The +very foundation of this branch of banking is constructed by the New York +bankers, and from their banking houses emanate the basic prices and +quotations upon which foreign bills are bought and sold throughout the +United States. + +It is the custom of New York foreign exchange brokers to furnish their +Western clients, direct, or through their local representatives, daily +market quotations, and to promptly advise them of fluctuations +throughout the day. So closely is the West allied to the East, in this +respect, that any interruption caused by delayed or suspended +telegraphic service, immediately superinduces a practical standstill of +exchange transactions, and operations thereafter must necessarily be +made in the "dark" until free communication is again renewed between the +cities.... + +The absorptive power of the New York market, to digest not only the +surplus foreign exchange of the Chicago market, but that of the entire +United States as well, has been demonstrated for many years. The reason +for this can be attributed to the fact that international trade balances +are at the present day, and always will be, adjusted by the financiers +of New York City. + + +HOW MONEY IS MADE IN FOREIGN EXCHANGE--THE OPERATIONS OF THE FOREIGN +DEPARTMENT + +[116]Complete description of the various forms of activity of the +foreign exchange department of an important firm would fill a large +volume, but there are certain stock operations in foreign exchange which +are the basis of most of the transactions carried out and the +understanding of which ought to go a long way toward making clear what +the nature of the foreign exchange department's business really is. + + +I. SELLING "DEMAND" AGAINST "DEMAND" + +The first and most elementary form of activity is, of course, the buying +of demand bills at a certain price and the selling of the banker's own +demand drafts against them at a higher price. A banker finds, for +instance, that he can buy John Smith & Co.'s sight draft for £1,000, on +London, at the rate of 4.86, and that he can sell his own draft for +£1,000 on his London banking correspondent at 4.87. All he has to do, +therefore, is to buy John Smith's draft for $4,860, send it to London +for credit of his account there, and then draw his own draft for £1,000 +on the newly created balance, selling it for $4,870. It cost him $4,860 +to buy the commercial draft, and he has sold his own draft against it +for $4,870. His gross profit on the transaction, therefore, is $10. + +As may be imagined, not very much money is made in transactions exactly +of this kind--the one cited is taken only because it illustrates the +principle. For whether the banker sends over in every mail a bewildering +assortment of every conceivable form of foreign exchange to be credited +to his account abroad, or whether he confines himself to remittances of +the simplest kind of bills, the idea remains exactly the same--he is +depositing money to the credit of his account in order that he may have +a balance on which he can draw. That is, indeed, the sum and substance +of the exchange business of the foreign department of most banking +houses--the maintaining of deposit accounts in banks at foreign centres +on which deposit account the bank here is in a position to draw +according to the wants and needs of its customers. + + +II. SELLING CABLES AGAINST DEMAND EXCHANGE + +A "cable," so-called, differs from a sight draft only in that the banker +abroad who is to pay out the money is advised to do so by means of a +telegraphic message instead of by a bit of paper instructing him to "pay +to the order of so and so." + +Under ordinary circumstances foreign exchange dealers who engage in the +business of selling cables carry adequate balances on the other side, +balances which they keep replenishing by continuous remittances of +demand exchange. + + +III. SELLING "DEMAND" BILLS AGAINST REMITTANCES OF LONG BILLS + +If there is a stock operation in the conduct of a foreign exchange +business it is the selling by bankers of their demand bills of exchange +against remittances of commercial and bankers' long paper. Bills of the +latter class make up the bulk of foreign exchange traded in, and its +disposal naturally is the most important phase of foreign exchange +business. What the foreign exchange business really is grounded on is +the existence of commercial bills called into existence by exports of +merchandise. + +Buying and remitting commercial long bills is no pastime for an +inexperienced man. Entirely aside from the question of rate, and profit +on the exchange end of the transaction, there must be taken into +consideration the matter of the credit of the drawer and the drawee, the +salability of the merchandise specified in the bill of lading, and a +number of other important points. + +Where documents accompany the draft and the merchandise is formally +hypothecated to the buyer of the draft, it might not be thought that the +standing of the drawer would be of such great importance. Possession of +the merchandise, it is true, gives the banker a certain form of security +in case acceptance of the bill is refused by the parties on whom it is +drawn or in case they refuse to pay it when it comes due, but the +disposal of such collateral is a burdensome and often expensive +operation. The banker in New York who buys a sixty-day draft drawn +against a shipment of butter is presumably not an expert on the butter +market and if he should be forced to sell the butter, might not be able +to do so to the fullest possible advantage. Employment of an expert +agent is an expensive operation, and, moreover, there is always the +danger of legal complication arising out of the banker's having sold the +collateral. It is desirable in every way that if there is to be any +trouble about the acceptance or payment of a draft, the banker should +keep himself out of it. + +The successive steps in an actual transaction are as follows: + +The banker in New York having ascertained by cable the rate at which +bills "to arrive" in London by a certain steamer will be discounted, +buys the bills here and sends them over, with instructions that they be +immediately discounted and the proceeds placed to his credit. On this +resulting balance he will at once draw his demand draft and sell it in +the open market. If, from selling this demand draft, he can realize more +dollars than it cost him in dollars to put the balance over there, he +has made a gross profit of the difference. + +To illustrate more specifically: A banker has bought, say, a £1,000 +ninety days' sight prime draft, on London, documents deliverable on +acceptance. This he has remitted to his foreign correspondent, and his +foreign correspondent has had it stamped with the required "bill-stamp," +has had it discounted, and after having taken his commission out of the +proceeds, has had them placed to the credit of the American bank. In all +this process the bill has lost weight. It arrived in London as £1,000, +but after commissions, bill-stamps, and ninety-three days' discount have +been taken out of it, the amount is reduced well below £1,000. The net +proceeds going to make up the balance on which the American banker can +draw his draft are, perhaps, not over £990. He paid so-and-so many +dollars for the £1,000 ninety-day bill, originally. If he can realize +that many dollars by selling a demand draft for £990 he is even on the +transaction. + + +IV. THE OPERATION OF MAKING FOREIGN LOANS + +In its influence upon the other markets, there is perhaps no more +important phase of foreign exchange than the making of foreign loans in +the American market. The mechanics of these foreign loaning operations, +the way in which the money is transferred to this side, etc., will now +be taken up. + +To begin at the very beginning, consider how favorable a field is the +American market for the employment of Europe's spare banking capital. +Almost invariably loaning rates in New York are higher than they are in +London or Paris. This is due, perhaps, to the fact that industry here +runs on at a much faster pace than in England or France, or it may be +due to the fact that we are a newer country, that there is no such +accumulated fund of capital here as there is abroad. Such a hypothesis +for our own higher interest rates would seem to be supported by the fact +that in Germany, too, interest is consistently on a higher level than in +London or Paris, Germany, like ourselves, being a vigorous industrial +nation without any very great accumulated fund of capital saved by the +people. But whatever the reason, the fact remains that in New York money +rates are generally on so much more attractive a basis than they are +abroad that there is practically never a time when there are not +hundreds of millions of dollars of English and French money loaned out +in this market. All through the past ten years London has at various +times opened her reservoirs of capital and literally poured money into +the American market. + +To take up the actual operation of loaning foreign money in the American +market, suppose conditions to be such that an English bank's managers +have made up their minds to loan out £100,000 in New York--not on joint +account with the American correspondent, as is often done, but entirely +independently. Included in the arrangements for the transaction will be +a stipulation as to whether the foreign bank loaning the money wants to +loan it on the basis of receiving a commission and letting the borrower +take the risk of how demand exchange may fluctuate during the life of +the loan, or whether the lender prefers to lend at a fixed rate of +interest, say 6 per cent., and himself accept the risk of exchange. + +What the foregoing means will perhaps become more clear if it is +realized that in the first case the American agent of the foreign lender +draws a ninety days' sight sterling bill for, say, £100,000 on the +lender, and hands the actual bill over to the parties here who want the +money. Upon the latter falls the task of selling the bill, and, ninety +days later, when the time of repayment comes, the duty of returning a +_demand_ bill for £100,000, plus the stipulated commission. In the +second kind of a loan the borrower has nothing to do with the exchange +part of the transaction, the American banking agent of the foreign +lender turning over to the borrower not a sterling draft but the dollar +proceeds of a sterling draft. How the exchange market fluctuates in the +meantime--what rate may have to be paid at the end of ninety days for +the necessary demand draft--concerns the borrower not at all. He +received dollars in the first place, and when the loan comes due he pays +back dollars, plus 4, 5, or 6 per cent., as the case may be. What rate +has to be paid for the demand exchange affects the banker only, not the +borrower. + +Loans made under the first conditions are known as sterling, mark, or +franc loans; the other kind are usually called "currency loans." At the +risk of repetition, it is to be said that in the case of sterling loans +the borrower pays a flat commission and takes the risk of what rate he +may have to pay for demand exchange when the loan comes due. In the case +of a currency loan the borrower knows nothing about the foreign exchange +transaction. He receives dollars, and pays them back with a fixed rate +of interest, leaving the whole question and risk of exchange to the +lending banker. + +To illustrate the mechanism of one of these sterling loans. Suppose the +London Bank, Ltd., to have arranged with the New York Bank to have the +latter loan out £100,000 in the New York market. The New York Bank draws +£100,000 of ninety days' sight bills, and, satisfactory collateral +having been deposited, turns them over to the brokerage house of Smith & +Jones, the borrowers. Smith & Jones at once sell the £100,000, receiving +therefor, say, $484,000. + +The bills sold by Smith & Jones find their way to London by the first +steamer, are accepted and discounted. Ninety days later they will come +due and have to be paid, and ten days prior to their maturity the New +York Bank will be expecting Smith & Jones to send in a _demand_ draft +for £100,000, plus 3/8 per cent. commission, making £375 additional. +This £100,375 less its commission for having handled the loan, the New +York Bank will send to London, where it will arrive a couple of days +before the £100,000 of ninety days' sight bills originally drawn on the +London Bank, Ltd., mature. + +What each of the bankers concerned makes out of the transaction is plain +enough. As to what Smith & Jones' ninety-day loan cost them, in addition +to the flat 3/8 per cent. they had to pay, that depends upon what they +realize from the sale of the ninety days' sight bills in the first place +and secondly on what rate they had to pay for the demand bill for +£100,000. Exchange may have gone up during the life of the loan, making +the loan expensive, or it may have gone down, making the cost very +little. Plainly stated, unless they secured themselves by buying a +"future" for the delivery of a £100,000 demand bill in ninety days at a +fixed rate, Messrs. Smith & Jones have been making a mild speculation in +foreign exchange. + +If the same loan had been made on the other basis, the New York Bank +would have turned over to Smith & Jones not a _sterling bill_ for +£100,000, but the _dollar proceeds_ of such a bill, say a check for +$484,000. At the end of ninety days Smith & Jones would have had to pay +back $484,000, plus ninety days' interest at 6 per cent., $7,260, all of +which cash, less commission, the New York Bank would have invested in a +demand bill of exchange and sent over to the London Bank, Ltd. Whatever +more than the £100,000 needed to pay off the maturing nineties such a +demand draft amounted to, would be the London Bank, Ltd.'s profit. + +From all of which it is plainly to be seen that when the London bankers +are willing to lend money here and figure that the exchange market is on +the down track, they will insist upon doing their lending on the +"currency loan" basis--taking the risk of exchange themselves. +Conversely, when loaning operations seem profitable but rates seem to be +on the upturn, lenders will do their best to put their money out in the +form of "sterling loans." Bankers are not always right in their views, +by any means, but as a general principle it can be said that when big +amounts of foreign money offered in this market are all offered on the +"sterling loan" basis, a rising exchange market is to be expected. + +From what has been said about the mechanism of making these foreign +loans, it is evident that no transfer of cash actually takes place, and +that what really happens is that the foreign banking institution lends +out its credit instead of its cash. For in no case is the lender +required to put up any money. The foreign lender is at no stage out of +any actual capital, although it is true, of course, that he has +obligated himself to pay the drafts on maturity, by "accepting" them. + +Where, then, is the limit of what the foreign bankers can lend in the +New York market? On one consideration only does that depend--the amount +of accepted long bills which the London discount market will stand. For +all the ninety days' sight bills drawn in the course of these transfers +of credit must eventually be discounted in the London discount market, +and when the London discount market refuses to absorb bills of this kind +a material check is naturally administered to their creation. + + +V. THE DRAWING OF FINANCE-BILLS + +Approaching the subject of finance-bills, the author is well aware that +concerning this phase of the foreign exchange business there is a wide +difference of opinion. Finance-bills make money, but they make trouble, +too. Their existence is one of the chief points of contact between the +foreign exchange and the other markets, and one of the principal reasons +why a knowledge of foreign exchange is necessary to any well-rounded +understanding of banking conditions. + +Strictly speaking, a finance-bill is a long draft drawn by a banker of +one country on a banker in another, sometimes secured by collateral, but +more often not, and issued by the drawing banker for the purpose of +raising money. Such bills are not always distinguishable from the bills +a banker in New York may draw on a banker in London in the operation of +lending money for him, but in nature they are essentially different. +Whether or not any collateral is put up, the whole purpose of the +drawing of finance-bills is to provide an easy way of raising money +without the banker here having to go to some other bank to do it. + +The origin of the ordinary finance-bill is about as follows: A bank here +in New York carries a good balance in London and works a substantial +foreign exchange business in connection with the London bank where this +balance is carried. A time comes when the New York banking house could +advantageously use more money. Arrangements are therefore made with the +London bank whereby the London bank agrees to "accept" a certain amount +of the American banker's long bills, for a commission. In the course of +his regular business, then, the American banker simply draws that many +more pounds sterling in long bills, sells them, and for the time being +has the use of the money. In the great majority of cases no extra +collateral is put up, nor is the London bank especially secured in any +way. The American banker's credit is good enough to make the English +banker willing, for a commission, to "accept" his drafts and obligate +himself that the drafts will be paid at maturity. Naturally, a house has +to be in good standing and enjoy high credit not only here but on the +other side before any reputable London bank can be induced to "accept" +its finance paper. + +The ability to draw finance-bills of this kind often puts a house +disposed to take chances with the movement of the exchange market into +line for very considerable profit possibilities. Suppose, for instance, +that the manager of a house here figures that there is going to be a +sharp break in foreign exchange. He, therefore, sells a line of +ninety-day bills, putting himself technically short of the exchange +market and banking on the chance of being able to buy in his "cover" +cheaply when it comes time for him to cover. In the meantime he has the +use of the money he derived from the sale of the "nineties" to do with +as he pleases, and if he has figured the market aright, it may not cost +him any more per pound to buy his "cover" than he realized from the sale +of the long bills. In which case he would have had the use of the money +for the whole three months practically free of interest. + +It is plain speculating in exchange--there is no getting away from it, +and yet this practice of selling finance-bills gives such an opportunity +to the exchange manager shrewd enough to read the situation aright to +make money, that many of the big houses go in for it to a large extent. +During the summer, for instance, if the outlook is for big crops, the +situation is apt to commend itself to this kind of operation. Money in +the summer months is apt to be low and exchange high, affording a good +basis on which to sell exchange. Then, if the expected crops +materialize, large amounts of exchange drawn against exports will come +into the market, forcing down rates and giving the operator who has +previously sold his long bills an excellent chance to cover them +profitably as they come due. + + +VI. ARBITRAGING IN EXCHANGE. + +Arbitraging in exchange--the buying by a New York banker, for instance, +through the medium of the London market, of exchange drawn on Paris--is +another broad and profitable field for the operations of the expert +foreign exchange manager. Take, for example, a time when exchange on +Paris is more plentiful in London than in New York--a shrewd New York +exchange manager needing a draft on Paris might well secure it in London +rather than in his home city. + +Between such cities rates are not apt to be wide enough apart to afford +a wide margin of profit, but the chance for arbitraging does exist and +is being continuously taken advantage of. So keenly, indeed, are the +various rates in their possible relation to one another watched by the +exchange men that it is next to impossible for them to "open up" to any +appreciable extent. The chance to make even a slight profit by shifting +balances is so quickly availed of that in the constant demand for +exchange wherever any relative weakness is shown, there exists a force +which keeps the whole structure at parity. The ability to buy drafts on +Paris relatively much cheaper at London than at New York, for instance, +would be so quickly taken advantage of by half a dozen watchful exchange +men that the London rate on Paris would quickly enough be driven up to +its right relative position. If a chance exists to sell a draft on +London and then to put the requisite balance there through an +arbitration involving Paris, Brussels, and Amsterdam, the chances are +that there will be some shrewd manager who will find it out and put +through the transaction. Some of the larger banking houses employ men +who do little but look for just such opportunities. + +The foregoing are the main forms of activity of the average foreign +department, though there are, of course, many other ways of making money +out of foreign exchange. + + +GOLD MOVEMENTS + +[117]When there is a heavy demand for exchange and little supply, the +price of exchange gradually advances. The banker, called on by his +customers to draw exchange for them, finding few bills in the market +that he can remit to cover his drafts, sends gold and directs its +equivalent in foreign coin to be placed to his credit, and against this +credit he draws. There may be no market abroad for our crops or +manufactures; but gold need not be sold in order to produce money; it +need only be coined. As this process can be carried on indefinitely, the +cost of sending gold is obviously the limit beyond which the price of +demand bills cannot advance. Let us follow this transaction in detail. +The pure gold contained in one English sovereign is exactly equal to the +pure gold contained in $4.8665 of our gold coins; so that, apart from +charges and expenses, $4.8665 of our gold will, when sent abroad, +produce a credit of £1; to this cost must be added freight, insurance, +and other expenses, amounting to about one-fourth of 1 per cent. This +brings the cost of £1 through shipment of gold to about $4.88, which is, +roughly, the gold export point for full weight coin. The exporting +banker obtains his gold either by drawing gold coin from his bank or +else by drawing suitable currency from his bank, and obtaining gold coin +for it at the subtreasury. In either case, he obtains coin that has +suffered more or less abrasion by handling, and this loss of weight by +abrasion, amounting to perhaps one-tenth of 1 per cent., increases the +cost of his remittance. Generally, however, the banker can obtain gold +bars from the United States Assay Office at the nominal charge of one +twenty-fifth of 1 per cent., although at times a larger charge is made. +The banker prefers bars, because on these there is no loss by abrasion; +the Government can afford to give bars, because their export prevents +the export of coin, and so saves the cost of coining new money to +replace that shipped. + +Now for gold import. When there is a large volume of bills offered to +bankers, perhaps by grain and cotton exporters, and but little demand +from buyers of exchange, the market gradually declines in price, while +New York bankers, sending abroad the bills they buy, with little +occasion to draw against them, accumulate large sums to their credit in +London, with no way of getting the money back to New York through +operations in the exchange market. They are not, however, helpless; they +can order gold sovereigns sent here, and, once here, can have them +melted down at the United States Assay Office and coined into eagles and +double eagles, which they can deposit with their banks. Obviously, the +amount received in dollars for each melted sovereign will mark the price +the banker can afford to pay for sterling bills, and competition among +bankers will prevent the rate of exchange from declining below this +point by more than a fair margin of profit. The British sovereign, if +full weight, will, when sent here and melted down, yield gold for which +the United States Assay Office will pay $4.8665; the expense of sending +the sovereign, freight, insurance, cartage, and kegs, will amount to +about one quarter of 1 per cent., so that the net yield of the full +weight sovereign in dollars will be $4.85-3/8. But between the day on +which the banker buys the bill of exchange in New York and the day on +which he receives in New York the gold which the bill entitled him to +collect in London, there must elapse the time needed to send the bill to +London, plus the time needed to send the gold back (roughly fifteen +days), during which period the banker loses the use of the money. This +loss of interest must be deducted from the net yield of the imported +sovereign, and thus, if money is worth 6 per cent. per annum, the net +yield of full weight sovereigns is brought down to about $4.84-1/4, +which is the gold import point for demand exchange, when money is worth +6 per cent. per annum. Losses by abrasion will bring down this point by +perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is +higher, the import point will be lower, and _vice versa_. There is +therefore a margin of profit in buying demand bills and importing gold +sovereigns against the purchase, whenever the rate for demand bills +falls below the gold import point. Active exchange bankers take +advantage of this profit whenever exchange prices decline to the proper +point, and their competition in buying bills to cover their gold +importations stops further decline in exchange rates. It is interesting +to note that during the recent crisis, when gold and currency were at a +premium, bankers could sell the imported gold at a premium, and this +constituted an additional and very large profit; gold importers could +therefore pay higher prices than ordinarily for exchange bought to cover +the importations, and the stress of competition so drove up the rate of +exchange that gold was being imported at a profit, though exchange rates +stood at what, under ordinary circumstances, would have been the gold +export point. + +Gold is, however, not always imported from England in the form of +sovereigns. The Bank of England has in its vaults large quantities of +American eagles and double eagles exported to England in the past and +held without melting. The bank also holds foreign coin and bar gold. Any +holder of Bank of England notes can get sovereigns on demand--other gold +he can get only as the result of a special bargain. When gold is wanted +for export, the bank is often glad to sell bar gold or double eagles at +rates somewhat more advantageous to the exporter than would be the +export of sovereigns; this the bank can afford to do, for the expense +of coining sovereigns to replace those exported is thus saved, while +the exporter, if he can get bar gold on the same basis as sovereigns, +avoids the losses of abrasion. Eagles are even more advantageous to +the exporter, for they are bought in England by weight and used in +America by count; the banker therefore gets an advantage if they are +light, so long as that lightness is not so great as to make them +uncurrent--practically he buys them as light and uses them as full +weight.... + +The mechanism of gold import to, and export from, Germany is practically +the same as with England, the Reichsbank being required to give gold +coin in exchange for its circulating notes. At times, however, German +exchange has fallen below the theoretical gold import point, owing, not +to the refusal of the Reichsbank to give gold, but to the practical +obstacles that at times are somehow placed in the way of free export of +gold. The Reichsbank does not refuse gold for its bank-notes, but +German bankers say to their correspondents: "Don't ask us to get gold +for you, or we shall lose caste," and on such occasions German exchange +rates drop to a point that is theoretically impossible. I do not mean to +criticise them: German banks, when they refuse to demand gold of the +Reichsbank, do no more than our own banks and bankers did recently, when +asked by foreign correspondents to collect in gold the maturing +obligations of railroads and other corporations. As will be remembered, +clearing-house funds rather than cash were at that time current here, +and New York banks and bankers sent to their foreign correspondents the +same answer as the Germans have at times sent us. I cite the German +instance in partial mitigation of censure of our own course rather than +as a reproach to them. + +The Bank of France is not compelled to give gold in exchange for its +circulating notes; it may at its option give silver. Thus, when it is +inconvenient to give gold, the bank can refuse, or, if it prefers, it +can exact a premium. This power has been very moderately and very wisely +used by the bank to modify foreign demands on the one hand, and, on the +other, to keep interest rates low for the requirements of internal +trade. Of course, when a premium is exacted, the French gold import +point drops accordingly. + +Between the gold export point and the gold import point, exchange +fluctuates under the sway of conflicting currents and tendencies--I had +almost said emotions, for these currents and tendencies have their rise +in emotions, needs, and passions as varied as life itself, whether they +be hunger as expressed in the grain bill, or love of elegance in the +importation of silk, or forethought in the profitable investment of +capital. + +This brief review will have made clear what is meant by a free gold +market--a market in which current money can at all times be exchanged +for gold without delay and without premium. Such a market has great +commercial advantages; its stability draws business to it. London is +such a market, and its commercial and financial pre-eminence is in great +measure due to that fact. Paris is not such a market and does not +pretend to be; Berlin pretends to be, but cannot always be counted on; +New York was believed to be before our recent panic. + +I have spoken of the exchange market as an economical mechanism, +automatically making delicate international adjustments. In +justification of that observation, let me direct attention to the manner +in which gold, in moving from financial centre to financial centre, +always travels by the most direct route, and that, too, not because some +public official is charged with the duty of preventing waste, but +because a private trader is trying to make a profit, and is incidentally +serving the community; serving it perhaps better than if he had +consciously determined to serve it. + +Useful acts springing from self-interest have one very comforting +aspect--we need have no misgivings as to their continuance. Charity may +grow weary or disgusted, but self-interest, once enlisted, may be +counted on to continue in operation, whether it be the business man's +self-interest in a profit or the professional man's self-interest in +advancement and fame. Of course, both the business man and the +professional man, in addition to seeking the direct rewards of their +labor, take an interest in their work as work and make it yield them +pleasure. + +It is therefore satisfactory to know that, so long as the banker looks +after his profits, gold will move by the most direct route. Let us +suppose the United States to be exporting a large quantity of cotton to +England at a time when little merchandise is being imported here from +England, but when much is being imported from France. If the volume of +exports to England and of imports from France were large enough, we +might conceivably be importing gold from England in payment of our +produce, and exporting it to France in payment for her luxuries; but, in +practice, gold does not move that way. Every morning, the New York +exchange banker learns by cable the Paris market rate for demand bills +on London. When, therefore, he finds a large volume of bills on London +offered for sale, and little demand for such bills, while there is large +demand for bills on Paris and little supply, he determines, instead of +drawing from New York against his purchases of London bills, to let his +Paris agent draw against these purchases, placing the proceeds to his +credit in Paris; against this credit in Paris, the New York banker draws +his bill in francs, having thus supplied via London the New York demand +for bills on Paris. He knows how many dollars each pound sterling costs +him in New York, and the Paris rate for bills on London tells him how +many francs each pound sterling will net him in Paris, and so he can +calculate how many cents each franc will cost him. Moreover, he is not +the only banker in New York that receives cable quotations; and so with +a large volume of London bills offered and little direct demand for such +bills, and large demand for Paris bills with little direct supply, we +get a situation where New York bankers, competing with each other to buy +the London bills for use via Paris, prevent the price of sterling from +falling to the gold import point; and then, as a result, these same +bankers, competing with each other to supply the demand for Paris bills, +by their competition prevent the Paris rate from rising to gold export +point. Lastly, they compete with each other in Paris, where all are +sellers of bills on London against their New York purchases of London +bills, and by that competition they reduce the rate for London bills in +Paris to the point, at which, other things being equal, gold will go +from London to Paris. What has happened, therefore, is that instead of +our importing gold from London, and then exporting it to Paris, it has +gone direct from London to Paris. + + +COMPLICATIONS IN THE DETERMINATION OF GOLD POINTS + +[118]It is safe to assert that when the exchanges go down to the point +at which it pays better to ship gold from London than to buy a bill, +gold will go. But in the first place, experts always differ as to where +that point begins; and in the second, gold often leaves London long +before there is any question of its being the more profitable form of +remittance. In fact, it may be asserted that the foreign exchanges very +seldom go down to the export gold point, because gold begins to go +before they can get there. + +It has often happened to me, when I was a financial journalist and had +to try to find out the how and why of gold movements, to ask several of +the most experienced and well-informed cambists in the city whether a +gold shipment which had taken place had been made as a genuine exchange +transaction or was done for some other reason, and to hear from one that +there was a reasonable exchange profit on it, from another that there +might be just a shade of a turn to be got out of it if you scraped it +very hard with a knife, and from another that you could not find a +particle of profit in it if you put it under a microscope for a week. So +many complications have to be considered that the most eminent doctors +may be pardoned for disagreeing. + +It may be objected that dealers in exchange, and the comparatively few +firms that make a special study of gold shipping, are not in the +business for their health, and that shipments would not happen if there +were not some profit in them. This is perfectly true, but the profit +need not be got from the exchange. As an exchange transaction it only +pays to ship gold to America when bills on London can only be sold in +New York at a lower price than gold would fetch if brought from London +and exchanged into dollars in New York. If bills on London are selling +at 4.83-3/4, and gold can be bought and shipped and turned into dollars +at the rate of 4.83-7/8, after allowing for all charges and commissions +and the loss of interest during transit, then the operation pays as an +exchange transaction. If the dollars realized by the gold were at the +rate of only 4.83-3/4 the importer would be no better off than if he had +sold a bill; if they were at the rate of 4.83-5/8 he would be out of +pocket on the business, viewed strictly as an exchange transaction. But +this is by no means the only consideration. Gold has such a magical +fascination for moneyed mankind, and its movements are so eagerly +discussed in their markets and newspapers, that it is often handled and +shipped at a loss, especially in America, for the sake of the +advertisement that the importing firm thereby gains for itself. + +Moreover, imports of gold have a very stimulating effect on speculative +stock markets, because an increase in the amount of gold available means +a roughly corresponding increase in the amount of credit that bankers +can give, so that when gold is known to be coming speculators know that +credit will be cheaper for carrying their commitments, and will come in +and buy, with a light heart, stock that they could not possibly pay for, +but hope to pawn with their bankers until they can sell it at a higher +price. And so unless the loss on the exchange side of the business is +too great, it often pays the leaders of a bull campaign to import gold, +having first laid in a line of stock, and make their profit by unloading +during the fit of exhilaration produced by the news that the gold is on +the way. + +Or, again, quite apart from any speculative and spectacular motives +behind gold shipments, it may pay bankers, in a country where rates for +money are ruling high, to import gold at an apparent loss, because of +the high rates that they get for the credit that they are thereby +enabled to give. They thus, in effect, borrow gold, and recoup +themselves by being able to lend, on profitable terms, larger amounts +than they borrow, since they can always create credit to larger amounts +than that of the gold in their vaults. Sometimes, in fact, in times of +pressure banks find themselves obliged to import gold so as to +strengthen their position, whatever the loss on exchange may be. + +For instance, last September, when the Berlin exchange was at the point +at which, if theory ruled in these matters, Berlin ought to have been +thinking of packing up some gold to send to London, Berlin was buying +gold in London and shipping it to the Fatherland, because there is +always great pressure for currency in Germany at the end of September +when the interest on mortgages falls due and has to be paid in cash, +with the result that the Reichsbank's note circulation expands very +rapidly and the backing of gold behind it has to be increased. +Sometimes, again, in order to attract gold, a central bank will give +importers credit for gold that is on the way, so that they may be saved +from loss of interest while the metal is afloat. Thus the actual +importer may make a profit on the shipment, not as a genuine exchange +transaction, but at the expense of the central bank. + +In these cases two of the many functions performed by gold have to be +considered. As a means of international remittance, it may not be as +cheap as a bill, but it may have to be sent, not as a means of +remittance, but because it is urgently wanted in the importing country +as a make-weight for the balloon of credit. + +So we see that the grumbling bill broker who ... [said] that these +confounded exchanges only work one way, was actually understating his +case. Not only do we [Englishmen] always lose gold when the exchanges go +against us, and often get none when they go in our favour, but we also +often lose gold long before the exchanges are sufficiently against us to +justify its going, and sometimes even when they are strongly in our +favour. + +The effect on the exchange of an import or export of gold is, of course, +just the same as that of the import or export of any other commodity--an +import turns the exchange against us and an export turns it in our +favour. If we send gold, for example, to Germany we thereby meet a +German claim on us or create a claim for ourselves on Germany; in the +former case the bills drawn on us will be less by the amount of the gold +shipped, and the supply in Berlin of bills on London will be less in +relation to the demand, so that the tendency will be for the price of +sovereigns, as expressed in marks, to rise. In the latter case some one +in Berlin will have a claim to meet in London and will have to bid there +for a bill on London, and his bidding will have the same beneficent +effect on the exchange. When we import gold, whether brought out of +bankers' vaults, or dug out of the bowels of the earth, the country that +sends it to us meets claims of ours on it or establishes claims on us. +In either case the tendency is for the exchange to move against us. + + +THE HANDLING OF GOLD SHIPMENTS + +[119]Whether in coined pieces or bars (bullion), the gold is packed in +strong kegs or boxes, securely strapped with hoop iron, and carefully +sealed with private seals; the latter to discover if tampered with en +route. Space is chartered from the steamship company, as in the case of +merchandise, although nearly all large fast steamers have rooms +especially constructed for such valuable cargo.... As an extra safeguard +in case of large shipments, the steamship company details special armed +men to guard the room day and night, and sometimes the shipper employs +special detectives in citizens' clothes to watch the passengers on the +trip, since it is generally known several days in advance when large +shipments of gold are to be made. + + +THE SILVER EXCHANGES + +[120]... It is acknowledged that commerce between gold standard +countries is satisfactory to all classes of traders, for both importers +and exporters know exactly the return they may expect, but in trade +between a silver-using country and one on a gold basis, a large measure +of uncertainty invariably exists. Whenever there is a fall in the gold +value of silver, either the exporter in the gold standard country or the +importer in the silver country must suffer. + +Let us take the case of the exporter. We will suppose that A. Blank & +Company, of Manchester, calico printers, send goods to Shanghai, which +they hope to sell there for a total sum of, say, £1,000. The price of +silver when the shipment was despatched was, we will say, 25_d._ per +standard ounce, and on this basis A. Blank & Company have calculated the +selling price which is to yield them £1,000. By the time the calico +arrives in Shanghai, the gold price of silver has dropped, we will +suppose, to 20_d._ per standard ounce, and this obviously indicates that +the manufacturers will receive one-fifth less for their wares, since +they are paid in the currency of the province (taels in this instance), +and when Blank & Company's money comes to be converted back into British +gold pieces, they are face to face with the fact that the outturn is +£200 less than they had calculated: they have lost one-fifth, and +receive £800 only. This is, of course, an extreme case, as in the +ordinary course silver would be unlikely to drop 5_d._ in the period +between shipment and arrival of the goods in Shanghai; but whatever the +fall, the principle is the same, and the illustration serves to show +exactly what happens. + +It is not only the British exporters who stand to lose in the lottery of +trade with countries which have an unstable silver exchange; the +capitalist also, and every class of investor, is liable to be adversely +affected in operations with silver standard countries. The rate of +exchange between such countries and gold standard countries is plainly +the exchange between gold and silver; therefore, if a person has +invested in undertakings in the silver country, when he receives his +dividends in the currency of that country, he will obtain less for his +dividend warrant on the London market in proportion to the fall in the +price of silver--assuming that it does fall. Conversely, he may reap a +higher return on his investment if silver has gone up before the +encashment of his dividend. + +Finally, the principal is affected in the same way, whenever it is +desired to convert it back into gold. A further example will show how +this works out in practice. + +We may assume that an investor, encouraged by the chance of earning 6 +per cent. on his money, remits to China £1,000. The price of silver on +the 1st January, 1914, was 26-7/16_d._ per ounce standard; on the 31st +December, 1914, 22-11/16_d._ For the sake of argument, we will imagine +our investor sent the money out to the Eastern country on the 1st +January, 1914, but circumstances made it advisable for him to recall his +money at the end of December in the same year, when the metal had +depreciated to 22-11/16_d._; in converting his principal back to British +currency he will find himself faced with a sharp loss. Silver, in which +the investment stood, has dropped 3-3/4_d._ of its gold equivalent, +roughly, one-seventh; consequently on conversion the gold value of his +original £1,000 has fallen to about £857.... + +... The exchanges of these silver standard countries ... [are] quoted in +shillings and pence to the dollar, tael, or rupee, as the case may be, +that is, the gold value of the respective silver coins. Hong-Kong, for +instance, is quoted 1_s._ 10-3/8_d._ to the dollar, and Shanghai, 2_s._ +5-5/8_d._ to the tael. The rates from these centres ... indicate the +price for telegraphic transfers on London: the unit of exchange in the +centres named being by general consent the rate for telegraphic +transfers on London. + +Let us take the Shanghai rate as an example: 2_s._ 5-5/8_d._ per tael, +means that for every silver tael the remitter hands over to the exchange +bank in Shanghai, 2_s._ 5-5/8_d._, or, to give it its real significance, +a little less than one-eighth of a sovereign in gold, will be paid to +the person in whose favour the remittance is made, as soon as a telegram +can reach the bank's London branch.... + +... Besides the T. T. rate, as it is called for the sake of brevity, we +have the four months' sight and six months' sight rates, which are the +quotations for first-class bank bills. Both quotations are higher than +for the telegraphic transfers, that is to say, for every silver tael +paid in Shanghai the bank will allow more shillings and pence where it +is a question of paying the gold value in London four or six months +hence, than it would if the payment is to be made on demand or by wire. +The reason is, that if a bill drawn on London, payable four months after +sight, is sent, the remitter is bound to place the receiver in such a +position that if the latter chooses to turn the bill into cash after it +has been "sighted" and accepted, he will not be worse off than if the +money had been sent by cable.... + +As may be gathered, therefore, the discount rates ruling on the London +market are of great importance to the Eastern bankers and exchange +dealers: so important are they in fact, that it is necessary for each +side to keep in direct telegraphic communication regarding the existing +discount quotations and the probable trend of the markets.... + +... The rate at which they are able to cover their drawing operations +... governs the price at which they will sell bills. If a banker has +funds deposited with his correspondent upon which he can draw, well and +good: if he has no balance with the agent, he must either provide the +wherewithal to meet the bills which he has drawn, or, alternatively, he +can instruct the agent to draw on him in reimbursement. Finally, there +comes a time,... when, as all other means of placing his correspondent +in funds have been exhausted, the banker will be obliged to ship ... +silver to be sold for what it will fetch.... + +It is fairly clear that the real trouble in Eastern exchange lies in the +fact that we have three main factors to deal with instead of two. In the +gold exchanges we have simply the demand for and supply of bills and +telegraphic transfers; in the silver exchanges the matter is complicated +by the way in which we also have to depend upon the fluctuations in the +price of silver on the London market.... + +Shanghai draws on London for the cost of her exports and remits to +London for the value of her imports, and the principal reason for this +procedure is that the manufacturer in Great Britain does not wish to be +bothered with the variations in exchange, although as the reader has +seen, he may be pretty severely affected if silver has depreciated +before his goods are sold. Leaving that out of the question, however, we +may take it that as all his expenses are payable in gold, he naturally +prefers to deal in terms of that metal. Consequently, goods shipped to +China are nearly always paid for by remittances, or drawn for in +sterling, which comes to the same thing. The Chinese producer is on +rather a different footing. His expenses are in silver, and in silver he +wishes to be paid. His produce, however, he has sold to Great Britain +for a gold price, and either he cannot afford to, or does not want to +wait until a remittance can be sent by mail from London. The one way +open to him is to draw in sterling and settle the rate of exchange on +the spot, which he does and so makes an end of the matter.... + +FOOTNOTES: + +[103] Hartley Withers, _Money Changing_, pp. 30-35. E. P. Dutton and +Company. New York. 1914. + +[104] Adapted from the Rt. Hon. Viscount Goschen, _The Theory of the +Foreign Exchanges_, pp. 85-88. Effingham Wilson. London. 1913. + +[105] Adapted from Franklin Escher, _The Elements of Foreign Exchange_, +pp. 3-14. Bankers Publishing Company. New York. 1913. + +[106] _Ibid._, pp. 15-24, 26, 31-33, 44. + +[107] Adapted from Frederick I. Kent, _Financing Our Foreign Trade_, The +Annals of the American Academy of Political and Social Science, Vol. +XXXVI, No. 3, November, 1910, pp. 492-500. + +[108] [The method explained would apply without qualification to our +imports generally prior to 1914, whether coffee from Brazil, hides from +the Levant or textiles from France. The recent and growing practice of +drawing on New York rather than on London is discussed later in this +chapter.] + +[109] Adapted from Archibald J. Wolfe, _Foreign Credits_, pp. 22, 23, +Special Agents Series--No. 62. Department of Commerce and Labor. +Washington. 1913. + +[110] George Clare, _The A B C of the Foreign Exchanges_, pp. 11-15. +Macmillan and Company. London. 1911. + +[111] [English bills drawn on our banks have increased in volume since +1914, through the operation of the Federal Reserve Act and the amended +New York State Bank Law which make provision for the acceptance of time +drafts by National and New York State banks, respectively.] + +[112] John E. Rovensky, _How the War Affects Practical Operations in +International Exchange_, Journal of the American Bankers Association, +Vol. 7, No. 12, June, 1915, pp. 1008, 1009. + +[113] Joseph T. Cosby, _The Economies and Advantages of "Dollar +Credits."_ The National City Bank. New York. 1915. + +[114] Harry G. Brown, _International Trade and Exchange_, pp. 65-66. The +Macmillan Company. New York. 1914. + +[115] Anthony W. Margraff, _International Exchange_, pp. 104-105. Fergus +Printing Company. Chicago. 1903. + +[116] Adapted from Franklin Escher, _Elements of Foreign Exchange_, pp. +68-101. Bankers Publishing Company. 1910. + +[117] Albert Strauss, _Gold Movements and the Foreign Exchanges_, The +Currency Problem and the Present Financial Situation. A Series of +Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The +Columbia University Press. 1908. + +[118] Hartley Withers, _Money Changing_, pp. 159-164. E. P. Dutton and +Company. New York. 1914. + +[119] Address by H. K. Brooks. _Lectures on Commerce_, Edited by Henry +Rand Hatfield, University of Chicago Publications of the College of +Commerce and Administration, Vol. I., pp. 283-4. The University of +Chicago Press. Chicago. 1904. + +[120] William F. Spalding, _Foreign Exchange and Foreign Bills in Theory +and in Practice_, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New +York and Melbourne. 1915. + + + + +CHAPTER XIX + +CLEARING HOUSES + + The following discussion of clearing houses is confined + mainly to the United States and England. References to the + clearing houses of France and Germany, where the + introduction of the use of checks and the consequent + development of clearing facilities have been tardy, are + contained in the chapters devoted to the banking systems of + those countries. + + +I. IN THE UNITED STATES + + +A CLEARING HOUSE DEFINED + +[121]What is a clearing house? The Supreme Court of the State of +Pennsylvania has defined it thus: + + It is an ingenious device to simplify and facilitate the + work of the banks in reaching an adjustment and payment of + the daily balances due to and from each other at one time + and in one place on each day. In practical operation it is a + place where all the representatives of the banks in a given + city meet, and, under the supervision of a competent + committee or officer selected by the associated banks, + settle their accounts with each other and make or receive + payment of balances and so "clear" the transactions of the + day for which the settlement is made. + +But we must go farther than this, for though originally designed as a +labor-saving device, the clearing house has expanded far beyond those +limits, until it has become a medium for united action among the banks +in ways that did not exist even in the imagination of those who were +instrumental in its inception. A clearing house, therefore, may be +defined as a device to simplify and facilitate the daily exchanges of +items and settlements of balances among the banks and a medium for +united action upon all questions affecting their mutual welfare. + + +METHODS OF EXCHANGE IN NEW YORK PRIOR TO 1853 + +[122]During a comparatively short period immediately following 1849 the +number of banks in New York increased from 24 to 60. In the daily course +of business each bank received checks and other items on each of the +other banks, which had to be presented for collection. All such items on +hand were assorted and listed on separate slips at the close of the day, +and items coming in through the mail on the following morning were added +at that time. To make the daily exchanges each bank sent out a porter +with a book of entry, or pass book, together with the items to be +exchanged. + +The receiving teller of the first bank visited entered the exchanges +brought by the porter on the credit side of his book and the return +exchanges on the debit side, who then hurried away to deliver and +receive in like manner at the other banks. It often happened that five +or six porters would meet at the same bank, thereby retarding one +another's progress and causing much delay. Considerable time was +consumed in making the circuit. Hence, the entry of the return items in +the books of the several banks was delayed until the afternoon, at an +hour when the other work of the bank was becoming urgent. + +A daily settlement of the balances was not attempted by the banks, owing +to the time it would have required, but they informally agreed upon a +weekly adjustment, the same to take place after the exchanges on Friday +morning. At that time the cashier of each bank drew a check for each of +the several balances due it, and sent a porter out to collect them. At +the same time the porter carried coin with which to pay balances due by +his bank. After the settlement had been made, there was a meeting to +adjust differences and bring order out of chaos. + +An old bank officer (J. S. Gibbons), in describing the inconveniences +and defects of this system, says that some of the more speculative banks +took advantage of the weekly method of settlements by carrying a line of +discounts to an amount greater than their legitimate resources would +allow. Thus, a bank would manage to carry a small debit balance of +$2,000 or $3,000 with thirty or more institutions, making a total debit +balance of, say, $100,000 on which it discounted paper. It was the +practice to borrow enough on Thursday to make the settlements on Friday, +and the return of the loan on Saturday threw it again into the debtor +column. Virtually, therefore, the weekly settlements were nominal only, +and to show that there was no attempt at economy of time and labor in +making them, it is only necessary to say that the cashier drew a check +for every balance due him, whereas a draft on one bank in favor of +another might have settled two accounts at once. + +The banks were at liberty to draw on each other for their credit +balances without waiting for the settlements on Friday, and hence, when +specie was needed, this was not infrequently done. But so far did many +of the banks extend their loans and discounts that a single small draft +by one bank on another would induce a general drawing and involve them +all in confusion and virtual war on each other. Three o'clock would +arrive, with the line of drafts incomplete, thus enabling debtor banks +ofttimes to add $50,000 to their specie, whereas creditor banks would +find themselves at the close of the day depleted in perhaps twice that +sum. + + +THE ORIGIN OF THE NEW YORK CLEARING HOUSE + +[123]The desirability of a substitute for such a system had long been +realized, but as yet no plausible scheme had been proposed. As early as +1831 a plan had been suggested by Albert Gallatin, which, to a very +remarkable degree, coincided with the one ultimately adopted. + +But the times were not ripe for the scheme thus proposed. Mr. Gallatin +was thinking in advance of the age. In time, however, the question began +to be more generally discussed. For nearly a year it was under +consideration, and finally it was deemed advisable to call a meeting to +take decisive action upon it. + +On August 23, 1853, 16 presidents, 1 vice-president, and 21 cashiers, +representing 38 banks, assembled in the directors' room of the +Merchants' Bank, and at this meeting a resolution was passed providing +that "a committee be appointed to procure or hire a suitable room in or +near Wall Street, for the purpose of holding meetings of the officers of +the city banks; that the said committee be requested to submit a plan, +at an adjourned meeting of this body, to simplify the system of making +exchanges and settling the daily balances; and that when a room is +procured or hired for the above purpose, the presidents or cashiers be +requested to meet weekly until a plan is agreed upon." In compliance +with this request, the committee presented a plan for the daily +settlement of balances, at a meeting held on August 31, 1853, which plan +was amended so as to provide "that a room be procured for that purpose, +sufficiently large to afford suitable accommodations." + +On September 13, 1853, the scheme was adopted and the committee was +"clothed with full power to hire a room, appoint a manager and clerks, +and make all the necessary arrangements to carry the plan for a clearing +house into effect." The date for beginning operations was fixed for +October 11. Accordingly, on the appointed day, the representatives of +the banks, members of the association, met in a room which had been +procured in the basement at No. 14 Wall Street, and made the first +exchanges. The total clearings on that day were $22,648,109.87, and the +balances were $1,290,572.38. These clearings have since been eclipsed by +over $30,000,000 in the totals of a single bank. + +The clearing system in America was thus fairly launched, and from that +time forth its success exceeded the expectations of even its most ardent +projectors. The association consisted at that time of 52 banks, banded +together for their common good, which, as they then conceived, consisted +solely in the exchange of items and settlement of balances at a uniform +time and place. For nearly a year the operations were conducted without +a constitution. The adoption of such an instrument was opposed, on the +ground that it was not needed and might lead to a dangerous +concentration of power in the hands of a few managers, who might use it +for personal aggrandizement, or for the exercise of an arbitrary +supervision. + + +MEMBERSHIP AND ADMITTANCE FEES AT NEW YORK + +[124]The association at present (1909) consists of 50 members[125] (32 +National Banks and 18 State Banks) and the United States subtreasury +located at New York. The latter makes its exchanges only at the clearing +house, its balances being settled at its own counter. It has no voice in +the government of the association, and pays a nominal sum for actual +expenses. The privilege which the subtreasury enjoys of making its +exchanges through the clearing house is a matter of great accommodation +both to the subtreasury and to the banks. The New York post-office +clears through one of the members, but renders no compensation to the +association for the privilege. + +The membership of the association since its organization has been +constantly changing, owing to the admission and expulsion of members and +voluntary withdrawals, as provided by the constitution. + +The association began with 51 members, but by 1858 the list had declined +to 46, the lowest number in the history of the clearing house. A +membership of 67 was attained in 1895. + +On February 28, 1854, the Bank of the Union was expelled and the +clearing-house association was authorized to return to it whatever +amount was necessary to offset its advances toward the expenses of the +clearing house. In the following December the Empire City Bank was +expelled and a similar resolution was passed but in no case thereafter +were any such refunds made.... + +The constitution is very explicit in its terms governing the admission +and conduct of members. Applicants are first considered by the +clearing-house committee and referred hence to the committee on +admissions. The latter committee, if, in its opinion, after a careful +examination, the applicants are qualified for membership, refers them to +the association for final action, a three-fourths vote of those present +being necessary for admission. Banks may be elected to membership at any +meeting of the association, but before being considered by the +clearing-house committee each applicant must be shown to have an +unimpaired capital or an unimpaired capital and surplus of at least +$500,000. Each new member is required to signify its assent to the +constitution, in the same manner as the original members, and pay an +admission fee, according to capital, as follows: A bank the capital of +which does not exceed $5,000,000 must pay $5,000; a bank the capital of +which exceeds $5,000,000 must pay $7,500. Any member increasing its +capital is required to pay in accordance with those rates. + + +[126]METHODS OF SETTLING BALANCES + +There are no less than five different methods of settling balances, in +whole or in part, without the use of money at the clearing house. They +are (1) by manager's check on debtor banks given to creditor banks; (2) +by borrowing and loaning balances without interest; (3) by borrowing and +loaning balances with interest; (4) by the use of one or more of four +forms of certificates, viz., gold and currency depository certificates, +United States assistant treasurer certificates, and clearing-house loan +certificates; and (5) by draft on another city. + +When money is not used in the adjustment of balances at the clearing +house, one of the most common methods of settlement is by manager's +check on debtor banks in favor of creditor banks. In such cases the +creditor banks send clerks to the clearing house to receive the +manager's checks, which may be cashed by the debtor banks, exchanged for +cashier's checks or exchange on another city, or sent through the +clearings on another day. + +There is one important advantage of the manager's check over settlements +in cash at the clearing house: By its use only one transfer of cash is +necessary in making settlements, and thus the risk is greatly +diminished. + +The second mode of settlement, other than on a cash basis, is by +borrowing and loaning balances without interest. At Chicago and +Pittsburg this method is practised as a matter of convenience to the +several members. After the exchanges have been made and the balances +determined, a certain length of time is devoted to this transfer. + +The third method is that of borrowing and loaning balances upon +interest, as practised in Boston. + +The fourth method is that of employing some form of certificate. Many of +the large clearing houses provide for a depository to receive in special +trust such United States gold coin as any of the banks belonging to the +association may voluntarily deposit with it for safekeeping, upon which +certificates may be issued, to be used in the settlement of +clearing-house balances. Such certificates are usually issued in +denominations of $5,000 and $10,000, and are negotiable only among the +associated banks. Many of the clearing houses impose a fine for their +transfer to any other party than a member of the association. + +Coin certificates were devised by F. W. Edmunds of New York, and came +into use about 1857. The Bank of America first acted as a depository, +but after the beginning of the greenback epoch the associated banks +chose the United States subtreasury as such depository for both gold and +currency. When the new clearing house in Cedar Street was occupied, the +gold deposits were transferred to the magnificent vaults with which it +is provided, and these at the present time hold a very heavy deposit of +gold, as well as a very large amount of currency, against which have +been issued clearing-house certificates as before mentioned. The +associations in practically all of the large cities of the United States +now use these gold depository certificates in the settlement of +clearing-house balances. + +Clearing-house loan certificates are issued only in emergencies. The +period during which balances are settled by such instruments lasts +usually only three or four months, or until the financial disturbance +which called them forth has subsided. + +The fifth method is by draft on some other city. In some places the +option is given of settling in cash or by draft, as at Austin, Tex.; +Charleston, S. C.; Frederick, Md.; Jacksonville, Fla.; Kansas City, Mo.; +New Orleans, La.; Rochester, N. Y.; and Saginaw, Mich. In others +settlements are made exclusively by drafts on another city. Among these +are Syracuse, N. Y.; Worcester, Mass.; Fall River, Mass.; Fremont, +Ohio; Hartford, Conn.; Holyoke and Lowell, Mass.; and Binghamton, N. Y. +Sometimes foreign drafts are used in payments of equal thousands only, +as at Wilmington, Del., and Chester, Pa. + +Generally speaking, about 40 per cent. of the clearing houses of the +United States use drafts on other cities in paying their balances. About +30 per cent. settle by manager's check, and about 25 per cent. settle by +cash alone, the remaining 5 per cent. settling by a combination of two +or more of the foregoing methods. + +Clearing houses located in New England settle, as a rule, with drafts on +Boston or New York, or both. Clearing houses in the vicinity of +Philadelphia usually settle with drafts on that city or on New York, and +those located in that part of the country lying east of the Mississippi +River settle more or less by draft on New York or Chicago. Settlement is +also sometimes made by draft on some of the larger cities, such as +Baltimore, Washington, Savannah, Kansas City, Detroit, Omaha, and San +Francisco. + + +[127]RATIO OF BALANCES TO CLEARINGS + +The ratio of balances to clearings depends partly upon the number of +banks, but much more upon the amount and character of their business and +upon their relations one to another. This is illustrated by figures +which have just been collected, covering the transactions for the year +1908. At Pittsburg, with 20 members and 128 non-members clearing through +members, the balances were 16.5 per cent. of the clearings; at Buffalo, +with 11 members and 7 non-members, 12 per cent.; at Chicago, with 20 +members and 40 non-members clearing through members, 7.5 per cent.; at +Philadelphia, with 31 members and 1 non-member, 11.5 per cent.; at St. +Louis, with 17 members and 35 non-members, 9.3 per cent.; while in New +York, during the fifty-four years of its existence, the percentage of +balances to clearings has been only 4.64 per cent., notwithstanding the +operation of the United States assistant treasurer, who almost always +has a heavy debit balance. + +The more nearly the banks stand on an equality with one another, the +more nearly will their transactions approach a complete offset, which, +of course, would leave no balance to settle. + + +[128]THE NATURE OF CLEARING-HOUSE LOAN CERTIFICATES + +Clearing-house certificates are of two kinds--those issued upon the +deposit of gold coin (and in New York City and Boston on gold and silver +certificates and legal-tender notes) and those issued upon the deposit +of collateral securities. The former are employed in ordinary times +solely as a method of economizing time and labor and reducing risk in +handling large sums of money. The latter are employed in times of +financial disturbance or panic, and although both are intended for use +solely in the settlement of balances at the clearing house, the +circumstances that call them forth, the results effected by their use, +and the part they play in banking economy have little or nothing in +common. The certificates issued upon the deposit of gold, etc., are +termed "Clearing-house certificates," and those issued upon the deposit +of collateral security are very properly termed "Clearing-house loan +certificates," with which latter only are we here concerned. + +Clearing-house loan certificates may be defined as temporary loans made +by the banks associated together as a clearing-house association, to the +members thereof, for the purpose of settling clearing-house balances. +Such certificates are negotiable, as a rule, only among the members of +the association, and are not in any sense to be regarded as currency. +They are not even seen by the business community, and do not pass from +bank to bank except in payment of clearing-house balances. + +To obtain an intelligent understanding of the real character and purpose +of such certificates it will be well to treat somewhat of the +circumstances under which they are issued. In the course of the present +century the United States has undergone periodical derangements of +business affairs, when confidence was displaced by mistrust, when the +payment of debts became difficult, when property values declined, and +business houses failed; when industry and trade were paralyzed, and +general stagnation ensued in all lines of enterprise. In such times +depositors in banks, stricken with fear and sometimes pressed by need, +draw out their deposits, in many cases to such an extent as to render it +difficult or even impossible for the banks to contract their loans +sufficiently to meet the demands thus made upon them. Under our currency +system no adequate method is [was] provided for expanding the money +volume as occasion demands, whereby the banks can continue their usual +loans and discounts, and thus prevent a panic with all its evil +consequences. Hence it is left in a large measure to the financiers of +each community to work out their own remedy, supplemented by such mutual +assistance as a courteous regard for each other may dictate or as +business relations may demand. + +Quick to see the defects in our currency system, and the desirability of +in some way supplying it, the bankers of New York, nearly fifty years +ago, devised the scheme of issuing clearing-house loan certificates as a +method of relief from temporary stringencies. Subsequently, nearly all +the clearing houses in the great centres adopted the same device, and by +their heroic resort to the measure they have at different times relieved +the business community of untold disaster, for which invaluable service +they have justly received the grateful recognition of the entire +country. + +The great value of clearing-house loan certificates lies in the fact +that they take the place of money in settlements at the clearing house, +and hence save the use of so much actual cash, leaving the amount to be +used by the banks in making loans and discounts, and in meeting other +obligations. The volume of currency, to all intents and purposes, is +expanded by this means to the full amount of the certificates issued. + +The loan certificates are taken out by the clearing-house members +through loan committees, specially appointed, and are used, as a rule, +only in the payment of balances among the associated banks. Thus, when +the stringency in the money market seems sufficient to demand it, the +clearing-house association meets and appoints a committee called the +"loan committee," consisting usually of five bank officers, to act in +concurrence with the president of the clearing-house association, who +serves ex officio as a member. It is the duty of such committee to meet +each morning at the clearing house and examine the collateral offered as +security by the banks and issue loan certificates thereon, in such +denominations and proportions to collaterals deposited as may be agreed +upon. In the past the denominations have varied from 25 cents to +$100,000 in the different associations and in proportions varying from +$50 to $100 of certificates to $100 of collateral deposited. + +These loan certificates bear interest at rates varying from 5 to 10 per +cent. per annum, payable by the banks to which they are issued to the +banks receiving such certificates in settlement of daily balances. Hence +the interest charged against certain banks must exactly equal and offset +that credited to certain other banks. The aim is to fix the rates +sufficiently high to insure the retirement of the certificates as soon +as the emergency which called them forth has passed by. As a rule they +are retired by the banks, which take them out as soon as they have +obtained sufficient cash to meet their daily obligations. Notice is +given by the debtor banks to the committee, calling for such +certificates as they wish to retire, and the committee gives notice to +the banks holding the same, stating that the interest will cease after a +specified date. In due course the holders send the certificates to the +clearing house for redemption. Upon the retirement of the certificates +the collateral deposited as security is surrendered by the committee in +the same proportion to certificates turned in as was required for +deposit at the time of issue. + +It is by no means the general practice for all the members to take out +loan certificates when issues are arranged by the association. Some +banks are in such condition as to be able to weather the storm without +them, while others are weak and in great need of relief. Some banks +regard their use of clearing-house loan certificates as a reflection +upon their standing, and hence refuse to apply for them unless driven to +it by sheer necessity. Others regard it as in no way prejudicial to +their interests, but rather as a patriotic movement in which all the +banks should engage, both for the purpose of assisting their +fellow-members and for the welfare of the community as a whole. + + +CLEARING-HOUSE LOAN CERTIFICATES AND THE EQUALIZATION OF RESERVES[129] + +Comparison of the course of events during the crisis of 1873 with that +in subsequent crises shows a progressively increasing unwillingness or +inability among the New York banks to make use of their cash reserves. +In 1873 the New York banks at the outset of the crisis held an available +reserve of $34,300,000. In the course of four weeks this was reduced to +$5,800,000, and the ratio to deposit liabilities was then less than 4.5 +per cent.[130] Suspension was not escaped in 1873 but it was of shorter +duration than in later crises. The banks at that time were unable to +increase their cash resources by any of the means which have been +available in later crises. The Government had no surplus of greenbacks, +aside from about $12,000,000 which was almost entirely secured and +retained by the savings banks. Banknotes could not be issued because the +total circulation was at that time limited by law. Finally, additional +supplies of gold, secured through imports, were useless for ordinary +banking purposes because the business of the country was then carried on +by means of an inconvertible and depreciated paper currency. +Notwithstanding all these special difficulties, the New York banks, by +continuing to use their reserves freely even after payments had been +restricted, were able to restore confidence in a comparatively short +time, and money began to flow back to them within three weeks after the +outbreak of the crisis. + +In 1893 the New York banks were in what was for them an unusually strong +condition at the beginning of the disturbance, having early in June a +cash reserve exceeding 30 per cent. of their net deposits. A succession +of banking failures in the West and South led to heavy withdrawals from +New York during the latter part of June and the beginning of July. Then +followed a lull and money began to be returned to New York. During the +third week of July banking failures were renewed in the West and South +and the drain was resumed. The positively unfavorable aspects of the +situation were altogether similar to those of the previous month with +the one further circumstance of a reduced cash reserve in New York. On +the other hand, additional means with which to meet the situation were +becoming available. At the end of July gold imports in large amount had +been arranged. Foreign purchases of our securities were heavy, +reflecting increasing confidence in the repeal of the silver purchase +law. Arrangements had also been made which would certainly lead to a +considerable increase in the issues of bank-notes during August and +September. Notwithstanding all these favorable circumstances the New +York banks suspended, during the first week of August, when they still +held a cash reserve of $79,000,000, more than 20 per cent. of their +deposit liabilities. + +In 1907 the New York banks restricted payments when they still held a +cash reserve of more than $220,000,000 and when the reserve ratio was +also above 20 per cent. Both in 1893 and in 1907 suspension was not a +measure of last resort taken after the banks had entirely exhausted +their reserves and when there was no means of securing additional cash +resources. Moreover, after cash payments were restricted the policy of +the banks was unlike that adopted in 1873, in that the banks did not +make further use of their reserves; they hoarded them and added to their +amount, thus unduly prolonging the period of suspension. + +Explanation of the failure of the banks in 1893 and 1907 to use their +cash resources as completely as in 1873 is simple; but it is of the very +greatest significance because it will bring to light the most serious +element of weakness in our credit structure. [Written before our banking +reform of 1913.] + +In 1893 and in 1907 the clearing-house loan certificate was the only +device resorted to in order to secure the adoption of a common policy by +the banks. In 1873, as on earlier occasions when its use was +authorized, provision was also made for the equalization of the reserves +of the banks. Thus in 1873 the Clearing House Association in addition to +the customary arrangements for the issue of loan certificates adopted +the following resolution: + + That in order to accomplish the purposes set forth in this + agreement the legal tenders belonging to the associated + banks shall be considered and treated as a common fund, held + for mutual aid and protection, and the committee appointed + shall have power to equalize the same by assessment or + otherwise at their discretion. For this purpose a statement + shall be made to the committee of the condition of such bank + on the morning of every day, before the opening of business, + which shall be sent with the exchanges to the manager of the + Clearing House, specifying the following items: + + (1) Loans and discounts. (2) Amount of loan certificates. + (3) Amount of United States certificates of deposit and + legal tender notes. (4) Amount of deposits deducting + therefrom the amount of special gold deposits. + +Two fairly distinct powers were given the clearing-house committee: the +right to issue clearing-house certificates, and control over the +currency portion of the reserves of the banks. This machinery was +devised (according to tradition) after the crisis of 1857 by George S. +Coe, who for more than thirty years was president of the American +Exchange National Bank. The purpose of the certificate was to remove +certain serious difficulties which had become generally recognized +during that crisis. The banks had pursued a policy of loan contraction +which ultimately led to general suspension, because it had proved +impossible to secure any agreement among them.[131] The banks which were +prepared to assist the business community with loans could not do so +because they would be certain to be found with unfavorable +clearing-house balances in favor of the banks which followed a more +selfish course. The loan certificate provided a means of payment other +than cash. What was more important, it took away the temptation from any +single bank to seek to strengthen itself at the expense of its fellows, +and rendered each bank more willing to assist the community with loans +to the extent of its power. + +But in addition to the arrangement for the use of loan certificates +provision was also made for what was called the equalization of +reserves. The individual banks were not, of course, equally strong in +reserves at the times when loan certificates were authorized. From that +moment they would be unable to strengthen themselves, aside from the +receipt of money from depositors, except in so far as the other banks +should choose to meet unfavorable balances in cash. Moreover, +withdrawals of cash by depositors would not fall evenly upon the banks. +Some would find their reserves falling away rapidly with no adequate +means of replenishing them. The enforced suspension of individual banks +would pretty certainly involve the other banks in its train. Finally, it +would not be impossible for a bank to induce friendly depositors to +present checks on other banks directly for cash payment, instead of +depositing them for collection and probable payment in loan +certificates, through the clearing house. The arrangement for equalizing +reserves therefore diminished the likelihood of the banks working at +cross purposes--a danger which the use of clearing-house certificates +alone cannot entirely remove. + +These arrangements had enabled the banks to pass through periods of +severe strain in 1860 and in 1861 without suspension. In both instances +the use of the loan certificate was followed immediately by an increase +in the loans of the banks, and in no short time by an increase in their +reserves. The situation in 1873 was more serious, and as events proved, +the reserve strength of the banks, while sufficient to carry them +through the worst of the storm, was not enough to enable them to avoid +the resort to suspension. + +In 1884, the next occasion when clearing-house loan certificates were +issued, the opposition to the provision for the equalization of reserves +was so widespread that it does not appear that it was even formally +considered. The ground for this opposition can be readily understood. In +1873 the practice of paying interest upon bankers' deposits was +generally regarded with disfavor. Only twelve of the clearing-house +banks offered this inducement to attract deposits; but by this means +they had secured the bulk of the balances of outside banks. It was in +meeting the requirements of these banks that the reserves of all the +banks were exhausted at that time. The noninterest paying banks entered +into the arrangement for the equalization of reserves in expectation of +securing a clearing-house rule against the practice of paying interest +on deposits. But their efforts had resulted in failure. Some of them had +employed their reserves for the common good most reluctantly in 1873, +and the feeling against a similar arrangement in 1884 was naturally far +stronger and more general. Moreover, the working of the pooling +agreement in 1873 had occasioned heart-burnings which had not entirely +disappeared with the lapse of time. It was believed, and doubtless with +reason, that some of the banks had evaded the obligations of the pooling +agreement. It was said that some of the banks had encouraged special +currency deposits so as not to be obliged to turn money into the common +fund. Further, as the arrangement had not included bank-notes, banks +exchanged greenbacks for notes in order either to increase their +holdings of cash or to secure money for payment over the counter. Here +we come upon an objection to the pooling arrangement which doubtless had +much weight with the specially strong banks, although it is more +apparent than real. In order to supply the pressing requirements of some +banks, others who believed that they would have been able to meet all +demands of their depositors were obliged to restrict payments. That such +an expectation would have proved illusory later experience affords ample +proof. When a large number of the banks in any locality suspend, the +others cannot escape adopting the same course. But in 1884 the +erroneousness of the belief had not been made clear by recent +experience. + +The New York banks weathered the moderate storms of 1884 and 1890 +without suspension, by means of the clearing-house loan certificate +alone, and in the course of time all recollection of the arrangement for +the equalization of reserves seems to have faded from the memory of the +banking community. There was, however, in those years another potent +influence which tended to lessen the likelihood of suspension following +the issue of loan certificates. Many banks were unwilling to take them +out, fearing that such action would be regarded as a confession of +weakness. The prejudice against them was indeed so strong that needed +loan expansion did not follow the authorization of their issue. In 1890 +the directors of the Bank of Commerce, then, as now, one of the most +important banks of the city, passed a resolution urging other banks to +relieve the situation by increasing loans and by taking out loan +certificates. + +In 1893 only a small part of the balances between the banks was settled +in certificates at first; but by the end of July practically all +balances were settled in that way and suspension followed at once. In +1907 all the banks having unfavorable balances, with but one important +exception, took out certificates on the first day that their issue was +authorized, and suspension was then for the first time simultaneous with +their issue. + +The connection between suspension and the use of clearing-house loan +certificates as the sole medium of payment between the banks is simple +and direct. The bank which receives a relatively large amount of drafts +and checks on other banks from its customers cannot pay out cash +indefinitely if it is unable to secure any money from the banks on which +they are drawn. So long as only a few banks are taking out certificates +and the bulk of payments are made in money, no difficulty is +experienced; but as soon as all the banks make use of that medium, the +suspension of the banks which have large numbers of correspondents soon +becomes inevitable. The contention of bankers both in 1893 and in 1907 +that they had not suspended since they had only refused to honor drafts +on other banks was untenable. The clearing-house loan certificate was a +device which the banks themselves had adopted and they had failed to +provide any means for preventing partial suspension as the result of its +use. The further contention of some bankers that they had suspended +because they had no money to pay out was doubtless true of a few banks, +but for that very reason other banks must have been all the stronger, +probably well above their required reserve. + +That the arrangement for equalizing the reserves, adopted in 1873, would +have availed to prevent suspension on subsequent occasions, is highly +probable, indeed a practical certainty. In 1893 events proved that the +banks had maintained payments up to the very last of the succession of +disasters with the results of which they had been contending. During +August the number of bank failures was not large and none of them was of +great importance. We cannot, of course, know how soon money would have +begun to flow back to New York, but certainly the suspension of payments +could hardly have hastened the movement. From the beginning of September +the reported movements of currency showed a gain for the New York banks, +and for the week ending September 16 the gain was no less than +$8,000,000. One month more of drain, therefore, was the most that the +banks would have been obliged to endure, and for the needs of that month +the banks would not, as in 1873, have been confined to the single +resource of the $79,000,000 of the cash in their vaults.[132] + +Similarly, the enormous increase in the money supply of the country in +November and December, 1907, would have offset much of the loss of +reserve which the banks would have incurred, if they had continued to +meet all the demands of their customers for cash. And, finally, it may +be observed that in the unlikely event that alarm had not been allayed +and suspension in the end had become unavoidable, it would not have made +any practical difference to depositors whether the reserves of the banks +had been but 10 per cent. rather than 20 per cent. of their demand +liabilities. + + +CLEARING-HOUSE BANK EXAMINATIONS[133] + +Most bank failures are due to the gradual acquirement of undesirable +assets over a period of years, and if some authority exists with power +to make recommendations of a remedial character, with the further power +to enforce such recommendations, if necessary, there is little doubt +that many bank failures would be averted. + +The panic of 1907 presented many striking examples of just what is +intended to be here emphasized, viz., that under the careful +supervision of a competent and reliable examiner many of the assets of +the failed banks, upon which it was impossible for them to realize at a +time when they needed their funds, would probably have been liquidated +upon his recommendation and advice long before the necessity for such +liquidation had arisen. + +Mr. J. B. Forgan of Chicago, has recently said on this subject: + + A competent examiner--and there are many such now in the + government employ--while he can not pass judgment on all the + loans in a bank, can, after a careful examination, or a + series of examinations, form a wonderfully correct judgment + as to the general character of its assets and as to whether + its management is good or bad, conservative or reckless, + honest or dishonest. Examinations, as they are now + conducted, have a most beneficial influence on bank + management, especially by way of restraint. The + correspondence carried on by the Comptroller, based on the + examiners' reports, does an inestimable lot of good in the + way of forcing bank officers to comply with the law and in + compelling them to face and provide for known losses as they + occur. Supervision by examination does not, however, carry + with it control of management and can not, therefore, be + held responsible for either errors of judgment or lapses of + integrity. Examination is always an event after the act, + having no control over a bank's initiative, which rests + exclusively with the executive officers and directors, and + depends entirely on their business ability, judgment, and + honesty of purpose. + +The clearing-house association of Chicago was the pioneer in the +establishment of an independent system of clearing-house bank +examinations in this country, its system having been inaugurated on June +1, 1906, with results that have, to the present time, more than +fulfilled the expectations of the bankers of that community[134].... + +In substantially his own words the Chicago examiner operates under the +following conditions: The examinations extend to all the associated +banks of Chicago and to all non-member institutions. The work is +conducted with the aid of five regular assistants, each fitted by +experience to thoroughly do that part of the work assigned to him. The +examinations include, besides a verification of the assets and +liabilities of each bank, so far as is possible, an investigation into +the workings of every department and are made as thorough as is +practicable. After each examination the examiner prepares a detailed +report in duplicate, describing the bank's loans, bonds, investments, +and other assets, mentioning specially all loans, either direct or +indirect, to officers, directors, or employees, or to corporations in +which they may be interested. The report also contains a description of +conditions found in every department. One of these reports is filed in +the vaults of the clearing house, in the custody of the examiner, and +the other is handed to the examined bank's president for the use of its +directors. The individual directors are then notified that the +examination has been made and that a copy of the examiner's report has +been handed to the president for their use. In this way every director +is given an opportunity to see the report, and the examiner, in every +instance, insists upon receiving acknowledgment of the receipt of these +notices. + +The detailed report retained by the examiner is not submitted to the +clearing-house committee, under whose direct supervision he operates, +unless the discovery of unusual conditions makes it necessary. A special +report in brief form is prepared in every case and read to the +clearing-house committee at meetings called for that purpose. The report +is made in letter form, and describes in general terms the character of +the examined bank's assets, points out all loans, direct or indirect, to +officers, directors, or employees, or to corporations in which they may +have an interest. It further describes all excessive and important +loans, calls attention to any unwarranted conditions, gross +irregularities, or dangerous tendencies, should any such exist, and +expresses, in a general way, the examiner's opinion of each bank as he +finds it. + +Less than a year after the Chicago Clearing House Association appointed +its special examiner the associated banks of Minneapolis took similar +action. The conditions under which the Minneapolis examiner operates are +substantially the same as those governing the examiner at Chicago, the +principal difference being that instead of the examiner sending a copy +of his report to the president of the examined bank and notifying each +of the directors of such bank that he has made such examination and +that the report is in the hands of the president of the institution, as +is the rule of procedure at Chicago, and which, in a measure, leaves it +to the discretion of the directors whether they examine the report +carefully and in detail, the original report is delivered by the +examiner at Minneapolis in person to the board of directors of each bank +which he examines, at a meeting convened for that purpose. The report is +read and the criticisms, if any, are fully discussed, and the +recommendations considered. In this way no director can complain that he +had not sufficient opportunity to become fully conversant with all the +details of his bank. + + +II. CLEARING HOUSES IN ENGLAND + + +THE LONDON BANKERS' CLEARING HOUSE AS THE FOREMOST EXAMPLE + +[135]The exact origin of the London Bankers' Clearing House will +probably never be determined, for, like other institutions whose purpose +has been to save time and trouble, its system appears to have been +gradually evolved.[136] + +With the growth of the check system, each banker would daily find +himself in possession of a number of drafts for the credit of his +customers that needed collection at the offices of other bankers. This +would necessitate each bank sending out one or more clerks on what +became known as "walks" to obtain cash or notes for these drafts from +the houses on which they were drawn. + +As in London alone there were some fifty or more private firms carrying +on a banking business this necessitated a considerable amount of work +and was attended with grave risk of robbery. + +It is probable, therefore, that arrangements were made by some of the +bankers, as it is still done in some country towns, to meet at one bank +one week and at another the next for the purpose of exchanging checks. + +But in consequence of the number of the London bankers this method would +prove awkward, and about the year 1770 we find that the walk clerks from +the city and West End banks had made a practice of meeting at lunch time +at a public house called the Five Bells in Dove Court, Lombard Street, +close to St. Mary Woolnoth Church, and not so very far from the site of +the Bankers' Clearing House of to-day. Here in the public room, or +according to tradition on the posts in the court outside, each day after +lunch a rough system of exchange of checks was carried on between the +clerks from each bank, the balances being settled in notes and cash. +From this rough system has developed the efficient organization of +to-day. + +In May, 1854, the clearing house was closed for alterations and +enlargement, and the business was temporarily carried on at the Hall of +Commerce. Here, on June 6, 1854, applications for admission to the +clearing house were received from the following joint-stock banks: The +London and Westminster, the London Joint Stock, the Union Bank of +London, the Commercial Bank of London, and the London and County Bank; +and it was resolved "that the secretary be authorized to comply with +such applications, subject to the payment of an annual sum to be fixed +by the committee to reimburse them for the outlay that has been found +necessary to afford accommodation for their admission." There were at +this time 25 private banks in the clearing house. + +Following on the admission of the five premier joint-stock banks in 1854 +there were frequent applications from other joint-stock banks--many from +the moment of their foundation. But the wise reply of the committee was +invariably that they did not "deem it expedient to take into +consideration such applications from any banking establishment that has +not been in operation at least for a period of twelve months." + +Though the joint-stock banks had been admitted to the clearing house yet +they were only allowed to rent seats there and had no share in the +management, so for the support of their mutual interests they had a +committee of their own which settled the rate to be given by the +joint-stock banks in the London district for deposit money at seven +days' notice. + +In 1858 the country bankers submitted a plan for establishing a country +bankers' clearing house in London and proposed that the clearing house +committee should appoint two or three of their number to unite with them +as a working committee. + +The establishment of a separate country bankers' clearing house would +have led to many inconveniences, and Mr. John Lubbock, now Lord Avebury, +submitted a plan for carrying out a separate country clearing at the +clearing house. The committee approved the plan and submitted it to the +country bankers' committee, who also gave their approval. + +Thus was instituted at the Bankers' Clearing House the country clearing, +which more than all else has brought about the almost universal use of +checks in England, to the exclusion of notes and coin. + +Mr. Lubbock's scheme was so well thought out that from its initiation to +the present time the rules have had to be only very slightly modified. + +In 1864 the Bank of England entered the clearing house to clear on one +side only, the outside, for though the bank presents to the clearing +bankers at the clearing house all checks payable by them, all checks and +bills drawn on the bank are presented by the clearing bankers at the +bank itself, and the proceeds placed to the credit of each bank's +account. At the same time the governor of the Bank of England was made +ex officio a member of the committee of clearing bankers. After 1864 few +changes were made in the working of the clearing house, the volume of +the country and town clearings increased greatly, but the house proved +capable of meeting any increase. + +Friction between the old private bankers and the joint-stock banks grew +less as amalgamations and absorptions increased, and before many years +the committee of London clearing bankers and joint-stock banks committee +amalgamated, it being agreed, as a condition of the joint-stock banks +committee ceasing to exist, that all the banks would abide by the ruling +of the committee as to the rate of deposit at seven days' notice. +Henceforth, every bank in the clearing house was entitled to have one +representative on the committee. Such representatives have hitherto +been chosen solely from the board or the partners and are nominated by +their banks and formally elected by the committee. The committee elects +its own chairman, vice-chairman, and honorary secretary. This committee +meets regularly on the first Thursday in each month, Thursday being the +day on which the Bank of England in normal times makes any alteration in +the bank rate of discount, but it may be summoned by requisition at any +time and meets automatically should the bank rate be altered, since this +governs the rate of deposit allowed by the bankers. + +The committee has full power over all clearing house matters, and from +the importance of the banks who compose the clearing house its opinion +carries very great weight on all matters in the banking world. It is, +however, controlled only by the mutual agreement of its members: and the +decision of the majority of its members, though followed loyally, is +never used with any ultimate power of compulsion in matters affecting +banking in general. + +In 1907 a third clearing, the Metropolitan, was established. Hitherto, +with the exception of one or two city offices which were included in the +town clearing, the collection of drafts on London branches of the +clearing banks had been effected by the post and by the sending out of +walk clerks by each bank; but in 1907 it was determined to do away with +such means of collection as far as possible and to collect the branch +checks through the clearing house. This proved so successful that the +West End banks were approached the following year, and with one +exception readily consented to come into the new plan by which their +clearing agents had delivered to them at the Metropolitan clearing all +checks drawn upon them. This clearing is the first clearing made each +morning and is handled so expeditiously that even the most distant +London branches get their checks almost earlier than under the old +system. They have, therefore, plenty of time to go through them and to +make returns of any checks that cannot be paid in time for such return +checks to reach the clearing house early in the afternoon. There are now +over 330 banks and branches using this clearing. + +For the better defining of the three clearing areas--town, +metropolitan, and country--the letters T M C have been placed in the +corner of all bank checks. From February 19, 1907, the date of the +initiation of the Metropolitan Clearing, up to December 31 of that year, +£482,227,000 was paid in this clearing, while for the year 1908 the +total was £647,842,000, as compared with the town clearing total for +that year of £10,408,254,000 and the country total of £1,064,266,000, +making in all a grand total of £12,120,362,000, which figures, vast as +they are, were a decrease of £610,031,000 on the total £12,730,393,000 +for the previous year, 1907.[137] The work entailed by such vast figures +as these could scarcely have been dealt with by hand alone, but by the +installation of adding machines the work is easily and quickly done. + +It must not be thought that all checks on London are presented through +the clearing house, for checks on the London branches of the Scotch +banks and of the colonial and foreign banks are still presented over the +counter. + +Moreover, though it is mutually understood between the clearing banks +that checks on each other will only be presented through the clearing +house, this agreement has no legal binding. + +Two exceptions are continually made; documents or goods have to be taken +up against cash, and the owner before parting wishes to be certain of +his money. In this case the presenting banker either presents his check +for marking--that is to say, the paying banker having ascertained from +his customer's account that there is sufficient money thereon, marks the +check for payment, which has the same effect as if the banker had +accepted it; or, as is becoming more usual, the paying banker gives one +of his own drafts on the Bank of England in exchange for the check. + + +PROVINCIAL CLEARINGS + +Besides the London clearing house, which is an irregular building of no +architectural features whatever, there are eight provincial clearing +houses in England--Birmingham, Bristol, Leeds, Leicester, Liverpool, +Manchester, Newcastle and Sheffield.[138] + +Two only of these clear over £100,000,000 in the year. Manchester +cleared £320,296,332 in 1907, with an average weekly total of £6,159,545 +and an average daily total of £1,039,923, and Liverpool £196,325,829. +The others cleared in the same year from £12,000,000 to £61,000,000. +Small figures, indeed, compared with London, where the highest total +paid on any one day was, in 1907, £106,703,000. In 1908 the highest +total paid in one day in the London clearing was £85,833,000 and the +lowest £24,903,000. + +In London, as in the provincial places, the object of the clearing house +is primarily the convenience of exchange of checks, not the regulation +of banking, and little is regulated save, perhaps, the rate of interest +to be paid on deposits at seven days' notice. + +In these days, too, when the tendency is strong for amalgamation, the +local banks are dwarfed by their gigantic competitors, with their +branches in many counties and head offices in London, with the result +that London each year controls more of the banking in England and the +provincial clearings cease more and more to be under local control, but +are controlled by their London head offices. + +This may, if the present tendency of amalgamation continues,[139] result +in the committee of London clearing bankers becoming an important +controlling body, but that time is not yet at hand, and though, as we +have said, an expression of opinion on the part of the committee carries +very great weight, yet anything like dictation would very properly be +resented by the important and old-established banks in both London and +the provinces that are outside the clearing house. + +FOOTNOTES: + +[121] James G. Cannon, _Clearing Houses_, Publications of the National +Monetary Commission, Senate Document, No. 491, 61st Congress, _2nd +Session_, p. 1. + +[122] _Ibid._, pp. 148-150. + +[123] _Ibid._, pp. 150-154. + +[124] _Ibid._, pp. 163-165. + +[125] 62 members in 1914. + +[126] _Ibid._, pp. 41, 43, 44-46. + +[127] _Ibid._, p. 37. + +[128] _Ibid._, pp. 75-79. + +[129] O. M. W. Sprague, _Banking Reform in the United States_, pp. +104-113. Harvard University. 1911. + +[130] The figures in the text refer to the legal tender holdings of the +banks. The banks also held a considerable amount of specie but it was +not a free asset as most of it had been received on special accounts +payable in gold. Including the specie holdings the reserve ratio was +12.8 per cent. + +[131] C. F. Dunbar, Economic Essays, chap. XVI. + +[132] The increase in the amount of money in circulation for August, +1893, was estimated at $70,000,000. + +[133] James G. Cannon, _Clearing Houses_. Publications of the National +Monetary Commission, Senate Document No. 491, 61st Congress, _2d +Session_, pp. 137-141. + +[134] [A number of the more important cities such as St. Paul, St. +Louis, and Philadelphia, following the example of Chicago and +Minneapolis, have instituted clearing house bank examinations since +1907.] + +[135] Adapted from Robert Martin Holland, _The London Bankers Clearing +House_. Publications of the National Monetary Commission, Senate +Document No. 492, 61st Congress. _2nd Session_. + +[136] The date of the establishment of the Clearing House is not known. +The Clearing has, however, been in existence about 150 years.--EDITOR. + +[137] [For the five years 1910-14, the total clearings of the London +Clearing House were in the neighborhood of £15,000,000,000 per annum of +which the Town, Metropolitan, and Country Clearings were about 86, 5.5, +and 8.5 per cent., respectively.] + +[138] [The approximate number of clearing houses outside of London, in +England, in 1915 is twelve, but these are used only for local clearings. +In addition, most of the towns in England and Wales have a local +exchange which is a clearing on a small scale.] + +[139] This tendency has continued as to both the joint-stock and private +banks.--EDITOR. + + + + +CHAPTER XX + +STATE BANKS AND TRUST COMPANIES SINCE THE PASSAGE OF THE NATIONAL BANK +ACT + + +[140]The banking institutions of the United States other than national +banks are ordinarily classified into (a) state banks, (b) trust +companies, (c) stock savings banks, (d) mutual savings banks, and (e) +private banks. The following pages deal with two of these classes, viz., +state banks and trust companies. It will be desirable at the outset to +distinguish them from the other classes, and to outline the history of +legislation concerning them since 1865. + +The term "state bank" has been used in the United States in several +different senses; but whatever the variance in meaning, such banks have +always had one common characteristic--incorporation under state +authority. In the bank reports of some of the States, private banks are +not distinguished from state banks. This is due to the fact that in +these States incorporated and unincorporated banks are subject to the +same regulation. A private bank, however, is an unincorporated bank. + +Not all banking institutions incorporated by the States are state banks. +Mutual savings banks, stock savings banks, and trust companies are also +corporations organized under state laws or charters granted by state +legislatures. The distinction between mutual savings banks and state +banks is clear. Mutual savings banks do not have a capital stock and do +not carry on a discount and deposit business--_i. e._, they do not +discount commercial paper, and do not receive demand deposits payable on +check. State banks, on the other hand, have a capital stock and carry on +a discount and deposit business. Many state banks, however, receive +also savings deposits. The line of demarcation between state banks and +stock savings banks is much less definitely marked. Both state banks and +stock savings banks have a capital stock. Stock savings banks are +primarily savings banks, and many of them do not do a discount and +deposit business, but confine themselves to the savings bank business. +But in several States the distinction between state banks and stock +savings banks is of the most unsubstantial character, since the stock +savings banks carry on the business of a commercial bank, receiving +demand deposits payable on check, and discounting commercial paper. +Finally, the distinction between state banks and trust companies is not +exactly the same in any two of the States. + +"State banks" then, as the term is used in the following pages, are +banks of discount and deposit (as distinguished from savings banks, +mutual and stock) incorporated by one of the States or Territories (in +contrast with private banks, which are unincorporated, and with national +banks, which are organized under the national-bank act).[141] + +In 1860 there were in the United States 1,562 state banks. Owing to the +repressive influence of the national-bank act, hastened in its effect by +the 10 per cent. tax on state-bank notes, the number of state banks had +by 1868 fallen to 247. One result of this decline in the number and +importance of state banks was the cessation of state banking +legislation. The old laws regulating state banks of issue were swept +away by code revisions, or remained obsolete and unchanged on the +statute books. + +The number of state banks began to increase about 1870. In a few States +old banking laws intended for the regulation of banks of issue hampered +their development, but in the remaining States they were left for a +considerable period almost entirely without regulation. As late as 1892, +in his digest of the state statute law, Mr. Stimson said: + + It seems unnecessary to incorporate the state banking laws + in this edition. Nearly all the States, except the newer + States and Territories, have special chapters in their + corporation acts concerning banks and moneyed institutions, + but these chapters are usually of old date, and have + practically been superseded for so long a time by the + national banking laws that they have become obsolete in use + and form. + +The increasing attention paid in recent years by the state legislatures +to the regulation of the state banks has been partly due to the rapid +growth of the banks in numbers and in financial importance; but it is to +be accounted for primarily by a change of view as to the purpose of +banking regulation. The antebellum state-bank regulations were intended +to secure the safety of the bank note. Although the depositor was +protected by many of the regulations, this protection was purely +incidental. The view that note-issuing banks alone required governmental +regulation persisted for a considerable time after the passage of the +national-bank act. Since the national banks had a monopoly of the issue +of bank notes, the regulation of state banks was considered needless. As +the importance of note issue as a banking function decreased, banking +regulation, as seen in the national-bank act, began to be considered +desirable as a protection to depositors. + + +THE EVOLUTION OF THE TRUST COMPANY + +With the exception of the power to issue notes, which would be +unavailable because of the tax on note issue, the powers of the state +banks of to-day are essentially the same as the powers of the state +banks which were in operation before the Civil War. On the other hand, +the trust company is a new type of banking institution, the functions of +which are even yet not clearly defined. A great part of the legislation +with reference to trust companies, therefore, has had to do with +defining the powers of these corporations. + +The early laws for the incorporation of trust companies show the widest +differences of opinion with regard to their field of operation. The one +point of agreement appears to have been the idea that a corporation +could administer trusts more advantageously and safely than an +individual. But the companies in all the States were given additional +powers more or less closely connected with their trust powers. Some of +the companies, chiefly the very early ones, were empowered to insure +lives and to grant annuities. In a considerable number of States the +companies were authorized to insure the fidelity of persons in positions +of trust and in some States to insure titles to land. Almost all the +companies were empowered to do a safe-deposit business. Among these +powers there was a certain apparent connection. The power to insure the +fidelity of trustees, administrators, and executors seemed a natural +addition to the powers of a company which might act in such capacities. +Similarly, it appeared that the business of insuring titles to land was +one which could be most economically conducted by a corporation which, +in its capacity of trustee, would be a large owner of real estate. + +One other power was given to practically all the companies--the power to +receive deposits of money in trust. The following quotation from the +Report of the Massachusetts Commissioners of Savings Banks for 1871 +shows the use which it was expected would be made of this power: + + The trust company in Worcester and the New England Trust + Company in Boston, both in successful operation, are the + first of such corporations established in this State. They + were incorporated after a very careful investigation by the + legislature, with power to hold money in trust, and so + restricted in making loans and investments as to afford the + safety which the character of their business requires. A + similar institution will soon be organized in Northampton, + and others are contemplated. They are well calculated to + promote public interests by affording to the owners of + capital not engaged in business many of the advantages + secured by our savings-bank system for the savings of labor. + +The development of the trust company as reflected in the legislation +with reference to its powers shows two main tendencies: (1) The +companies have to a very large extent given up the insuring of the +fidelity of persons in positions of trust and the guaranteeing of land +titles. (2) They have largely increased their banking activities. + +1. In some States which formerly authorised trust companies to insure +the fidelity of persons in positions of trust, or to guarantee titles to +real estate, the more recent laws do not permit the combination of such +business with the business of a trust company. + +The fidelity insurance business during the past twenty years has been +largely concentrated in the hands of a comparatively small number of +companies which have agencies in all parts of the country and which do +not undertake a trust or banking business. The elimination of fidelity +insurance from the functions of the trust company has not been chiefly +or even largely due to adverse legislation, but to the nature of the +fidelity insurance business. The most successful conduct of that +business appears to require, like other kinds of insurance, that the +risks shall be numerous and widely distributed. These conditions are +best met by companies which carry on business in many different places. + +For the most economical conduct of the title insurance business an +expensive plant is necessary. The business in each city tends therefore +to fall into the hands of a single company, which ordinarily finds it +profitable to devote itself entirely to the one kind of business. At the +present time, only a very small part of the trust companies in the +United States insure titles to land. + +2. The second great tendency in the development of the powers of the +trust company--the enlargement of its banking powers--has also been +primarily an economic development and not one due to legislative design. +As has already been noted, the early trust companies ordinarily had +power to receive trust deposits and to loan money. Some such powers were +necessary for the exercise of their trust functions. The opportunity to +enlarge the banking powers of the companies lay in the difficulty of +distinguishing clearly between the powers which it was intended to +confer upon the trust companies and the banking powers possessed by +state and national banks. + +In the greater number of the States the wording of the sections +conferring powers to do a trust business was such that the trust +companies were either held by the courts to be empowered to do a banking +business, or, if the power to do such business seemed not to be granted, +were able by some change in the method of doing the kind of banking +business in question to bring it within the powers actually conferred. +In Missouri, for instance, since 1885 trust companies have been +empowered to "receive money in trust and to accumulate the same at such +rate as may be obtained or agreed upon or to allow such interest thereon +as may be agreed." The supreme court of Missouri in construing the power +thereby conferred has held that a trust company can take only +interest-bearing deposits, but that such deposits may be demand deposits +payable on check. The rate of interest may, however, be nominal. + +In other States the trust companies have attained legal recognition of +their banking powers by slow steps. The history of the Pennsylvania +trust companies affords an illustration. In the Pennsylvania general +corporation act of 1874 no provision was made for the formation of trust +companies, but provision was made for the incorporation of +title-insurance companies. By an amendment to the corporation act in +1881 title-insurance companies with a capital of at least $250,000 were +given trust and fidelity-insurance powers; but it was expressly provided +that such companies were not authorized thereby to do a banking +business. In 1885 the trust companies were given the power to receive +upon deposit for safekeeping valuable property of every description, and +in 1895 trust companies were given power to "receive deposits of money +and other personal property and to issue their obligations therefor ... +and to loan money on real and personal securities." In 1900 the United +States circuit court of Pennsylvania decided that Pennsylvania trust +companies might legally receive demand as well as time deposits. +Pennsylvania trust companies apparently even now cannot discount +commercial paper, but they may loan on it as collateral and may purchase +it from the holder. + +The States in which the banking powers of the trust companies have been +most narrowly restricted are Iowa, Michigan, Nebraska, and Wisconsin. In +Nebraska a trust company cannot do a banking business. In Iowa trust +companies cannot do a banking business except that they may receive time +deposits and issue drafts on their depositories. In Michigan trust +companies are expressly forbidden to do "a general banking business." +The Michigan commissioner of banking in his report for 1906 complained, +however, that the law was not clear as to the banking powers of the +companies. In Minnesota the trust companies may receive trust deposits, +but may not "engage in any banking business except such as is expressly +authorized for such a corporation." In Wisconsin the extent of the power +of trust companies to receive deposits was much debated until 1909, when +the legislature provided for the incorporation of "trust-company banks," +which have power to receive time and savings deposits, but do not have +power to receive deposits subject to check. + +The result of the two tendencies described above--the elimination of the +insurance powers of the trust company and the addition of banking +powers--has gradually standardized the powers of the trust company, +until at the present time the trust company, as it appears in the +corporation laws of most of the States, may be fairly well defined as a +bank which has power to act in the capacity of trustee, administrator, +guardian, or executor. + +In a number of States the legislation concerning trust companies deals +with them explicitly from this standpoint. The Illinois bank act of 1887 +provided that any bank might have power to execute trusts by complying +with the trust-company law. In Alabama and Tennessee any state bank may +be appointed and may act as an executor, administrator, receiver, or +guardian. In Mississippi any bank with a paid-up capital of $100,000 may +do a trust-company business. In Georgia any trust company may acquire +banking powers by complying with the laws regulating banks. In Texas +banks may acquire trust-company powers. The same tendency is shown in +the important banking laws enacted in Ohio in 1905 and California in +1909. + +The gradual change from the view that the trust company is an +institution of markedly different character from the ordinary bank of +discount and deposit to the view that the trust company is merely a bank +exercising functions additional to those exercised by the majority of +banks has been the chief influence in determining the form of the legal +regulations imposed upon trust companies. As long as the older view +obtained, the regulations concerning trust companies were widely +different from those imposed upon banks; but as the trust company has +increased both the scope and amount of its banking business, the +regulation of the banking business of the trust company has tended to +become assimilated to the regulations imposed upon state banks. + + +INCORPORATION + +Since 1865 state banks and trust companies have been incorporated by the +use of one of three methods: (1) By special charter; (2) under the +"business incorporation law"; (3) under the general banking law. Not +very many of the States have used consecutively all three methods, for +the special charter and the "business incorporation law" were used +contemporaneously in different sections of the country. Both have given +place, in the great mass of States, to the general banking law. From +1865 to 1875 probably the greater number of the banks formed were +incorporated under special acts; from 1875 to 1887 incorporation under +the "business incorporation law" was the prevailing method, and since +then the general banking law has become the almost universal method of +incorporating banks and trust companies. + + +CAPITAL AND SURPLUS REQUIREMENTS + +When the States began to give attention to the regulation of the banking +business the question of capital received immediate attention. The +national-bank act and the banking laws in New York and the Middle West +which had survived from the antebellum period contained provisions +concerning the amount and payment of capital. A requirement with regard +to capital was recognized as the central point in any system of bank +regulation. The capital stock is a buffer interposed between the bank's +creditors and losses which the bank may suffer. If there is no capital, +losses may fall directly on the creditor, and the larger the capital +stock, other things being equal, the less the likelihood of loss to the +depositor. + +The States and Territories may be divided roughly into two groups +according to the amount of the smallest permissible capital for state +banks: + +1. In the Eastern States and the more easterly of the Middle Western +States, the banking laws, with one exception, require that banks shall +have a capital of at least $25,000. + +2. In the other sections of the United States banks in most of the +States are incorporated with a capital as small as $10,000, although in +a few of these States the smallest permissible capital is $15,000, +$20,000, $25,000, and $30,000, and in one, North Carolina, it is $5,000. + +The amount of capital required, except in a few States, is not a uniform +amount, but is graded, usually according to the size of the city in +which the bank is located. In 29 of the 37 States and Territories which +require under a general law a specified amount of capital for the +incorporation of state banks the amount of capital is thus graded. The +grading of the amount of capital required according to the population of +the place in which a bank is located has been chiefly due to the desire +to bring about some adjustment between the capital of each bank and the +volume of its business. It is assumed that the larger the business of +the bank the greater the chance of its suffering large losses and the +larger the capital necessary to protect its depositors against loss. It +is also assumed that the size of the city in which it is located is a +rough index of the volume of business done by a bank. Under many of the +state banking laws the grades are very numerous. The minute gradation of +the capital requirements found in many of the state banking laws is due +to the desire to encourage the formation of banks in the smaller cities +and towns, for it is to be noted that in the greater part of the state +laws the grades are not numerous for the larger places. + +Obviously, if any law requiring a minimum capital for banks is to be +effective, it must provide specifically for the payment either of all +the capital or of a specified sum; otherwise the directors of the bank +may require the payment of only a small part of the capital. The +provision in the national-bank act concerning the payment of capital has +been the model for similar provisions in the banking laws of a large +number of the States. Many of the state banking laws likewise contain +the same provision as the national-bank act with reference to surplus. + +In several States the laws make no provision with reference to the +amount of capital required for a trust company. In Connecticut, +Delaware, New Hampshire, and Vermont, trust companies are incorporated +only under special acts and the amount of their capital is determined in +each particular case by the legislature. In Rhode Island trust companies +are incorporated by a board which has power to fix the terms of +incorporation, including the amount of capital. + +The first general laws for the incorporation of trust companies in the +United States required such companies to have a much larger capital than +that required for banks, but the later legislation shows a distinct +tendency in the direction of lowering the requirements in regard to +capital. In nearly all of the States, however, the requirement for trust +companies is still substantially different from that for state banks. +The smallest permissible capital for a trust company ranges from $5,000 +in North Carolina to $1,000,000 in the District of Columbia. The +majority of the States, which provide that trust companies must have a +specified minimum capital, do not permit the organization of trust +companies with a smaller capital than $100,000. + +In only one State, Iowa, is the smallest permissible capital less for +trust companies than for state banks; in six States it is the same; in +all the others it is larger. The accumulation of a surplus is not +required in so many States for trust companies as for banks. + + +LIABILITY OF STOCKHOLDERS + +With the practical prohibition of the issue of state bank notes in 1866 +and the consequent decrease in the number of state banks, the liability +of stockholders in state banks became in nearly all of the States, +except where an additional liability was imposed by the constitution, +the same as that of stockholders in ordinary business corporations. +Since 1880, however, provisions imposing an additional liability on the +stockholders of banking corporations have been placed in the banking and +trust-company laws of nearly all the States in which state banks or +trust companies have assumed any great importance. In the larger number +of the States and Territories the liability is a proportionate one, and +the stockholders are responsible "equally and ratably and not one for +another." + +The imposition of the statutory liability on the stockholders of state +banks and trust companies has not proved of great service as a +protection to bank creditors against loss. As yet little has been +accomplished in the way of making the enforcement of the liability +effective. + + +RESTRICTIONS ON LOANS AND DISCOUNTS + +The desirability of some legal limitation on the extent of the liability +to a banking institution which any one person, firm, or corporation may +incur is largely due to the fact, that, since the American banking +system is a system of independent banks, the resources of many of the +banks are necessarily small in comparison with the needs of some of +their customers for loans. A large manufacturing concern located in a +small town may very well be able to use all the assets of the local +bank. If the local bank were the branch of a larger bank, the mere fact +that a large loan was wanted by a manufacturer in a small town would be +of no significance, since the amount of the loan would be small compared +with the total assets of the bank. + +Moreover, in many banks a controlling interest is held by a person, +firm, or corporation that is actively engaged in other business +enterprises. Such control is far more likely to be found in small banks +than in large, and in a system of independent banks than in one of +branch banks. One consequence of the close identification of interest +thus brought about between banking and other business enterprises is the +probability that loans will be made directly or indirectly to some one +borrower to an amount larger than a proper distribution of risks would +justify. + +The national-bank act in its original form provided that the total +liabilities to any national bank of any person, company, corporation, or +firm for money borrowed should not exceed one-tenth of the amount of the +paid-in capital stock of the bank. The liabilities of the members of the +firm or company were to be included in the liabilities of the firm or +company. It was provided, however, that "the discount of bills of +exchange in good faith against actually existing values and the discount +of commercial or business paper actually owned by the person negotiating +the same" should not be considered as money borrowed. This section of +the national-bank act remained unchanged until 1906, when it was amended +so as to permit a single liability to be contracted equal to one-tenth +of the capital and surplus, instead of one-tenth of capital only, but it +was also provided that the liability should not, in any case, exceed 30 +per cent. of the capital stock. + +In the banking laws of seven States the limit on the amount of single +liability is the same as under the national-bank act. The banking laws +of almost all the other States permit a larger amount to be loaned on a +single liability than is permitted by the national-bank act. + +In nearly all of those States in which trust companies have acquired +full banking powers the provision limiting the amount of any single +liability applies to both banks and trust companies. In only one State +or Territory--New Mexico--is there such a provision for trust companies +and none for state banks. In a few States--Kansas, Michigan, Minnesota, +Missouri, Montana, Oklahoma, New Jersey, Nebraska, and Wisconsin--there +are limitations on the amount of a single liability for banks, but none +for trust companies. + + +LOANS TO DIRECTORS AND OFFICERS + +In almost all the banking institutions of the United States the +directors or a part of them are actively engaged also in other business +enterprises; and in many cases they borrow from the banks or trust +companies in which they are directors. Moreover, in some banks one or +two of the directors own a controlling interest, and are at the same +time large borrowers. The possibility, in such cases, that larger loans +may be made than the credit of those directors warrant is very +considerable. The national-bank act contains no provisions regarding +loans to directors, but in the laws of about one-half of the States +attempts have been made to devise rules which would prevent the making +of loans to directors in excess of the amount to which their credit +entitles them. The requirement that loans to directors shall be formally +approved by the board of directors is the one most frequently found. It +has been thought that directors would be reluctant to vote for excessive +loans to other directors if their vote is to be recorded. + + +REAL ESTATE LOANS + +There is no more characteristic difference between state banking laws +and the national-bank act than the fact that, in almost all the States, +state banks and trust companies may make loans on the security of real +estate, whereas national banks are [were] prohibited from doing so +[before the passage of the Federal Reserve Act]. In some States, where +the influence of the example of the national-bank act was strong enough +at the beginning of state-bank regulation to secure the insertion in the +state banking laws of the prohibition of real estate loans, it has later +been found desirable to amend the laws in this respect. The Pennsylvania +general banking law of 1878, for instance, did not permit banks to loan +on real estate, but was amended in 1901, so as to permit such loans to +be made. In North Dakota and South Dakota, also, similar changes have +been made in the banking laws. In 1910 trust companies in all the States +and Territories where incorporated under general laws were allowed to +loan on the security of real estate. State banks so incorporated may +also loan on real estate in all the States and Territories except New +Mexico and Rhode Island. In Rhode Island, however, banks may loan on +real estate part of their savings deposits. + +A few of the state banking and trust-company laws contain provisions +limiting the amount which may be invested in real estate loans. + +Not withstanding the disadvantages of real estate as a convertible +asset, the power to loan on the security of real estate is a valuable +one to many of the state banks.[142] Many banks, particularly those in +the smaller towns and cities, if restricted to loans on personal +security, find it difficult to fully employ their funds. There are not +sufficient local loans of this kind to employ all the funds of the bank; +and the amount not so employed, if it is to yield a revenue, must either +be invested in outside commercial paper or deposited with banks in the +great commercial cities. + + +RESERVES + +In most of the antebellum state banking laws reserves were required only +against note issue. In Ohio, for example, the general banking law +required a reserve of 30 per cent., against circulation, but none +whatever against deposits. Several of the state banking laws which +survived the destruction of the state bank-note issue contained, +however, provisions requiring banks to hold a reserve against deposits; +but in none of these States was the increase in the number of state +banks important. In those States in which the state banks were organized +under the "business incorporation laws" there were, of course, no +reserve requirements. Until 1887 a reserve was required for state banks +in only three States, Ohio, Minnesota, Connecticut, and in these the +required reserves were small. Even since the revival of state bank +regulation, which began in 1887, the requirement of a reserve has not +been regarded in many of the States as an important part of the state +banking law. + +The most striking and important difference between the reserve required +by the national-bank act and the reserves required by the state banking +laws is that under the national-bank act the reserve is a percentage of +"deposits"--_i. e._, of all deposits--while under the banking laws of a +majority of the States either no reserve is required against time or +savings deposits, or a smaller amount of reserve is required than +against demand deposits. + +None of the state banking laws require that the reserve of any class of +banks shall consist wholly of cash in bank. All the laws permit balances +in other banks to be counted at least as a part of the reserve. There +are great differences among the laws, however, with respect to the +amount which may be so counted. + +The laws in all the States leave the banks almost entirely free to +deposit their funds in banks in the great commercial centres. The strong +economic pressure toward concentration is thus left free to act toward +drawing reserves into banks located in the reserve and central reserve +cities. + +In the greater number of States which incorporate both state banks and +trust companies the reserve requirement is the same for both classes of +credit institutions. Slight differences between the requirements for +trust-company reserves and those for state-bank reserves are chiefly of +two kinds. In the first place, the provisions for trust-company reserves +more frequently permit the counting of bonds as a part of reserve; +secondly, the provisions for differing amounts of reserve against time +and demand deposits. + +In recent years there has been much complaint in some States that the +reserves required for trust companies are inadequate. + + +BRANCH BANKS + +The most characteristic feature of American banking is the extent to +which the banks and trust companies are independent institutions. The +national-bank act makes no provision for the establishment of branch +banks except in cases of the conversion of state banks which already +have branches. Such banks are allowed to retain their branches on +condition that the capital is assigned to the mother bank and the +branches in definite proportions, but only a few national banks have +branches. Under none of the state banking laws has there been built up +an important system of branch banks. This has been partly due to the +very general desire of each American community, no matter how small, to +have its bank managed by its own citizens, and partly to the fact that +in most of the States the establishment of branch banks is either +explicitly forbidden or in no way provided for by law. In eight +States--Colorado, Connecticut, Mississippi, Missouri, Nevada, +Pennsylvania, Texas, and Wisconsin--the opening of branch offices is +forbidden by specific enactment. In a large number of other States the +banking laws make no provision for the establishment of branches, and it +has been held in most of these States that the opening of branch offices +is unlawful. + +The States in which state banks and trust companies are definitely +permitted to have branches are California, Delaware, Florida, Georgia, +New York, Oregon, Rhode Island, Virginia, and Washington. In Louisiana, +Maine, and Massachusetts trust companies may have branches. In Maryland +and North Carolina branches are operated by some banks and trust +companies which were chartered by special act. There are in several of +these States, however, restrictions on the opening of branch offices. In +New York and Massachusetts branches may be established only in the city +in which the principal office of the bank or trust company is located. +In New York, moreover, only banks located in a city of 1,000,000 +inhabitants or over may have branches; but any trust company may have +branches. In Maine a trust company may establish branches only in the +county in which it is located or in an adjoining county. + +In nearly all the States which permit banks or trust companies to +establish branches one or both of two conditions are imposed. In the +first place, additional capital is required for each branch bank over +and above the amount of the parent bank. Secondly, the establishment of +a branch bank must be specifically authorized by some state official or +officials. + +The number of branches of banks and trust companies cannot exceed a few +hundred in the entire United States. Compared with the total number of +banks and trust companies this is a small development. Moreover, the +most important affiliations among banking institutions are among those +located in the same city. The "chains" of country banks possess, for the +most part, little vitality, and in the total banking business of the +country they play an insignificant rôle. The great mass of state banks +and trust companies are independent institutions. The most enduring +affiliations at present existing among the banking institutions are +those between a national bank and a trust company or a state bank and a +trust company. The comparatively limited powers of the national banks +and in some States of the state banks have made it desirable for many of +these institutions to affiliate trust companies with themselves in order +that desirable business may not be lost. + + +FURTHER REASON FOR THE LACK OF BRANCH BANKS IN THE UNITED STATES + +[143]It would seem that there must be a reason for this peculiarity [the +small number of branches] in the banking system of the United States. In +searching for this reason, the first fact of importance seems to be +that, although the organization of branches has been permitted to the +non-note-issuing banks in some of the States, they have not been +organized, while in other countries they have been established in nearly +every case. by note-issuing banks. This seems at once to indicate that +in places where notes are the most important medium of exchange a +connection of some sort exists between the issue of notes and the +establishment of branches. + +The inducement to the establishment of branches by banks is, of course, +the possibility of profit. But as has already been frequently pointed +out, profit can be obtained only by making loans. These when greater +than the amount of the capital, as it is necessary that they should be, +can be made by the loan of funds left with banks by others or by the +issue of circulating notes. It is also clear that, were the +possibilities of loaning beyond the amount of the capital wholly or +chiefly confined to one of these forms of liability--the other being +unavailable, as in the case of the state bank notes whose issue is +prohibited by the 10 per cent. tax--and were this other form distasteful +or impossible of introduction among the community where the branch was +to be established, the motive for the creation of the branch would be +absent. This motive has been wanting in many parts of the United States. +By the laws of the United States, the issue of notes has been made +impossible to all save national banks, and the capital of these banks +has been limited to $50,000 as a minimum. Banks other than national +must, therefore, be established under state laws, some of which have +permitted the organization of such institutions with capitals as low as +$5,000 or $10,000. They can, however, make use only of deposits as a +means of loaning beyond the amount of their capital. But deposits do not +provide a desirable form of currency for use in country districts. It +follows, therefore, that the state-bank systems supply the deficiencies +of the national system only in so far as they furnish independent banks +of smaller capital than $50,000 ($25,000 since 1900). + +Nor would it have been of material assistance had the organization of +national banks of capitals smaller than $50,000 been allowed. As the +system has worked out, the issue function has been a useless one. The +compulsory deposit of bonds to secure circulation has hampered the banks +in exercising this function, since the requirement to deposit bonds now +cuts off all profit arising from the issue of notes. Moreover, the rural +communities are those where interest is highest, and hence where notes +can least advantageously be issued under the present system of +bond-deposit, owing to the high price of the bonds. These difficulties +probably cannot be overcome by the establishment of banks of lower +capitals than now exist. + +[144]At the 1910 convention of the Alabama Bankers' Association, held in +Birmingham in May, one of the speakers, whose topic was "State Banks and +Their Branches," closed a condemnatory address with the words: "We +believe the days of the branch bank are numbered." Two months later, at +Cooperstown, Hon. E. B. Vreeland told the bankers of New York State, at +their convention: "No one will ever live to see the day when the branch +banking system which prevails in Canada and in Germany and in England +and in France will be tolerated by the people of the United States."... +"The economies of the branch banking system are such that no other +system can live beside it. It is just as sure as the sun will rise +to-morrow that the branch banking system, if taken up in the United +States, would in the end drive out of existence all the banks in every +city and town in the country outside of the great financial centres. +That is the experience of the world." + +If this statement means anything it is a confession that the system of +local single-office banks is wasteful in operation, and it seems to me +that it sets forth one reason why branch banks are inevitable. When a +banking system is wasteful it is the stockholders, borrowers, and +depositors who suffer from the circumstance, and as soon as they realize +the fact its doom is sealed. + +It should be said here that it is not their economical operation alone +that has enabled the branch banks to displace the small local banks in +England, Germany, and France. The branch institutions are cleaner, more +efficient, and they provide better opportunities for the clerks and +officers; they give a better and more complete service to the localities +in which they work.... Another reason is found in their stability during +crises.... + + +THE NEW YORK STATE BANK ACT OF 1914[145] + +In June, 1913, George C. Van Tuyl, Jr., superintendent of banks of the +State of New York, appointed a commission to look into the banking +conditions of the State and to make a thorough revision of the law +relating to banks. This commission conducted many public hearings; +sought information from banking experts in this State and in other +States; made a careful study of private banking conditions, rural +credits, and other special banking problems of the State; and, finally, +on February 25, 1914, they presented their report in the form of a bill +of some 500 pages. After a good many amendments had been made to appease +conflicting interests, the bill was passed and became law April 16, +1914. + +In general, the new law marks a decided improvement and shows a +commendable spirit of progressiveness. Its framers believe that it is a +law which may well become the model for other States, and there are some +who say that it is without question the best balanced and most +comprehensive state banking legislation which has ever been enacted. + +The new law was the outgrowth of the general agitation for banking +reform which had swept over this country following the panic of 1907. +The inciting cause, however, was the passage of the Federal Reserve Act +which made it necessary to revise the state law so that the state banks +either might join the federal system or be in a position to compete +successfully against the national banks of the State, whose powers had +been considerably enlarged by this act. In part, the law is modelled +after the federal act, and, in part, European experience has been drawn +upon. + +Under the new law the state banks will have even more importance in the +competition for banking business than in the past. From the point of +view of banking power, the 278 banks of deposit and discount and trust +companies have aggregate deposits in excess of those of the 479 national +banks in the sum of $281,786,000.[146] Furthermore, it has been +estimated that the total resources of the New York state banks are +equivalent to 17 per cent. of the aggregate resources of all banks in +the United States, both state and national. Superiority in banking power +is one element in the strong competitive position of the state banks, +and another element is the privileges granted to these banks under the +new law which, in some respects, are superior to those granted the +national banks under the federal law. In view of the fact that the state +banks can enjoy either directly or indirectly most of the advantages of +the federal system and also that in some particulars the state law gives +them more liberal powers, it seems probable that these banks will +continue to see an advantage in their state charters; and thus the +amount of defection from the state system will be negligible. + +More real power has been given to the banking department in the +provisions of the law. Through investigation, authorization +certificates, and regular uniform reports, the superintendent of banks +has more direct control over the banks than ever before. Besides the +extension of the supervisory powers, the penal provisions of the act +have been strengthened and made more exacting. + +1. _Features of the act relating to banks of deposit and discount and +trust companies._ The reserves required against deposits were reduced +substantially, and made nearly uniform with those required for national +banks. The following table gives the percentage of reserve required and +the percentage of reserve on hand which the new law specifies for these +banks. + +------------------------+---------------------+-------------------------- + |Banks of deposit and | + | discount | Trust companies + |Per cent. of deposits| Per cent. of deposits +------------------------+----------+----------+----------+--------------- + Population | Required | Reserve | Required | Reserve + | reserve | on hand | reserve | on hand +------------------------+----------+----------+----------+--------------- +2,000,000 or over | 18 | 12 | 15 | 10 +1,000,000-2,000,000 | 15 | 10 | 13 | 8 +Elsewhere in the state | 12 | 4 | 10 | 4 or 3 +------------------------+----------+----------+----------+--------------- + +The reserve requirements are made still more definite by the fact that +the law compels the banks to keep one-half at least of the reserve on +hand in "gold, gold bullion, gold coin, United States gold certificates, +or United States notes: and the remainder in any form of currency +authorized by the law of the United States other than federal reserve +notes." + +Among the powers granted to these banks is the power "to accept for +payment at a future date, drafts drawn upon its customers and to issue +letters of credit authorizing the holders thereof to draw drafts upon it +or its correspondents at sight or on time not exceeding one year." This +clause gives a much wider power to the state banks in the important +matter of acceptances than its counterpart in the Federal Reserve Act. +In the one case both domestic and foreign acceptances may be made and +handled without stipulation as to aggregate amount and bearing +maturities of one year or less, while in the other case the acceptances +are limited to those arising out of the importation or exportation of +goods with maturities not exceeding six months. Seemingly, the state +banks have the advantage, and to this extent the state law is superior +to the federal act. + +One other important forward step was taken in relation to this group of +banks. They are given the privilege of establishing branches outside +the State of New York, either in the United States or in foreign +countries. This privilege is qualified, however, by the provision that +no bank can establish such branches unless it has a combined capital and +surplus of $1,000,000 or over and the written approval of the +superintendent of banks. Although the old law permitted trust companies +to establish branches in the place where they were incorporated, the +practical effect was to limit branch banking to the city of New York. In +this particular also the state banks have the advantage over the banks +in the federal reserve system which are allowed to establish branches +only in foreign countries. + +2. _Features relating to private banks and bankers._ The regulation of +private banks and bankers is an entirely new departure in the law of +this State. In the past the banking department had no authority to +supervise that relatively large number of private bankers who receive +deposits in small amounts from the wage-earning classes while conducting +in connection therewith a mercantile or some other kind of business. + +Mercantile firms like the Siegel Company, by paying a higher rate of +interest upon deposits than savings banks, were able to obtain the +savings of many small depositors. This money was invested in the +business and secured only by the capital stock of the mercantile +establishments. In case the firm failed there was no security back of +these deposits but these same shares of stock, and so depositors were +fortunate if they received in settlement even 40 per cent. of their +claims. Such firms were not doing a legitimate banking business inasmuch +as they did not keep their assets in liquid form and carried no reserve +against deposits. + +The new act corrects this situation by giving the banking department +authority to conduct independent investigations into any violation of +the banking law by a corporation or individual. In the future a +corporation which is in any way engaged in the business of banking +cannot hide under the wing of the general corporation law when the +banking department sees fit to make an investigation of its affairs. + +Some of the specifications of this part of the law are all securities, +property, and the evidences of title thereto in which the permanent +capital and the deposits are invested are to be segregated and kept +separate from all other property and assets of the private banker; +depositors have a prior lien on the assets of the private banker, in +case of insolvency or suspension of business; and, in addition, every +private banker must maintain a reserve of 15 per cent. against deposits +in cities of the first class and a reserve of 10 per cent. in any other +city, one-tenth of which shall consist of reserve on hand and the +remainder may be kept on deposit subject to call with banks approved by +the superintendent of banks. These requirements will go far toward +preventing the recurrence of such disasters as the Siegel failure. + +3. _Features relating to co-operative credit._ Within the last thirty +years the agricultural methods of the State, in harmony with the +agricultural methods throughout the United States, have undergone great +changes. Scientific farming, improved machinery, and changed market +conditions have brought new problems in the field of agricultural +credit. To-day agriculture has come to be in a real sense capitalistic +and has in consequence laid new requirements on the credit structure of +the nation. Moreover, the period of large returns or satisfactory +returns from an extensive and rather careless cultivation of the soil, +which made possible an ignoring of unit cost, or, at least, brought the +farmer to minimize the importance of such cost, has given way, so far as +the successful farmer is concerned, to the careful estimates of cost and +close calculations of profits on a narrow margin between unit cost and +unit selling price. + +In the field of cost, the rate at which capital or money may be borrowed +is no small factor; and with the high rates prevailing in the United +States in comparison with those current in Europe, the borrower in this +country who pledges his land or agricultural products as security for a +loan finds himself at a disadvantage. To meet this condition cheaper +agricultural credit has been strongly urged. Europe furnishes the +example in her well-organized land banks and co-operative credit unions. +Already Massachusetts has a law authorizing co-operative organizations +for furnishing cheaper credit facilities to the agriculturalist, and in +Illinois there is a "crédit foncier" which has been in successful +operation a number of years. New York State has put itself in line with +this growing movement to furnish ample and cheaper credit to the farmer +and the purchasers of real estate by putting into the new law provisions +for the establishment of a land bank and co-operative credit unions. + +Sections 421-438 authorize ten or more savings and loan associations, +the aggregate resources of which shall not be less than $5,000,000, to +form a Land Bank of the State of New York. This bank can "issue, sell +and redeem debenture bonds secured by bonds and first mortgages made to +or held by member associations" and "invest its capital and other funds +in bonds secured by first mortgages on real estate situated within the +territory in which its members are authorized to make loans." The bank +is not permitted to do a general deposit business or incur any +indebtedness upon notes and bonds in excess of twenty times the amount +of its capital. The debenture bonds authorized by the act are to be +issued in series of not less than $50,000, and may be called on any +interest day at 102-1/2 provided a sixty-day notice is given. +Amortization payments upon mortgages which are given as collateral +security for the debentures of the land bank shall be sufficient to +liquidate the debt in a period not exceeding forty years. + +In Article XI the law provides for the establishment of credit unions. A +credit union may be organized by any seven or more persons with a share +capital the par value of which shall not exceed $25. The objects of the +credit union are: (1) to loan money in small amounts on personal +security or in larger amounts on endorsed notes at rates not exceeding 1 +per cent. per month, inclusive of all charges incident to the making of +such loans; (2) to receive the savings of its members in payment of +shares on deposit; (3) to borrow money to an amount not to exceed 40 per +cent. of its capital; (4) to pay dividends on its share capital. As to +the method of making loans, the law prescribes that a credit committee +shall pass upon all applications for loans which must be made in writing +and must state the purpose for which the loan is desired and the +security offered. No loan will be made unless it receives the unanimous +approval of the members of the committee present at the meeting, +provided always a majority of the committee is present. + +With the land bank acting as a central clearing agency for the local +savings and loan associations and the organization of many rural credit +unions the problem of agricultural credit will be largely solved for New +York State. This, however, all hinges on the proper functioning of the +land bank and the co-operation of the farmers in the establishment of +local credit unions. Agriculturists as a class are slow to adopt new +methods and it may be only after prolonged education that all the +possibilities of this new legislation will be realized. + +FOOTNOTES: + +[140] Adapted from George E. Barnett, _State Banks and Trust Companies +since the Passage of the National Bank-Act_, Publications of the +National Monetary Commission. Senate Document No. 659, 61st Congress, +_Second Session_. + +[141] [At least one savings bank has gained admittance to the Federal +Reserve System as a "state" bank.] + +[142] According to reports to the National Monetary Commission on April +28, 1909, the loans of all the state banks in the United States on the +security of real estate were 20.6 per cent. of their total loans and +discounts. + +[143] _The Report of the Monetary Commission of the Indianapolis +Convention_, pp. 377-8. The University of Chicago Press. 1898. + +[144] Adapted from H. M. P. Eckardt, _Branch Banking Among the State +Banks_, The Annals of the American Academy of Political and Social +Science, Vol. 36, No. 3, November, 1910 pp. 626-630. + +[145] Adapted from Everett W. Goodhue, _The Revision of the New York +State Banking Law_, The American Economic Review, Vol. V, No. 2, pp. +413-421. + +[146] Annual Report of the Superintendent of Banks of the State of New +York, Jan. 6, 1915, p. 33. + + + + +CHAPTER XXI + +THE CANADIAN BANKING SYSTEM + + +[147]Financially, Canada is part of the United States. Fully half the +gold reserve upon which its credit system is based is lodged in the +vaults of the New York Clearing House. In any emergency requiring +additional capital Montreal, Toronto, and Winnipeg call on New York for +funds just as do St. Paul, Kansas City, and New Orleans. New York +exchange is a current and universal medium in Canada and is in constant +demand among the banks. A Canadian wishing to invest in securities that +may be quickly marketed commonly turns to the New York market for stocks +and bonds. Yet the American banker visiting in Canada, if he is +unacquainted with the history of banking in his own country, finds +himself in a land of financial novelties, for Canada has a banking +system unlike any in operation in the United States at the present time. +Twenty-nine banks, known as the "chartered banks," transact all the +banking business of the Dominion. They have 2,200 branches, and each may +establish new branches without increase of its capital stock. [At the +close of the year 1915 there were twenty-two banks with approximately +3,200 branches.] They issue notes without depositing security with the +Government and in such abundance that no other form of currency in +denominations of $5 and above is in circulation. Notwithstanding the +fact that the notes are "unsecured," their "goodness" is unquestioned +among the Canadian people. + + +THE SYSTEM NOT NEW + +But to the student of the history of banking in the United States there +is little that is radically new in the Canadian system. He finds in it +many of the practices and expedients that were found excellent in the +United States in the first half of the nineteenth century, and is almost +persuaded that but for the Civil War what is now known as the Canadian +banking system would everywhere be called the American system. + +The fiscal exigencies of war, which have caused changes in the banking +systems of most countries, have had no influence upon the development of +banking in Canada. During the first half of the nineteenth century the +commercial and financial interests of Canada and the United States were +comparatively intimate and the financial institutions of both countries +developed on similar lines. The safety-fund system, first introduced in +the State of New York in 1829, found favor also in Canada and is still +an integral part of the Canadian banking system. Branch banking, which +was most successfully illustrated in this country by the State Bank of +Indiana, and which now exists in some form or other in almost all +countries except the United States, has always prevailed in Canada. The +importance of a prompt redemption of bank notes as exemplified in the +old Suffolk banking system in New England before the war, was fully +realized in Canada and is probably better illustrated in the present +Canadian system than in any other country. There bank notes and bank +checks are treated as identical in nature, both being cleared with the +same regularity and promptness. The so-called free banking system, which +was first adopted in the State of New York in 1839 and thereafter +adopted by eighteen other States of the Union, was tried in Canada in +the fifties, but not on a large scale. This system, requiring that +issues of bank notes should be secured by a segregated deposit of +certain classes of stocks and bonds, has never met with approval among +the leading bankers of Canada. + +The Canadian system is a product of evolution. It has taken its present +form because of the commercial and financial needs of the Canadian +people. It was not created by lawyers or statesmen to meet a fiscal need +of the Government, but has grown up gradually under the fostering care +of experienced bankers, no changes having been made until experience +proved them necessary or advisable. + +The chartered banks transact the business which in the United States is +divided among national banks, trust companies, private banks, and +savings banks. They buy and sell commercial paper, discount the notes of +their customers, lend money on stocks and bonds, make advances to +farmers, and sometimes aid in the financing of railroads and industrial +enterprises. To a Canadian the word "bank" means one of the twenty-odd +"chartered banks," for the law prohibits the use of the word "bank" by +any other institution. + + +OTHER FINANCIAL INSTITUTIONS + +The only other financial institutions in Canada which possess much +importance are the mortgage and loan companies. These usually operate +under charters granted by the provincial legislatures and do a business +similar to that of the farm and mortgage companies which once flourished +in the United States, making loans to farmers for a term of years and +taking farm mortgage for security. They also make loans upon urban and +suburban real estate and thus aid in the upbuilding of the cities and +their suburbs. The business of these institutions is made possible by +the fact that the bank act does not permit the chartered banks to accept +loans secured by real estate. + +The Dominion Government maintains a double system of savings banks. One +set is managed by the post-office department, every post-office +receiving deposits. The other set is managed by the finance department. +The post-office department also sells annuities and old-age pensions. +The money received through the savings banks is regarded as a loan from +the people and is used, like money obtained by taxation, in the payment +of the Government's general expenses. The Government is required to +carry a gold reserve of 10 per cent. against the savings deposits, but +no assets are set aside for their security. The chartered banks pay the +same rate of interest and get most of the business, for they offer +facilities with which the Government does not attempt to compete. Most +of the Government's deposits come from the poorest and most ignorant +classes, people who in all countries are suspicious of banks. Some of +the Canadian cities maintain municipal savings banks, but they are of +relatively small importance. + +Trust companies in Canada are not financial institutions. They are +trust companies in fact as well as in name, their business being to act +as trustee and administrator. A few of them accept deposits, although it +is not certain that they have a right to do so. The bulk of the money +they handle comes to them through the administration of estates and +trust funds. + +Private banking firms are almost unknown in Canada, there being only two +or three in the entire Dominion, and these do a mortgage and loan +business rather than a strictly commercial banking business. + +Hence, if any one seeks to understand the financial or banking situation +in Canada, he must devote his attention in the main to the chartered +banks. These through their branches furnish the loanable capital +necessary for the support of the Dominion's trade and industry and for +much of its agricultural enterprise. To them the Government turns when +funds are needed for internal improvements or when the exchequer faces a +deficit. The promoters of street railways, steam railways, steam +railroads, and other permanent improvements take counsel with the +managers of these chartered banks before they issue their securities. +The banks as a rule do not invest their funds in the stocks or bonds of +new enterprises, yet their managers are the men most familiar with the +world's money markets and their approval, therefore, of any financial +undertaking is highly esteemed. + + +THE ESSENTIALS OF THE SYSTEM + +A chartered bank in Canada is a bank of branches, not a bank with +branches. The parent bank, technically known as the "head office," +neither takes deposits nor lends money. All the banking business is done +by the branches, each enjoying considerable independence, but all +subject to the supervision and control of the head office. The law +places no restrictions upon the number or location of branches. Canadian +banks, therefore, have branches in foreign countries as well as in +Canada. + + +PROCESS OF INCORPORATION + +The provisions of the bank act with respect to the organization of new +banks are intended to guard against the entry of unfit or inexperienced +persons into the banking business. The minimum required capital of a +bank is $500,000, of which all must be subscribed and one-half paid in +before a new bank can open. At least five men of integrity and good +financial standing must agree to act as provisional directors and secure +a favorable report on their project from the parliamentary committee on +banking and commerce. These men must agree to subscribe for fairly large +blocks of stock, otherwise the committee will be inclined to reject +their application. They must convince the committee that their project +is a well considered one, that there is need for the new bank. If they +satisfy the parliamentary committee it will be granted. The bank, +however, cannot yet begin business. Provisional directors now have +merely the right to advertise and cause stock books to be opened. If +inside of one year capital stock to the amount of $500,000 has been +subscribed and $250,000 thereof paid in, the provisional directors may +call a meeting of the shareholders, at which a board of regular +directors shall be chosen. Before this meeting is held at least $250,000 +in cash must be paid over to the Minister of Finance. The regular +directors must then apply to a body known as the treasury board for a +certificate permitting the bank to issue notes and begin business and +the treasury board may refuse this certificate unless it is entirely +satisfied that all the requirements of the law have been met. Delay on +the part of the treasury board might prove fatal to the new enterprise, +for if a new bank does not obtain a certificate within one year from the +date of its incorporation, all the rights, powers, and privileges +conferred by the act of incorporation cease. These requirements make it +impossible to organize a new bank in Canada with any degree of secrecy. + + +NOTE ISSUES + +Having obtained its charter, a new bank must open its head office in the +place designated, and may then proceed to establish branches or +agencies, upon the number and location of which the law places no +restriction. Under its charter it has authority to issue circulating +notes up to the amount of its unimpaired paid-up capital in +denominations of $5 and multiples thereof. An amendment of the bank act +passed July 20, 1908, gives the bank the right to issue what may be +called an emergency circulation during the crop-moving season (October 1 +to January 31). During this period the legal maximum of the circulation +of a bank is its paid-up capital plus 15 per cent. of its combined +paid-up capital and surplus or rest fund. This emergency circulation, +which consists of notes in form and in other respects exactly like the +regular issues, is subject to a tax at a rate not to exceed 5 per cent. +per annum, the rate being fixed by the governor in council. If a bank's +circulation does not exceed its paid-up capital, it pays no tax. + + +SECURITY OF NOTES + +The law is silent on several subjects that seem of great importance to +most bankers in the United States. For instance, it does not require +that the banks shall deposit with a government official, or in any way +set aside any kind of security for the protection of the note holder. It +does not even require that the banks shall carry a cash reserve against +either notes or deposits, nor does the law make the notes a legal tender +for any payment. A bank need not accept the notes of other banks. The +Government does not guarantee the redemption of the notes. Neither does +it bind itself to receive them in payment of dues to itself. + +Nevertheless the notes of the Canadian banks are everywhere acceptable +at par, the people apparently not being at all concerned about their +"goodness." And their confidence in the note has been well justified, +for nobody since 1890 has lost a dollar through the failure of a bank to +redeem its notes. Following are the legal requirements, which for twenty +years have proved adequate protection for the note holder: + +1. Every bank must redeem its notes at its head office and in such +commercial centres as are designated by the treasury board. The +redemption cities are the same for all the banks. They are Toronto, +Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown. + +2. Each bank must keep on deposit with the Minister of Finance a sum of +lawful money (gold or Dominion notes) equal to 5 per cent. of its +average circulation; the total so deposited is called the "circulation +redemption fund." It is a guaranty or insurance fund for use, if need +be, in the redemption of the notes of failed banks. + +3. Bank notes possess first lien upon the assets of a bank. + +4. Bank stockholders are liable to an assessment equal to the par value +of their stock. + +5. A bank must make to the Minister of Finance on or before the +fifteenth of each month a detailed statement of its assets and +liabilities on the last business day of the preceding month. This +monthly return, the form for which is set forth in the act, must be +signed by three general officers. + +6. The Canadian Bankers' Association, an incorporated body of which each +bank is a member, is given supervision by the bank act of the issue and +cancellation of notes and of the affairs of a failed bank. + +7. The notes of a failed bank draw interest at 5 per cent. from the date +fixed for their redemption by the Minister of Finance, who may redeem +them out of the assets of the bank or out of the "circulation redemption +fund." + + +IMPORTANCE OF REDEMPTION + +Each of these provisions of the law has its value and significance, but +only the first is absolutely essential to the successful operation of +the system. All the other provisions might be changed or abolished +without impairment of the efficiency of the banking system. But the +abolishment of this redemption system would at once give Canada a new +banking system. The bank note is _almost the sole circulating medium_ in +Canada, and the people have confidence in it because it is tested every +day at the clearing houses and proves itself as good as gold. This daily +test would probably not take place with the same regularity as now if +the banks did not have branches or if they were obliged to deposit +security against their issues. Canadian banks are national, not local +institutions. All but a few of them have branches in every part of the +Dominion, and these branches, as fast as they receive the notes of other +banks, either send them in to the nearest redemption centre or convert +them into lawful money--or its equivalent, a bill of exchange--through +branches of the issuing banks located in the same towns. Each bank is +seeking, through its branches, to satisfy all the legitimate needs of +the people for a circulating medium. When the note of a bank is in +circulation it is earning money for the bank, but when it is in the +vault or on the counter of the bank it is an idle and useless piece of +paper. Hence every bank always pays out its own notes through its +branches and sends the notes of other banks in for redemption, thus +increasing its own circulation and _strengthening its own reserve_. + +Furthermore, if the banks were not allowed complete freedom of issue +within the prescribed limit, but were required to deposit some form of +security, as is required of the national banks in the United States, an +investment or speculative risk would arise that would inevitably cause +friction. If bonds were designated as security, bankers might often be +tempted by high prices to sell their bonds and forego the profit on +circulation for the sake of making a larger profit by the sale of the +security. Thus the volume of bank notes might contract even at a time +when the people needed more currency. In such case, of course, Canada +would be obliged to import gold in order to fill the gap in the +circulating medium. + + +THE CIRCULATION REDEMPTION FUND + +The 5 per cent. insurance fund for the redemption of the notes of failed +banks is theoretically an important and prominent part of the system, +yet practically it would seem to be of little consequence, for not once +since 1890 has it been necessary to use a dollar of the fund. Banks have +failed, to be sure, but the notes of these banks have always been +redeemed either out of the assets or by recourse to the double liability +of the shareholders. It is a mistake to suppose that the people of +Canada have confidence in bank notes because of the existence of this +redemption fund. The average business man knows nothing about the fund +and if his attention were called to it as being a source of security for +the bank notes, he would probably think a 5 per cent. reserve altogether +too small. The real reason why the people have faith in bank notes is +because the notes are always honored by the banks and never fail to +stand the test of the clearing house. In other words, they believe that +bank notes are good for about the same reason that they believe the sun +will rise in the east every twenty-four hours, and do not bother +themselves about reasons. + +Nevertheless this redemption fund does contribute to the strength of the +banking system. It makes each bank to a certain extent liable for the +mistakes of other banks, and as a result gives rise to a spirit of +mutual watchfulness and helpfulness. Other features of the system +contribute to the same result, especially the fact that a Canadian bank +accepts from a depositor without indorsement the notes of other banks. +Since the banks have branches in agricultural and mining communities, +often distant from the railroad by several days' journey, and these +branches are accepting the notes of other banks and giving credit for +them as if they were gold itself, it is evidently important that each +banker should have all possible information with regard to the status +and business of his competitors. As a result one finds among the bankers +of Canada a surprisingly intimate knowledge of each other's affairs. + + +TWO NEGATIVE QUALITIES + +The two negative qualities of the Canadian bank note--its lack of a +legal-tender quality and of a government guaranty--at first sight may +seem to readers in the United States a source of weakness. Yet Canadian +bankers would doubtless all agree that nothing would be gained by making +bank notes legal tender for any kind of payment or by making the +Government in any measure liable for their ultimate redemption. Such +measures would probably be rejected as likely to prove harmful. It would +be like hampering a flying machine with unnecessary bars of steel. Bank +notes, like bank checks, are mere promises to pay money and are more +convenient than money because they can be created as need for a medium +of exchange arises. When either has done the work that called it into +existence, it should disappear from circulation and be redeemed. If it +is made a legal tender like money itself, or if its redemption is +guaranteed by a strong government, there is always the danger that +ignorant classes of people will regard it as money itself and withdraw +it from circulation. + +The Canadian Government has nothing to do with the daily redemption of +bank notes and does not guarantee that they shall be redeemed. It is +custodian of the 5 per cent. redemption fund and is under obligation to +redeem the notes of failed banks out of this fund, but if a series of +bank failures should exhaust it the note holder has no guaranty that +government funds will be used for his relief. + +The possession by the note holder of a first lien upon the assets of a +bank, including the funds that may be collected from shareholders on +account of their double liability, gives rise to such general confidence +in the ultimate convertibility of a bank note that the notes of a failed +bank, on account of the interest they bear, sometimes command a premium. +As a rule, the notes of such a bank are collected by the other banks and +held until the date of redemption has been named by the Minister of +Finance. + + +CANADIAN BANKERS' ASSOCIATION + +The Canadian Bankers' Association is an incorporated body with powers +and duties prescribed in an amendment to the Bank Act passed in 1900. +Each chartered bank is represented in the membership and has one vote. +The association is required by law to supervise the issue of bank notes +and to report to the Government all over-issues, to look after the +destruction of worn and mutilated notes, and to take charge of suspended +banks. Its headquarters are in Ottawa. The expenses of the association +are apportioned among the banks and do not apparently constitute a very +heavy burden, for the secretary has an exceedingly small staff. All +expenses incurred by the association on account of a suspended bank are, +of course, a charge against the assets of the bank. + +When the notes of a bank are so worn or mutilated that it wishes to +replace them with new notes, notice is sent to the secretary of the +association, a date is fixed, and in the presence of the secretary the +old notes are duly counted and taken to a furnace, where they are +consumed in the presence of the secretary and other witnesses. After +this solemn operation has been performed and the signatures of all +parties observing it have been duly attested, new notes are issued by +the association to replace those that have been destroyed. + +The clearing houses in the Dominion are subject to regulation by the +association. It also has the power to establish sub-sections and to do +educational work by providing for lectures, competitive papers, +examinations, etc. The _Journal of the Canadian Bankers' Association_, a +quarterly publication of excellent quality, is edited by the secretary +and is at present the only educational force at work among bank +employees. + + +ELASTICITY OF THE CIRCULATION + +While the amount of notes that the chartered banks may issue is limited +by the Bank Act to the amount of their paid-up capital, experience has +proved that this legal limitation is only nominal and that the real and +effective limit is imposed unconsciously and automatically by their +customers and themselves. Each constantly seeks to increase its issue of +notes to the legal limit, yet the combined efforts of all are never able +to force into circulation more notes than the people need. + +The reason why an excessive issue of bank notes in Canada is impossible +is found in the two following facts: + +1. Every bank must redeem its notes on demand in seven commercial +centres in different parts of the Dominion. + +2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and +"change" consists entirely of bank notes. + +The redemption system is an automatic and effectual check against +inflation. It is easier to get notes redeemed in Canada than it is to +secure payment of checks in the United States, for the notes are +redeemable at different points throughout the Dominion and no exchange +is ever charged. If a country merchant accumulates more currency than he +desires to keep on hand, he deposits it, together with his checks and +drafts, in the local branch of his bank. This branch immediately sorts +out the notes of other banks and treats them as it does checks and +drafts upon other banks, either sending them to the nearest redemption +agency or using them as an offset in the local clearing house if the +issuing banks have branches in the locality. The branches of a bank are +not obliged to redeem the notes of the parent bank, but must accept them +at par in the payment of all dues. Thus each bank is doing its utmost to +bring about the redemption of the notes of other banks. At the same +time it is paying out its own notes to all customers who ask for cash, +seeking to bring its circulation up to the limit. As a result of these +operations, two powerful forces are constantly at work, one putting +notes into circulation, the other retiring them, and the people of +Canada always have on hand just the amount of currency they need and no +more. It is the people, not the banks, who determine how much the +circulation of the banks shall be. + + +BANK NOTES HAVE NO COMPETITION + +The fact that the bank note has exclusive possession of the monetary +field in Canada is most important. His ignorance of this fact is one +reason why the average banker or business man in the United States has +been unable to get a practical understanding of the Canadian system. Its +significance is easily seen. If Canada, like the United States, had in +circulation a lot of government notes in denominations of $5, $10, $20, +the Canadian banks would be able to increase their issues of bank notes +almost without limit, for their new notes would simply take the place of +the government notes, the latter going into bank reserves. The people of +Canada in making deposits would not discriminate against bank notes, but +would deposit the government paper quite as freely as the bank paper. As +a result, the amount of the government paper in circulation would +gradually decrease and the amount of bank notes would increase. The +volume of Dominion notes in the vaults of the banks would expand, and as +these notes are redeemable in gold the banks would feel justified in +larger extension of their credit, so that an increase in deposits and +current loans would ensue. Under such circumstances such freedom of +issue as is enjoyed by the Canadian banks would doubtless result in +inflation. + +But such conditions do not exist in Canada. All the paper currency in +the hands of the people, excepting $1 and $2 bills, is in the form of +bank notes. There is no chance to substitute bank notes for government +notes. Hence, if at any time business relaxes and the need for money +among the people grows less, an increasing tide of bank notes flows into +the banks. The people who bring these notes do not ask for money in +exchange, for to them the notes are money. They take bank notes to the +banks just as people in the United States take greenbacks and silver +certificates--to be exchanged for a deposit credit or account. + + +NO LIMIT OF ISSUE REALLY NECESSARY + +Theoretically there is no reason why any limit should be fixed upon the +amount of notes which a bank may issue. Even though a bank has a +monopoly of issue in a country--like the Bank of France--it nevertheless +is unable to expand its circulation beyond the people's needs. Such a +bank, unless it should adopt a reckless policy of lending which would +bring ruin quickly upon itself, can exercise very little influence upon +the amount of currency in circulation. In a country like Canada, where +several banks are issuing currency, no single institution can enlarge +its issue of notes beyond the needs of its own customers. If it should +endeavor to do this by lending freely to customers who promised to use +its notes in different parts of the country, the effort would be futile. +The notes would quickly find their way into the branches of other banks +and be sent in for redemption. + +Like most other countries, however, Canada has placed a limit on the +note-issuing privilege, fixing it at the amount of a bank's paid-up +capital. While there is no scientific necessity that such a limit be +fixed in order to prevent the over-issue of notes, nevertheless there +are other considerations which justify it. It is an indirect method of +compelling banks to increase their capitalization _pari passu_ with the +growth of their business. Inasmuch as the capital of a bank is the +stockholder's contribution toward its assets, it is exceedingly +desirable that this contribution be made as large as possible, for, +other things being equal, the strength of a bank varies with the amount +of its capital. It is not unreasonable, therefore, to require that banks +in return for the useful note-issuing privilege should be required to +keep their capital resources large. + +When a Canadian bank has reached the limit of its note issue--which has +rarely happened--it begins at once to treat the notes of other banks +very much as if they were its own. Instead of going to the expense of +sending them in for redemption, it uses them as counter money, paying +them out to depositors in response to their calls for cash. If all the +banks in Canada should issue notes up to the limit, as some of them did +during the exciting months of 1907, and if the current rate of interest +did not warrant the issue of the taxed notes provided for by the +amendment of 1908, the note circulation would immediately lose its +elasticity. As further expansion would be impossible, the banks would +have to meet any increasing demand for currency by paying out gold and +Dominion notes, thus depleting their reserves. Such a situation would +doubtless lead to a sharp advance in the discount rate and to the +importation of gold. + + +THE PRACTICAL LIMIT UNDER THE LEGAL + +It should be noted that the practical limit of note issue is about 10 +per cent. below the legal limit. The manager of a bank having a paid-up +capital of $1,000,000 begins to get nervous when his circulation equals +$900,000. His office may be in Montreal and his bank may have branches +in the far East and in the far West and in the mining wilderness of the +North. Some of these branches he can not reach by telegraph and some are +distant a week by mail. He immediately sends warning to all the branches +and cautions them against any large out-giving of notes and against +entering into transactions which will be likely to lead to unusual +demands for currency. On account of this situation, even in times of +greatest pressure, the total issue of the banks is usually 10 per cent. +below the authorized limit. + + +DEPOSITS + +The liabilities of Canadian banks, like those of commercial banks in +Great Britain and the United States, furnish a fairly correct index to +the expansion of the country's credit. Since the Canadians, like other +Anglo-Saxons, make free use of the check book in the settlement of both +business and private accounts, any increase of bank loans and discounts +is usually attended by a corresponding increase in deposits. When a +Canadian business man discounts his note at his bank he almost +invariably leaves the proceeds on deposit with the bank. As he makes +his payments by check his own deposit account declines, but the bank +accounts of his creditors increase, so that the net result of borrowing +in Canada is an increase in the total of bank deposits. Consequently, in +good times, when the banks are freely extending credit, the deposits +grow, and in periods of dullness and liquidation they decline. A growth +of deposits, therefore, is commonly accepted as an indication of +business and industrial activity. + +If a business man in Canada has temporarily a large balance in his bank +and realizes that he will not need the money for several months, he will +either arrange for its entry as a time or savings bank account, or for +the payment of interest on his balance as a current account. Of course, +the bankers do not encourage this practice, nor can it be indulged in by +a depositor who is also a borrower. Depositors of the class who are paid +a small rate of interest--usually 2 per cent.--by national and state +banks in the United States, usually have savings department accounts in +Canada and get 3 per cent. + + +SAVINGS DEPOSITS ALWAYS PAID ON DEMAND + +On account of the fact that the time or savings bank deposits contain +such a large proportion of money likely to be needed in business at any +time, the banks regard both classes of deposit as being essentially the +same form of liability. Practically all the deposit liabilities of a +Canadian bank are payable on demand, although payment on two-thirds of +them at the present time can not legally be demanded until after notice. +Custom has made it imperative that a Canadian bank shall pay any and all +of its depositors on demand. For any bank to refuse to let a depositor +have his money when he calls for it would be regarded by the public as +an acknowledgment of weakness. Certainly no Canadian bank would take the +risk of making the experiment. + +Canadian bankers feel that 3 per cent. is too high a rate of interest to +pay depositors. This rate is a matter of tacit agreement among the banks +and no single bank can afford to lower it, for such action would cause +it a loss of business. On the other hand, if any bank, hoping to +increase its deposits, should offer to pay 3-1/2 per cent. or 4 per +cent., its conduct would be looked upon with grave disapproval by its +competitors. Some of the new banks in recent years have obtained +business in this manner and have been severely criticised by the +managers of the older institutions. + + +SAVINGS DEPOSITORS NOT PROPERLY REWARDED + +To an outsider it would seem that the savings bank depositor in Canada +is not generously treated. In the United States he gets 4 per cent. on +his savings even in the large cities. In Canada, a country where real +estate mortgages yield from 7 to 9 per cent. and the bonds of new +corporations are selling at prices giving the investor a higher return +than he can get in the United States, it is certain that a real savings +bank could well afford to pay depositors 4 per cent. It is doubtless +true that 4 per cent. is a higher rate of interest than most of the +savings depositors in the chartered banks have a right to expect. A +large part of these deposits are not savings deposits at all. +Nevertheless it is doubtful if the banks would be justified in a +reduction of the rate. + +The right solution of the problem seems to lie in another direction, +namely, in the making of a sharper distinction between demand and +savings deposits. The funds received from both classes of depositors +should not be treated alike. The money of savings bank depositors should +be invested in bonds and mortgages and then could be made to yield a net +return of over 5 per cent. If the depositors were not allowed to check +upon their accounts they would be a source of such little expense to a +bank that it could easily afford to pay them interest at the rate of 4 +per cent. At the present time the banks are paying 3 per cent. interest +on money which they are lending to commercial borrowers and for the care +of which they are maintaining an expensive force of clerks. Depositors +who have checking accounts might be allowed 2 per cent. on large +balances, but out-and-out savings depositors, people who make no use of +the check book, are certainly entitled to a 4-per-cent. rate in a +country where investment capital is as fruitful as it is in Canada. + +Strictly speaking, the savings departments of the chartered banks are +not savings banks, for they do not pretend to devote their time funds +to long-time investments. The amount of securities held by the banks is +never equal to the amount of time deposits. + +A thorough reorganization of the savings departments of the chartered +banks, to equip them for the real business of a savings bank, would not +be possible without an amendment to the Bank Act, which now prohibits +them from loaning money upon real estate or upon the security of +real-estate mortgages. It is generally believed that this prohibition is +commonly evaded by the banks through the acceptance of such mortgages as +"additional security" after loans have been made. A savings bank, of +course, must have the legal right to accept such security. + + +NO BANKERS' BANK + +The indebtedness of banks to banks is not large in Canada. The branch +system makes it unnecessary for banks to carry balances in other +institutions located in the financial centres. Nearly every bank has a +branch in either Montreal or Toronto and in these branches carries the +major proportion of its cash reserve, so that branches in the far West +or in the maritime Provinces are always able to sell exchange on +Montreal or Toronto. Canada has no bankers' bank. The Bank of Montreal, +which is the largest bank in the Dominion, its assets being equal to +about 25 per cent. of the total, is often spoken of as the government +bank because it is the largest government depositary, yet it holds a +very small amount of funds belonging to other banks. + + +AMOUNT OF THE RESERVE FIXED BY EACH BANK + +It must not be supposed that the Canadian banks do not carry adequate +reserves. On the contrary, every bank manager gives to this subject +daily and most conscientious thought. To the Canadian banker the word +"reserve" means a fund immediately available for the liquidation of +liabilities. How much this fund ought to be depends altogether upon the +amount and character of the liabilities to be protected. + +A Canadian bank manager, having before him the amount of time deposits +and demand deposits, respectively, knowing the probable future needs of +the various depositors, being in constant touch with branch managers +both by wire and by letter, and having back of him information born of +many years' experience, easily determines how much his bank's reserve +ought to be in order to assure its safety. The law neither helps nor +hinders him; it simply requires that the bank shall satisfy the demands +of depositors in accordance with the terms of the contract and that it +shall redeem its notes on demand. The public by force of custom expects +a bank to do a little more than the law requires, for its credit is +bound to suffer if it take advantage of its legal privilege to delay +payment upon time deposits. The manager is a hired man, sworn to do his +utmost to protect the credit of the bank, trained for many years in its +service, familiar with its history and its policy, anxious to guard his +own reputation and character against criticism. Under these +circumstances it would be remarkable if he did not fix the amount of his +bank's reserve nearer the ideal figure--if an ideal banking reserve is +possible--than could possibly be done by a body of lawmakers or of any +other men outside the bank. + + +COMPETITION IS NOT LACKING + +In many respects banking competition is quite as active in Canada as it +is in the United States. Apparently there are only two things which the +banks do not like to do in order to attract business--lower the discount +rate, or advance the rate paid on depositors' balances. There is no +express agreement among the bankers on these points, but every banker +knows that he would become _persona non grata_ among his brethren if he +should discount certain kinds of paper at less than 6 per cent., or pay +his depositors on their monthly minimum balances more than 3 per cent. +per annum. In Montreal and Toronto large borrowers can get money at 5 +per cent., but the average merchant and manufacturer must pay 6. In +Winnipeg borrowers can do almost as well, but farther west the usual +rate is 7 per cent., and in some of the remoter districts merchants and +farmers alike pay 8 per cent. Bankers do not believe in lowering the +discount or interest rate unless they are compelled to do so in order +to find a market for their funds. + +Some of the older institutions would like to prevent competition from +absorbing the minor profits which come from collections and transactions +in exchange, but they are not entirely successful. The nominal or +schedule charges for collections and exchange are frequently cut for the +benefit of business men whose favor it is desired to propitiate. + +In their efforts to get new business, to be the first to open a branch +in a promising new community, or to keep their regular customers from +being dissatisfied, there seems to be the keenest kind of competition. +Few villages of 500 people can complain that their banking facilities +are less than they deserve, and many of them, with barely enough +business to pay the expenses of one branch, are supplied with two. The +recent rapid increase in the number of branches has been caused by the +great expansion of the West and by the competition among the more +progressive and energetic general managers, each desiring that his bank +shall be the first in a promising field, even though his enterprise lead +him to establish branches which at first do not pay expenses. In a new +mining camp the first bank, like the first saloon or the first boarding +house, usually begins business in a tent. Some of the more conservative +bank managers in Canada think that new branches are being started in +excess of the country's needs, but others are willing to take chances on +the country's future and to charge considerable sums to the debit side +of the profit and loss account in order to keep their institutions at +the front in the great and developing West. + + +BANKING IN DIFFERENT PROVINCES + +It is generally known that the Eastern branches get heavy deposits and +are creditors of the head office, and that the funds they collect are +forwarded to the Western branches, whose loans greatly exceed deposits. +Bankers will admit that this transference of funds takes place, but +there is considerable grumbling about it in the old communities of the +East, and the bankers fear that a monthly or even annual publication of +the facts would keep them perpetually in hot water. A glance at +clearing-house statistics leaves no doubt as to the banking importance +of the Western Provinces or as to the relative financial quietude of the +East. Between 1900 and 1909 the total of Canada's bank clearings +increased 227 per cent., but Halifax gained only 23 per cent., St. John +only 90 per cent., and Quebec only 68 per cent. On the other hand, +Toronto's clearings increased 179 per cent., Winnipeg's 600 per cent., +and Vancouver's 524 per cent. + + +EASTERN PROVINCES HAVE SUFFERED + +This transference of funds from sluggish to active communities is the +inevitable result of a system of branch banking and is the cause of the +tendency of the rate of interest toward uniformity in all parts of +Canada. Whatever may be said against a system of branch banks, there can +be no question that it does bring about a more even distribution of +capital in a country than is possible under a system of independent +local banks. Canadian bank managers are anxious to put out their money +where it is most wanted, for there they get the best possible rate of +interest and obtain paper of the best quality. No matter where a +manager's headquarters may be, he is most deeply concerned in three +questions: (1) Where is idle money accumulating? (2) How can he best +draw it into his bank? (3) In what parts of the Dominion is money most +needed? In localities of both kinds he establishes branches; in the one +the branches accumulate deposits often much in excess of their loans, in +the others the loans exceed the deposits. Thus it happens that the +savings of the Eastern Provinces, where the growth of industry and trade +is slow and the demand for new capital is not increasing, are sent +westward and loaned out to merchants and manufacturers and farmers of +the new territories. The people of the East supply the capital for the +development of the West, though many of them perhaps are entirely +ignorant of the useful purpose their savings are made to perform. In the +western cities of Canada one hears no talk among business men about the +scarcity of capital. A merchant or manufacturer in Manitoba gets the +money he needs as easily as does the merchant or manufacturer in +Toronto or Montreal. + +Justifiable as the bank's policy is from a national point of view, one +can not help believing that the branch banking system has really checked +the development of business and industry in the maritime Provinces. If +Canada during the last thirty years had depended, like the United +States, upon independent local banks, there would have been a plethora +of capital in the East, and Montreal, Quebec, and Halifax, like Boston, +New York, and Philadelphia, would years ago have had 4 and 5 per cent. +money, while Winnipeg and other Western cities, less populous than now, +would still be paying 1 per cent. a month. The relative cheapness of +capital undoubtedly helped build up the prosperous industries of +Massachusetts. The same cause operating in the maritime Provinces of +Canada would doubtless have led to the establishment there of industries +of which the people under existing conditions have not ventured to +dream. + + +LARGE USE OF DEPOSIT CURRENCY + +It is sometimes assumed that a free and large use of bank notes tends to +discourage the use of the check book and the growth of bank deposits. On +the continent of Europe, for instance, where the notes of central banks +supply all the currency the people need, the check book is comparatively +little used. This fact is sometimes explained by the ease with which +people can obtain bank notes for use in making all payments. Experience +in Canada makes one doubt the validity of this explanation. The check +book is almost as popular there as in the United States, and would +probably be used still more than it is if the banks would adopt a policy +as liberal as that in vogue in the United States. The Canadian banks not +only charge exchange on checks and drafts payable in other localities, +but even charge exchange on checks drawn on their own branches. The +charge is a small one and probably has no great effect one way or the +other, yet it certainly does not encourage the increase of deposits or +the use of the check book. When a Canadian starts on a journey it is in +a small way economical for him to fill his wallet with all the cash he +expects to need. The notes of his bank will be taken at par everywhere +throughout the country; his checks, even though he presents them at a +branch of his bank, will be cashed only at a discount. + +Notwithstanding this discrimination against the check, the deposits of +Canadian banks have grown much more rapidly than the note circulation +and the inference is that the volume of deposit currency has increased +at the same rapid pace. Since 1900 the volume of notes has increased +approximately 60 per cent., while the deposits by the public showed a +gain of 155 per cent. These figures prove that business men in Canada +appreciate the advantages of the check as a means of payment, and that +the proportion of business transactions settled by it is steadily +increasing. + + +BANKS SILENT PARTNERS IN INDUSTRY + +A large part of the so-called commercial paper of Canadian banks is +secured practically by title to goods in warehouses, factories, and +wholesale stores. Such security is more saleable than stocks and bonds, +and paper having such security back of it is therefore better banking +paper than notes secured by stock-market collateral. So far as would +seem possible the Canadian Bank Act makes merchandise of all kinds a +sort of collateral security for bank advances. It assumes that if a bank +advances capital for the conduct of a business it should have a claim +upon all the assets of the business and upon all goods as they come and +go in the course of trade. No matter how a merchant's stock may change +in character, it all belongs to his bank in case he fails to take up his +paper or meet his engagements. In the same way a manufacturer's stock of +goods, the raw material and the finished products, no matter how they +change from day to day and month to month, will become the property of +his bank if he fails to pay his note. The law practically makes every +bank a silent partner in many wholesale and manufacturing businesses and +gives it many rights which no ordinary silent partner can acquire. It +has the effect naturally of making bankers keep a close eye upon +business conditions as well as upon the affairs of their individual +borrowers. Canadian bankers are interested in the lumber market, in the +prices of metals, in changes in the tariff, and in the acquisition of +foreign markets for Canadian manufactures and products, even as the Wall +Street banker is interested in the prices of stocks and bonds. He is in +a sense the owner of merchandise of all kinds, and both trade and +financial news has equal significance to him. + + +A CUSTOMER'S LINE OF CREDIT + +In Canada the banks are managed by men whose long experience in the +business has taught them to avoid certain banking practices that are in +vogue in other countries. Realizing how important is the relation +between a bank and its customer, they believe that this relation should +be made as intimate and helpful as possible. Among Canadian bankers, +therefore, it is part of the law and gospel of banking that a bank is +entitled to full knowledge of the financial condition and business +operations and prospects of its customers. Hence a bank insists that its +customers shall rely _entirely upon itself_, that they shall make a full +statement of their affairs at least once a year, and that they shall +begin each year with a clean slate. + +As a result of this policy a business man in Canada deals exclusively +with one bank. Once a year he arranges with his bank for a line of +credit and learns exactly the amount of paper he will be able to +discount. If he happens to need less than he anticipated, he will not +exhaust the credit allowed by the bank and will pay interest, of course, +only upon such portion of the bank's funds as he actually utilizes. If, +on the other hand, his business is unexpectedly large, giving +opportunity to make bigger profits and creating the need for more +capital, he will find the bank ready to increase his line of credit, +provided the manager is satisfied that business conditions and prospects +warrant expansion. Under no circumstances, however, must the customer of +a bank seek to raise funds elsewhere unless he first gets the consent of +his bank. If he sells his notes in the open market, he must do it with +the full knowledge of his bank or run the risk of being placed upon the +"black list." + +As one would naturally expect, there is very little commercial paper +floating about in the Canadian money market. The bill broker is unknown. +Wholesalers and manufacturers, unless shipping to foreign countries, do +not draw upon their customers. If credit is granted, it takes the form +of a book account or of a promissory note. + +The promissory notes received by a manufacturer or wholesaler are +deposited with his bank. The book accounts under ordinary conditions +remain entirely at the disposal of the business, but in extraordinary +cases, when the situation is not satisfactory, or if an additional +credit at the bank is desired, an assignment of the book accounts to the +bank may be required. + +During the harvest season heavy drafts are made upon the resources of +the banks to provide for the movement of the grain crops of the West. In +its advance of money for this purpose the law makes it possible for a +bank always to have abundant security. Under section 88 of the Bank Act +the buyer makes assignment to his bank of the grain purchased. When the +grain is delivered to a railroad, the bill of lading becomes the +property of the bank. When it reaches Port Arthur, or some other +distributing point, and is stored in an elevator, the bank receives a +warehouse receipt in exchange for the bill of lading; and when shipment +is made to New York, to Montreal, or to Europe, the bank receives on +surrendering the warehouse receipt the shipper's draft on the consignee, +the bill of lading, and other documents. Throughout the entire +transaction, from the purchase from the farmer to the final sale to the +Eastern consumer, the bank practically has title to all agricultural +products which are being moved by means of its funds. + + +LOANS TO FARMERS + +The branches of Canadian banks in agricultural districts quite commonly +lend assistance to farmers. They do not make a practice of taking +mortgages on farm property, but lend outright on the farmer's credit, +depending for their security upon his character as a man and ability as +a farmer, and often as well upon a neighbor's indorsement. Farmers' +paper ranks high among the Canadian bankers and constitutes a +considerable proportion of the assets of some of the banks. The banks, +of course, do not undertake to supply the farmer with anything more than +working capital. They do not help him pay for his land and buildings, +but they do let him have at least part of the money he needs for tools, +wages, seed, stock, etc. Despite the fact that these advances are +unsecured by mortgage, the banks suffer very little loss on farm paper. + + +CALL LOANS IN CANADA AND ELSEWHERE + +After "current loans in Canada" the next largest item among the assets +is "call and short loans elsewhere than in Canada." The call loans +outside of Canada consist mainly of loans in the New York market and are +as a rule secured by collateral easily convertible into cash. These +loans are regarded by Canadian bankers as equivalent to cash and are +figured by them as part of their reserve. Only the larger banks make a +practice of loaning on call in New York. + + +THE BANKS AS FINANCIAL INSTITUTIONS + +That the chartered banks of Canada are financial as well as commercial +institutions is evidenced by their holdings of stocks and bonds. These +securities represent partly an investment carried as a secondary reserve +and partly a business carried on for the benefit of their customers. In +Canada the demand for long-time investments is not large, but whatever +market there is for securities is mainly in the hands of the chartered +banks. An investor seeks the advice of a bank manager and often is able +to obtain from him securities which satisfy his needs. The banks do not +publish a list of their holdings, but it is generally taken for granted +that they carry only gilt-edge securities. If a customer desires to +obtain second or third rate securities, being eager for a high rate of +return, a bank can accommodate him, not by selling him out of its own +stock, but by negotiating the purchase of the desired securities in New +York or London. + +As the wealth in Canada increases and idle capital accumulates in excess +of its immediate needs, this financial side of the business of Canadian +banks will doubtless expand. It may, indeed, during the next generation +or two greatly expand and become an important feature of the chartered +banks. They are in a position to take care of the business as it +develops and will doubtless be able to prevent the establishment of any +purely financial banking houses in Canada. + + +THE REVISION OF THE BANK ACT, 1913[148] + +The Canadian Bank Act, as is well known, is subject to decennial +revision. The last revision was due to take place in 1910; but owing to +circumstances which it is not necessary here to describe, it was not +until the present year that the work was finally undertaken. The leading +features of the Canadian banking system are so well known that they may +be passed over, and the nature and causes of the recent changes in the +act alone described. There were many minor modifications, but the +essential changes effected were: (1) provision for a shareholders' +audit, (2) the creation of central gold reserves, and (3) the providing +of additional facilities for making loans to farmers. + +In the recent revision of the act the public was most deeply concerned +with the problem of securing an adequate system of bank inspection. The +immediate reason for this was the disastrous failure of the Farmers' +Bank. This institution had gambled away its resources on the Keeley +mine; and had, in its failure, brought many farmers as well as others to +the verge of ruin. For several years previous, however, there had been +an insistent demand for some sort of external bank inspection.... + +The banks as a whole have been opposed to any change in the method of +inspection. The reason they advance is that the keynote of the +organization of Canadian banks has always been the centralization of +responsibility; and they do not think it wise to divide that +responsibility with any outside authority.... + +As far as the public is concerned it has no means of judging of the +soundness of a bank except by examining the monthly returns which are +required by law from each bank. These returns are fairly comprehensive, +and have been made more so by the revision of the act this year. The +Minister of Finance may call for supplementary information from any +bank, whenever, in his judgment, such data are required to afford a +fuller knowledge of a bank's affairs. Of course, these returns can be +taken only for what they are worth. In the case of several failed banks +the returns were made with every degree of falsification, because no +independent checking of the figures was possible. + +Nevertheless, in obedience to the strong demand for some sort of +independent bank examination, provision was made in the recent revision +of the act for a shareholders' audit of each bank's affairs. The +auditors are to be chosen by the shareholders from a list of forty names +selected by the whole body of the general managers of the banks. The +list must be submitted to the Minister of Finance for his approval. If +one-third of the shareholders of a bank are dissatisfied with the +auditor appointed by the majority, they may appeal to the Minister for +the appointment of another auditor. + +The auditors must submit a statement of their findings to the +shareholders at the annual meeting, or on any other occasion the +necessity may require. In addition the Minister of Finance may require a +special return to be made to him, the cost of the service rendered being +paid for by the Government. + +Canadians would be wise not to expect too much from this system of +external examination. After all, it can do no more than verify a bank's +statements and books.... In every large undertaking, the soundness of +the transaction must depend, as before, upon the judgment of the general +manager and the board of directors. + +The establishment of central gold reserves is the most important feature +added to Canada's banking system by the legislation of 1913.... Under +the new act each bank may issue any amount of notes that it may desire, +provided that it deposits with a board of trustees, at Montreal, gold or +Dominion notes to the full amount of the notes issued. These notes are +to be identical in form with the ordinary notes of the bank. The gold or +Dominion notes deposited with the trustees shall be returned to the bank +whenever the notes which the bank has outstanding do not amount to the +paid-up capital of the bank together with the amount of legal-tender +money deposited with the trustees. In other words, the banks can still +issue their notes up to the full amount of their paid-up capital, and an +additional amount from September 1 to the end of the following February, +which may equal 15 per cent. of a bank's combined capital and surplus. +It is only for notes issued in excess of these amounts that legal-tender +money must be deposited with the trustees at Montreal. It should be +observed, however, that the banks pay a tax of 4 per cent. on the extra +issue during the crop-moving period, whereas there is no tax upon +gold-reserve notes. And as Canadian banks are not required to keep a +legal reserve against their demand liabilities, there is no reason why +the idle gold in their reserves should not be sent to Montreal to form +the basis of new note issues, especially when it is considered that the +gold may be recalled at once when no longer needed to cover notes. + +The ability to issue notes to any amount required, on a gold basis, will +greatly strengthen the position of the banks. + +The third important new feature in the revision of the act is the power +given to the banks to make loans to farmers on grain which is stored on +the farm and still in the farmer's possession.... The permission granted +them to loan money to farmers on stored grain in the latter's possession +is an attempt to extend to the farmers aid similar to that hitherto +granted to manufacturers and wholesalers alone. It should not be +thought, however, that the banks have not always granted loans liberally +to farmers.... + +The possibility of making advances to the farmers on their grain is +expected to be of especial benefit to the West.... It is hoped that, +under the new legislation, the farmer will be able to hold his grain for +higher prices; and in the meantime secure accommodation from the banks +to meet his obligations. Many bankers, however, refuse to see any remedy +for the situation in the new legislation. They maintain that it will +involve too much risk to extend loans on grain over which the farmer +continues to assert control. Only the operation of time will enable us +to estimate the value of this feature of the act. + + +COMPARATIVE FIGURES OF CONDITION OF CANADIAN BANKS[149] + +ASSETS + + Nov. 30, 1915 June 30, 1914. +Gold and subsidiary coin-- + +In Canada $41,831,732 $28,948,841 +Elsewhere 29,527,921 17,160,111 + ----------- ----------- +Total $71,359,653 $46,108,952 +Dominion notes 140,751,331 92,114,482 +Deposit with Min. of Finance for security +of note circulation 6,770,645 6,667,568 +Deposit in central gold reserves 15,100,000 3,050,000 +Due from banks 169,429,330 123,608,936 +Loans and discounts 881,101,540 925,681,966 +Bonds, securities, etc. 121,953,898 102,344,120 +Call and short loans in Canada 83,203,787 67,401,484 +Call and short loans elsewhere than in Canada 135,530,562 137,120,167 +Other assets 76,993,424 71,209,738 + -------------- -------------- +Total $1,702,194,170 $1,575,307,413 + +LIABILITIES + +Capital authorized $188,866,666 $192,866,666 +Capital subscribed 114,422,866 115,434,666 +Capital paid up 113,987,275 114,811,775 +Reserve fund 112,718,473 113,368,898 + ------------ ------------ +Circulation 124,153,685 99,138,029 +Government deposits 36,001,548 44,453,738 +Demand deposits 538,764,279 458,067,832 +Time deposits 714,219,286 663,650,230 +Due to banks 30,973,072 32,426,404 +Bills payable 5,081,059 20,096,365 +Other liabilities 14,007,918 12,656,085 + -------------- -------------- +Total, not including capital or reserve fund $1,463,200,847 $1,330,488,683 + +NOTE.--Owing to the omission of the cents in the official reports, the +footings in the above do not exactly agree with the totals given. + +FOOTNOTES: + +[147] Adapted from Joseph French Johnson, _The Canadian Banking System_, +Publications of the National Monetary Commission, Senate Document No. +583, 61st Congress, _2d Session_. + +[148] W. W. Swanson. _The Revision of the Canadian Bank Act_, American +Economic Review, Vol. 3, December, 1913, pp. 993-998. + +[149] _The Commercial and Financial Chronicle_, Vol. 102, January 1, +1916, p. 13. + + + + +CHAPTER XXII + +THE ENGLISH BANKING SYSTEM + + +FOUNDATION AND GROWTH OF THE BANK OF ENGLAND + +[150]About the year 1691 the Government of William and Mary experienced +considerable difficulty in raising the necessary funds to prosecute the +war with France; but "the hour brings the man." The man on this occasion +was William Paterson, a merchant of Scotland, who had been educated for +the Church, but had led a varied and adventurous life. The scheme he +presented for the consideration of the Government for the relief of the +situation was the foundation of a public joint-stock bank; which, in +return for certain powers and privileges to be conferred, should advance +money to the Government.... + +... the bill establishing the Bank of England was successfully carried +through Parliament, and obtained the royal assent on the 25th April, +1694. + +The basis of the bill was that £1,200,000 should be voluntarily +subscribed by the public, and that the subscribers should be +incorporated into a body, to be known as "The Governor and Company of +the Bank of England." + +The whole of the sum forming the capital of the bank was to be lent to +the Government, for which the bank was to receive interest at the rate +of 8 per cent. per annum, together with an allowance of £4,000 per annum +for management and expenses; making in all £100,000 per annum. It was +also provided that the sum of £300,000 was to be raised by public +subscription, for which the contributors were to receive certain +terminable annuities. + +By its first charter, which was for ten years only, the Bank of England +was not allowed to borrow or owe more than the amount of its capital; +which meant that it could issue notes to the extent of its capital and +no more. If this amount were exceeded the members were liable for such +excess, in their private capacities, in proportion to their holding of +stock. + +The capital of the bank was subscribed in a few days, and when duly paid +up, the agreed sum of £1,200,000 was handed in to the Exchequer.... + +The charter originally granted to the bank was for ten years only, as we +have already seen; but this charter has from time to time been renewed, +and also varied--sometimes in favour of the bank and sometimes +curtailing its privileges. The monopoly of joint-stock banking was not +granted to the bank by its first charter, but this monopoly was +practically conferred on it in 1708. The act passed in that year +provides: + + That during the continuance of the said corporation of the + Governor and Company of the Bank of England, it shall not be + lawful for any body politic or corporate whatsoever, created + or to be created (other than the said Governor and Company + of the Bank of England), or for any other persons + whatsoever, united or to be united in covenants or + partnership, exceeding the number of six persons, in that + part of Great Britain called England, to borrow, owe, or + take up any sum or sums of money on their bills or notes, + payable at demand, or at a less time than six months from + the borrowing thereof.... + +We pass on now to the end of the eighteenth century, when the country +was plunged into the throes of war and financial difficulty. Up to this +time the bank, since its foundation, had succeeded in meeting its notes +when presented; but in the year 1796 a steady drain on the reserve of +the bank commenced, owing to the fear of invasion. This drain began to +assume a very serious aspect in the early part of 1797, and it appeared +probable that the bank would be subjected to the danger and humiliation +of a temporary stoppage. The directors, fully aware of this danger ahead +of them, laid the position before the Government, and left the solution +of the difficulty in its hands. After due consideration, an Order in +Council was issued on the 26th February, 1797, requiring the bank not to +pay its notes in gold.... It was not until 1823 that the restriction was +entirely withdrawn, although as a matter of fact the bank really +resumed paying in cash on demand on May 1, 1821, deeming it then safe to +do so. + +Although a period of safety and prosperity then appeared to have dawned, +the bank was not quite clear of its troubles. The very prosperity of the +times led imperceptibly to another period of distress and danger, +culminating in the panic of 1825.... + +In 1826 the Bank of England, by arrangement with the Government, agreed +to establish branches in various parts of the country, and gave up their +monopoly of joint-stock banking, except within a radius of sixty-five +miles of London. + +The year 1833, however, saw a further restriction in the powers of the +bank, when, after protracted negotiations, and in return for a further +renewal of its charter, the bank surrendered its monopoly of joint-stock +banking entirely, provided that no bank having more than six partners +might issue notes within the sixty-five-mile limit of London. + +It is a curious point that the charter of the bank never did restrict +joint-stock banking in its present accepted form, but only the issue of +notes by joint-stock bankers or banks having more than six partners. Up +to this time the issue of notes by a bank had been thought to be its +main business; so much so, that it was believed to be useless to attempt +to conduct a bank without power of issue, and consequently no +joint-stock bank had been founded. But about this time the need of such +institutions began to be felt, and the presumed monopoly of the Bank of +England was called in question--largely by Mr. Gilbart, the founder of +the London and Westminster Bank. The bank tried to assert their +monopoly, but without success, and in order to settle the matter +effectually, the following clause was inserted in the act passed in 1833 +dealing with the bank charter: + + Be it therefore declared and enacted, that any body politic + or corporate, or society, or company, or partnership, + although consisting of more than six persons, may carry on + the trade or business of banking in London, or within + sixty-five miles thereof, provided that such body politic or + corporate, or society, or company, or partnership, do not + borrow, owe or take up in England, any sum or sums of money + on their bills or notes payable on demand, or at any less + time than six months from the borrowing thereof, during the + continuance of the privileges granted by this Act to the + said Governor and Company of the Bank of England. + +It may be noted that this act of 1833 constituted Bank of England notes +a legal tender, except by the bank itself or its branches.... + + +PEEL'S ACT OR THE BANK CHARTER ACT OF 1844, AND ITS SUSPENSIONS + +[151]After the renewal of the charter in 1833, the directors of the Bank +of England laid down as a principle on which their future operations +were to be guided, that one-third of their liabilities should be kept in +cash and bullion, and the remaining two-thirds in securities. If this +principle had been acted on, the bank would have been saved from many of +the troubles which shortly assailed it; but though the intentions of the +directors were good, circumstances were too strong for them, and the +actual proportions of cash and securities to liabilities, respectively, +often differed materially from the standard laid down. This was notably +the case during the periods of financial pressure which were experienced +in the years 1836 and 1837. + +In the year 1839 matters assumed a very serious aspect. In the early +part of this year the amount of cash held by the bank was about +one-third of the amount of securities, but during the year the amount +invested in securities increased at the expense of the amount held in +cash; and by September we find that securities stood at nearly +£29,000,000, while the cash was reduced to a tenth of that figure, and +stood at £2,936,000 only. In order to avert a calamity which appeared to +be impending, the bank arranged loans in Paris and Hamburg to the extent +of between three and four millions. + +This manifest exhibition of weakness on the part of the bank led to the +appointment of a committee of the House of Commons to inquire into the +matter. The committee condemned the principles on which the bank was +working, but were powerless to effect any alteration, owing to the +charter of the bank not expiring till 1844. + +On the expiry of the charter, however, Sir Robert Peel brought forward +his famous act for remodelling the bank, and regulating the issues of +the country banks throughout. England and Wales. + +The act was passed on the 19th July, 1844, and continues without +alteration to the present day. The main provisions enacted thereby, +briefly stated, are as follows: + +I. The issue department and the ordinary banking department of the Bank +of England were to be entirely separated as from the 31st August, 1844. + +II. On such separation taking place, securities to the value of +£14,000,000 (including the [book] debt due to the bank from the +Government) were to be transferred to the issue department, together +with so much gold coin and bullion that the total so transferred should +equal the total amount of notes then outstanding. Thereafter (with the +exception noted below) the issue department must not issue any notes in +excess of a total of £14,000,000 except in exchange for gold coin or +bullion. + +III. The issue department might not at any time hold more silver than +one-fourth part of the gold held. As a matter of fact the issue +department holds no silver. + +IV. Notes might be demanded from the issue department by any person in +exchange for gold at the rate of £3 17_s._ 9_d._ per standard ounce. + +V. If any banker having the power of issue on the 6th May, 1844, should +relinquish such issue, the issue department may be authorised to +increase its issue of notes against securities to the extent of +two-thirds of the issue so relinquished; but all the profits on such +increased issue against securities were to belong to the Government. + +VI. The bank must issue a weekly statement of the position of both its +issue and banking departments, in a prescribed form. + +VII. Bankers having the right to issue their own notes on the 6th May, +1844, might continue such issue under certain conditions, and to an +agreed amount; but no provision was made compelling such bankers to keep +any reserve either in cash or securities against their issues. If any +issue lapsed, from any cause, it could not be resuscitated; and no +institutions could acquire the right of issue in the future. + +VIII. Banks consisting of more than six partners, though within the +sixty-five-mile radius of London, might draw, accept, or endorse bills +of exchange not being payable to bearer on demand. + +The first return issued by the bank in accordance with the regulations +of the new act was that of the 7th September, 1844, and was as follows: + + +ACCOUNT OF THE LIABILITIES AND ASSETS OF THE BANK OF ENGLAND + +For the Week ending 7th September, 1844 + +DR. ISSUE DEPARTMENT CR. + +Notes issued £28,351,295 Government debt 11,015,100 + Other Securities 2,984,900 + Gold coin and bullion 12,657,208 + Silver bullion 1,694,087 + ----------- ----------- + £28,351,295 £28,351,295 + +DR. BANKING DEPARTMENT CR. + +Proprietor's capital 14,553,000 Government securities 14,554,834 +Rest 3,564,729 Other securities 7,835,616 +Public deposits 3,630,809 Notes 8,175,025 +Other deposits 8,644,348 Gold and silver coin 857,765 +Seven-day and other + bills 1,030,354 + ----------- ----------- + £31,423,240 £31,423,240 + +... Taken as a whole the act has worked well, and has succeeded, in +combination with greater knowledge and foresight, in maintaining our +banking system in a sound condition.... + +The main point of contention between the supporters and opponents of the +act lies in its want of elasticity in time of need. Under no +circumstances can the bank increase its issue of notes against +securities beyond the prescribed limit, without a breach of the law; but +on three occasions in the past the law has been broken, though with the +consent of the Government, and subsequent confirmation of Parliament.... + +We will now briefly review the ... occasions on which the Bank Act was +suspended, and the effect of such suspensions. + +The first of these occasions was during the panic in the year +1847--known as the "railway panic." Shortly previous to this year a +great accumulation of capital had led to a demand for new investments, +which were duly provided for the public by those concerned with such +matters. Added to this, interest rates had ruled low for some time, and +this conduced to a period of speculative activity. Too much capital was +put into fixed investments--chiefly railways--and in one session of +Parliament sanction was asked for various railway schemes involving a +total capital of £340,000,000. Wild gambling in railway stocks ensued, +credit was inflated above all reason, and then the turn came. This was +primarily due to a bad harvest and potato crop, causing a heavy +importation of corn, and consequent export of gold. + +During the panic which ensued, the reserve of the Bank of England fell +to £1,600,000, but when the panic was at its height, the act, passed +only three years before, was suspended. The bank was authorised to +increase its accommodation to the public by exceeding, to an indefinite +extent, the limit fixed for the issue of notes not secured against gold. +The effect of this suspension of the act was immediate and complete. The +fear that "there was not enough to go round" passed from men's minds. As +a matter of fact, the issue on this occasion did not exceed the normal +limit, the mere knowledge that the bank was empowered to exceed this +limit proving sufficient to allay the panic. + +The second suspension of the Bank Act was due to the crisis of 1857, a +crisis that was brought about by reckless overtrading, and came upon the +public very suddenly and with practically no warning.... + +The third suspension of the Bank Act took place in 1866.[152] Many +elements of disturbance to the money market had been in force during two +or three preceding years. The Civil War in America had resulted in gold +being sent to this country; but the stoppage of the supply of cotton +from America, owing to the war, disorganised one of our staple national +industries, and supplies of cotton had to be obtained from elsewhere at +high prices, and paid for in cash. Hence a drain of gold set in on a +large scale. In addition, a large speculation had been built up on +credit in the stocks and shares of the many new limited liability +companies which were formed at that time. + +General uneasiness began to prevail towards the end of 1865; in January, +1866, the bank raised its discount rate to 8 per cent., and a crisis +began to develop rapidly.... + +On the 9th May the bank rate was raised to 9 per cent. On the 10th May +the failure of Overend, Gurney, and Company--for upwards of ten +millions--was announced, and the bank rate went to 10 per cent. This +failure was not made known till after business hours, so it was not till +Friday, the 11th May, 1866--known as "Black Friday"--that the crisis +reached its height. + +The stoppage of this large house affected the whole world, and general +failure seemed imminent, when, in the afternoon of the day on which the +failure became known, it was announced that the Bank Act was again +suspended, and calm began to take the place of mania. But though the +panic was allayed, many failures shortly took place, which delayed the +quick restoration of a sense of security.... + +From the above brief records of the financial tragedies of the past, we +see that on each occasion reckless speculation and overtrading had been +allowed to reach a dangerous height before any steps were taken to check +them, and on each occasion the check came too late. But we also see the +marvellously quick effect which the suspension of the act had on the +situation.... + + +THE FUNCTIONS OF THE BANK OF ENGLAND + +[153]The distinctive functions of the Bank of England consist in its +acting as: + +1. Banker to the British Government. + +2. Banker to the joint stock and private banks. + +3. (a) Sole possessor of the right to issue notes which are legal tender +in England; (b) sole possessor, among joint stock banks with an office +in London, of the right to issue notes at all. + +4. Provider of emergency currency. + +5. Keeper of the gold reserve for British banking. + +6. Keeper of the gold reserve which is most readily available for the +purposes of international banking. + +These various functions fit into and supplement one another, and though +their diversity is sometimes pointed to as throwing too much +responsibility onto one institution, it in fact enables the bank to +carry out its duties with extraordinary ease, and with the least +possible disturbance to the financial community. By the fact that it +keeps the balances of the other banks, the Bank of England is enabled to +conduct the payment of the interest on the British debt largely by +transfers in its books. By the fact that it keeps the balances of the +Government and has the monopoly of the legal-tender note issue, the Bank +has a great prestige in the eyes of the general public, which it +communicates to the other banks which bank with it. There is an +impression that the Government is always behind the bank, and that the +bank is always behind the other banks, and this feeling has certainly +done much to foster the confidence of the British public in its banking +system. + +A credit in the books of the Bank of England has come to be regarded as +just as good as so much gold; and the other banks, with one exception, +habitually state their "cash in hand and at the Bank of England" as one +item in their balance sheets, as if there were no difference between an +actual holding of gold or legal tender and a balance at the Bank of +England. It thus follows at times when an increase of currency is +desirable, it can be expanded by an increase in the balances of the +other banks at the Bank of England, since they thus become possessed of +more cash to be used as the basis of credit. For currency in England +chiefly consists of cheques, and customers who apply to the banks for +accommodation, by way of discount or advance, use it by drawing a cheque +which is passed on and so creates a deposit; and expansion of currency +thus consists chiefly in expansion of banking deposits. This expansion +is only limited by the proportion between deposits and cash which the +banks think fit to keep, and as long as they can increase their cash by +increasing their credit in the Bank of England's books the creation of +currency can proceed without let or hindrance. Their balances can be +increased by borrowing from the Bank of England, which is generally +carried out not by the banks themselves but by their customers from whom +they have called in loans, and the Bank of England is thus enabled to +provide emergency currency with great ease, by means of loans and +discounts which are used to swell the balances of the other banks, which +thus show an increase of the cash at the Bank of England which they use +as a basis for credit operations. The elasticity of the system is thus +remarkable, and the merchants and bill brokers of London can by taking +approved security to the Bank of England, increase the basis of English +credit in a few minutes by borrowing. + +1. Examining these functions of the Bank of England in closer detail we +find that its first and most obvious one, which originally brought it +into being, of financing the British Government and acting as its +banker, is now perhaps its least difficult and important duty. Apart +from the prestige which it thus acquires and its close touch with the +Government and the officials of the Treasury, the bank's position as +government banker is of little direct material advantage. Its duties as +such, besides the normal relation between a bank and a customer, consist +chiefly in making advances to the Treasury in the shape of "deficiency +advances" when the government balances are too low to admit of the +payment of the quarterly interest on the British debt without +replenishment, or against "ways and means" advances at times when the +revenue is coming in more slowly than government expenditure is +proceeding. It also, when the Government has to borrow to a greater +extent, manages its issues of Treasury bills, or any loan operation that +the Government may have to undertake. + +2. The second of the Bank of England's distinctive functions--its acting +as banker to the rest of the English banking community--is the one which +throws upon it its most serious responsibilities and gives it most of +its actual power and ease in working. The Government gives it prestige +in the eyes of the multitude, which considers that governments are +omnipotent; the other banks give it the power of providing emergency +currency by making entries in its books, and so acting as the easily +efficient centre of a banking system in which elasticity and the economy +of gold are carried to a perfection which is almost excessive. +Nevertheless, it pays heavily for its apparently privileged position as +bankers' bank. At first sight it would appear that these customers, +keeping a regular balance of twenty-odd millions, which varies little +and on which the Bank of England pays no interest, were a source of +comfortable income and no anxiety to it. But in the first place it is +obvious that a liability which is regarded as cash by the rest of the +banking community requires special treatment by its custodian, and in +practice it is so specially treated that the Bank of England maintains a +proportion of cash to liabilities which is fully twice as high as that +of the strictest of the other banks. This proportion rarely is allowed +to fall below 33 per cent. and generally ranges between 40 and 50 per +cent., and it need not be said that this high level of cash holding +tells heavily on the earning power of the Bank of England. Moreover, it +is its position as bankers' bank that exposes the Bank of England to the +responsibility of maintaining the gold reserve for English banking and +being prepared to meet, in gold, any draft on London that any one abroad +who has acquired or borrowed the right to draw wishes to turn into metal +to be shipped to a foreign country. + +The amount of the bankers' balances is not separately stated, but is +wrapped up in the total of the other deposits in the Bank of England's +weekly return. It is believed to average about 22 millions in these +days, and it is often contended that valuable light would be thrown on +the monetary position if this item were separated from the balances of +the other customers of the bank. Many of the outer bankers are in favor +of this change, but there is a serious practical objection to it, in +that a dangerous impression might be created in the public mind if at +any time it were seen that the bank's cash reserve was below its +liability to its banking customers; and the separate publication of the +bankers' balances might thus check the readiness with which the Bank of +England creates emergency credit. Another suggestion that is sometimes +made by the many critics of the existing order of things in English +banking is that the banks should keep their cash reserves themselves; +but this very revolutionary change would deprive the system of its two +great advantages, a centralised organisation with a centre which +specialises on the duties involved by acting as centre, and the extreme +elasticity with which the present arrangements work. At the same time it +must be admitted that the system by which the other banks treat their +balances at the Bank of England as cash leads to the existence of a vast +amount of "cash" in England which on being looked into is found to +consist of paper securities or promises to pay. + +3. The Bank of England's monopoly of note issue, which once gave it the +monopoly of joint-stock banking in London, is now a matter of +comparatively minor importance, owing to the change in English banking +habits by which the cheque has ousted the bank note for the purpose of +daily commercial payments, and the regulations which were imposed on the +note issue by the Bank Act of 1844. This monopoly was conferred on the +bank in 1706 and was maintained until 1826, when the implied monopoly in +joint-stock banking was restricted to a sixty-five-mile radius around +London. In 1833 joint-stock banks were established in London itself, +since it had been discovered that the Bank of England's alleged monopoly +only reserved to it the privilege of note issue, and the private bankers +in London had already found that it was more convenient to banker and +customer to work by the system of deposit and cheque. + +The development of this system was quickened by the provisions of Peel's +act of 1844, which, under the influence of banking disasters that had +arisen out of reckless note issuing by private banking firms in the +counties, laid down an iron rule for the regulation of note issues in +England. None of the other note issuers were allowed to increase their +issues under any circumstances, and the Bank of England, for every +additional note issued beyond £14,000,000, was to hold metal in its +vaults. Under the terms of Peel's act one-fifth of this metal might be +silver, and in the early returns issued by the bank under the act a +certain amount of silver is found among the assets of the issue +department. But since 1853, no silver has been held in the issue +department of the bank, and in 1897, when the influence of the +bimetallists on the existing Government led to a proposal that the +proportion of silver allowed by law should be held by the bank as +backing for its note issue, public opinion expressed itself so +vigorously that the suggestion was promptly buried. The bank's fiduciary +note issue, thus fixed at £14,000,000, was only allowed to increase by +the lapse of the issues of the existing issuers, the bank being +empowered to increase it by two-thirds of the amount lapsed. The lapsing +process has proceeded steadily by the amalgamation of country banks with +banks which have London offices and so are prohibited by the bank's +monopoly. And the bank's fiduciary issue has thus been raised from the +original £14,000,000 to £18,450,000. Above this line it can not go +except by means of the suspension of the Bank Act, which has been found +necessary occasionally in the past. The English currency system is thus, +as far as the law can rule it, entirely inelastic, but it has already +been shown that even when the law of 1844 was passed, the cheque +currency, over which the law exercises no restriction, was already +driving out the note, and banks without any right of note issue had been +eleven years established in London. The Bank of England's note issue is +now chiefly used by other banks as "till money," or part of the store of +legal-tender cash they keep to meet demands on them. It has thus become +part of the basis of credit in England, since the other banks roughly +base their operations on their holding of cash in hand and at the Bank +of England. Their cash at the Bank of England has already been discussed +above: their cash in hand consists of coin and notes, and since the +latter have thus become part of the foundation on which the deposit +liabilities of the other banks are based, there is reasonable ground for +the contention often put forward by practical expert critics of the +English system, that the fiduciary note issue should be reduced by the +repayment by the Government of the whole or part of a government debt of +£11,000,000 to the bank, which backs the greater part of it, and its +replacement by gold. It is evident that the amount of metallic backing +for a note issue which is intended to circulate as currency is a +different matter from that required in the case of a note issue which is +held by bankers as a reserve and used by them as a foundation for a +pyramid of credit operations. + +4. By the ease with which the Bank of England provides emergency +currency, it gives the English banking system the great advantage of +extreme elasticity and adaptability; and it is enabled to do this by the +fact that it acts as banker to the other banks, and that every credit +which they have in its books is regarded by them and by the rest of the +community as "cash" to be taken as practically equal to so much gold. +This cash at the Bank of England in the hands of the rest of bankers can +be multiplied as rapidly as the Bank of England is prepared to make +advances, and as the mercantile and financial community can bring it +bills for discount or securities to be borrowed on. There is no legal +restriction of any sort or kind, and the close relations between the +bank and its borrowing customers enable the necessary operations to be +carried through with a celerity which is unrivalled, at any rate in the +eastern hemisphere. The process works as follows: In every English bank +balance sheet there will be found an item among the assets "cash at call +or short notice," though in a few cases the slovenly habit is adopted of +including this entry along with the cash in hand. This "cash," as it is +called, really consists chiefly of loans made by the banks to the +discount houses, and regarded by the banks as the most liquid of their +resources. As such, it is at once made use of when for any reason, such +as the many payments which have to be made on quarter days, or at the +end of the half year when the preparation of balance sheets by firms and +companies require an abnormal amount of cash for more or less ornamental +purposes, the banks are subjected to extra pressure by their customers, +who both withdraw actual currency from them for smaller payments, and +require advances in order to show cash with bankers in their balance +sheets. + +The banks in order to meet this pressure, and at the same time to +preserve an adequate amount of cash in their own statements, call in +their loans from the discount houses; the discount houses, at a point, +can only repay them by borrowing from the Bank of England and +transferring the credit raised with it to the bankers, whose cash at the +Bank of England is thus increased. This book entry takes the place in +their balance sheets of the legal-tender cash that their customers have +withdrawn, and is used as the basis for the increased deposits that have +been created by the loans of the bankers to their customers for +ornamental purposes. Similarly at the time of year when the transfer of +the taxes to the Government's balance reduces the cash at the Bank of +England held by the other banks the gap is filled by the loans made by +the Bank of England to the customers of the other banks. In short, by +discounting and making advances the Bank of England can at any time +create book credits, which are regarded as cash by the English banking +community, and on which the latter can base the credits which give the +right to draw cheques, which are the most important part of the English +currency. The extent to which the Bank of England can create this credit +is a matter for its own discretion, but any creation of it diminishes +the proportion that it shows in its own weekly returns between its +reserve and liabilities. Consequently when it is applied to for amounts +which bring that proportion too low the Bank of England has to take +steps to reinforce its cash reserve. + +5. It has been shown that the Bank of England keeps the balances of the +other banks, and from this it follows that the latter look to it for +gold or notes at times when the local commercial community requires an +extra supply. At the end of every month, especially at the ends of the +quarters or at times of national holidays, the bank's note circulation +expands and coin is taken from it. The duty is thus thrown upon it of +keeping an adequate supply of cash for home purposes, and, as has been +already stated, its normal proportion of cash to liabilities is very +much higher than that of the other banks. But these movements are tidal +and regular, and though times of active trade increase slightly the +demand for coin and note currency in England, the extensive and +ever-growing use of the cheque reduces the importance of this part of +the bank's duties. + +6. Much more important is the Bank of England's duty as custodian of the +gold store for international banking. London is the only European centre +which is always prepared to honor its drafts in gold immediately and to +any extent. Consequently the Bank of England has to be prepared to meet +demands on it at any time from abroad, based on credits given to +foreigners by the English banking community, and it has thus to observe +the signs of financial weather in all parts of the world and to regulate +the price of money in London so that the exchanges may not be allowed to +become or remain adverse to a dangerous point. The difficulties of this +task are increased by the extent to which the English banking community +works independently of it, by accepting and discounting finance paper, +and giving foreigners credits at rates which encourage their further +creation. For the low and wholly unregulated proportion of cash to +liabilities on which English banking works, enables the other banks to +multiply credits ultimately based on the Bank of England's reserve, +leaving the responsibility for maintaining the reserve to the bank. This +it does by raising its rate when necessary, and so, if it has control of +the market and its rate is "effective"--a phrase which will be explained +later--raising the general level of money rates in London. + +When its rate is not effective, the Bank of England finds itself obliged +to intervene in the outer money market--consisting of the other banks +and their customers--and control the rates current in it. This it does +by borrowing some of the floating funds in this market, so lessening +their supply and forcing up the price of money. By means of this +borrowing it diminishes the balances kept with it by the other banks, +either directly or indirectly--directly if it borrows from them, +indirectly if it borrows from their customers who hand the advance to it +in the shape of a cheque on them. The result is that so much of the +"cash at the Bank of England," which the English banking community uses +as part of its basis of credit, is wiped out, money--which in London +generally means the price at which the bankers are prepared to lend for +a day or for a short period to the discount houses--becomes dearer, the +market rate of discount consequently tends to advance, the foreign +exchanges move in favor of London, and the tide of gold sets in the +direction of the Bank of England's vaults, and it is enabled to +replenish its reserve or check the drain on it. That the Bank of England +should have to go through this clumsy ceremony of borrowing money that +it does not want, in order to deprive the outer market of a surplus +which depresses discount rates in a manner that is dangerous owing to +its effect on the foreign exchanges, arises from the want of connection +between bank rate and market rate. In former days the London money +market never had enough money to work without help from the Bank of +England. Bagehot, in his great work on Lombard Street, published in +1873, says that "at all ordinary moments there is not money enough in +Lombard Street to discount all the bills in Lombard Street without +taking some money from the Bank of England." + +As long as this was so, bank rate--the price at which the bank would +discount bills--was at all times an important influence on the market +rate. Since then, however, the business of credit making has been so +quickly and skillfully extended that Lombard Street is frequently able +to ignore bank rate, knowing that it will easily be able to supply its +needs from the other banks, at rates which are normally below it. +Currency in England consists of cheques drawn against deposits which are +largely created by the loans and discounts of the other banks. There is +no legal limit whatever on the extent to which these loans and discounts +can be multiplied, and the only limits imposed are those of publicity, +which is applied rarely in all cases and in some not at all, and of the +prudence with which the banks conduct their business. Hence it follows +that competition between the banks often impels them to continue to make +advances or discount bills at low rates when the Bank of England, as +custodian of the English gold reserve, thinks it advisable in the +interests of the foreign exchanges to impose a higher level. This it +does by borrowing some of the credit manufactured by the other banks, in +order to create artificial scarcity of money, and make its own official +rate effective. + +It thus appears that the Bank of England's official rate is often +through long periods a mere empty symbol, bearing no actual relation to +the real price of money in London; and only becomes effective, and a +factor in the monetary position (1) when the trade demand for credit is +keen enough to tax the credit-making facilities of the other banks to +their full extent, (2) when the payment of taxes transfers large sums +from the other banks to the Government's account at the Bank of England, +so reducing the "cash at the bank" on which they build credit +operations, and (3) when, owing to foreign demands for gold, the Bank of +England takes measures, by borrowing, to restrict credits in the open +market and to make its rate effective. In other respects its official +rate differs materially from the rates quoted by ordinary dealers in +credit. It does not fluctuate according to the supply and demand for +bills, but is regularly fixed once a week at the meetings of the Bank of +England court on Thursday morning. It is extremely rare for any change +to be made in the Bank of England rate on any day except Thursday. +Instances occur rarely when some sudden change of position makes it +essential, as at the end of 1906, when the bank rate was raised to 6 per +cent. on a Friday morning. In normal times the rate which is fixed on +one Thursday is maintained until the next, though the rate is only a +minimum and the Bank of England occasionally takes advantage of this +fact and refuses to discount at its minimum, which still remains +ostensibly the bank rate, while the bank actually makes a rather higher +charge, which is usually made the official rate on the next Thursday. + +But it must not be supposed that when bank rate is ineffective the Bank +of England is doing no business. It discounts bills and makes advances +at market rates at its branches, and also at its head office to its +private customers. Bank rate may be described as the price at which the +bank is prepared to discount in its official capacity as centre of the +London market, and it is because appeal is only made in exceptional +circumstances to the bank to provide credit in this capacity that bank +rate is often ineffective. + + +THE JOINT-STOCK BANKS + +The most obvious function of the joint-stock banks of England is the +business of taking care of money for customers and meeting cheques drawn +against their balances. Customers place money with them either on +current or deposit account. On current account it can be withdrawn at +any time and earns, as a rule, no interest. Many banks make it a +condition that unless the current account is maintained at a certain +figure, generally £100, a charge shall be made for keeping it. A usual +charge is £1 5_s._ 0_d._ each half year, but arrangements vary according +to the terms agreed with different customers, and the keen competition +now prevalent enables many to obtain the convenience of a bank account +for nothing. Sums left on deposit are generally placed for a week or +longer, and if placed for a week the rate paid on them by the banks is +generally 1-1/2 per cent. below bank rate. + +Out of this function of meeting checks drawn by customers against the +sums deposited has grown the banker's chief duty, which is now the +provision of cheque currency for the mercantile and financial community. +Currency in England consists of coins, notes, and cheques. The note +issues are almost obsolete as currency, the Bank of England's being used +chiefly as reserve by the other banks, while the issues of the country +banks are so small as to be negligible. Most of the commercial and +financial transactions of England to-day are settled by cheques drawn on +the banks by their customers. These cheques are not legal tender, since +it would obviously be impossible that a cheque drawn by an individual on +a bank could be legally made acceptable by a creditor whether he wished +to take it or not. + +There is no legal obligation of any sort on them to maintain any regular +proportion between cash and liabilities, and as their position in this +respect is only subjected to occasional publicity they are not obliged +to consider even the effect upon their customers of any considerable +variation in the proportion between cash and liabilities which they +keep. The system thus works with extreme elasticity and banking +facilities can be provided in England with extraordinary ease. It has of +late years been frequently contended that the ease and elasticity with +which it works have carried the English banking machinery to a somewhat +extreme length in the matter of the economy of gold and legal tenders +and the extent of the credit pyramid which it builds up on them. After +the crisis of 1890, Lord Goschen seems to have been strongly imbued with +the conviction that the system had been carried too far. He therefore +urged upon the London banks that they should make a monthly statement of +their position, and this suggestion was adopted by the majority of them. +The result was that they published a monthly statement showing how they +stood on one day at the end of each month, and it thus followed that on +one day at the end of each month the banks showed a proportion of cash +to liabilities which they considered sufficiently adequate to stand the +light of publicity. But the system has long been seen to be faulty, and +a certain amount of abuse has grown up round it. It is strongly +suspected, for example, that some of the banks which publish these +statements make preparations for them by calling in loans or reducing +their discounts for the day on which the statements are drawn up. As far +as this is done the statement is to a certain extent misleading, and +this practice of "window dressing," as it is called in Lombard Street, +has been subject to frequent criticism, so much so that one of the +leading London banks--the London and County--adopted early in 1908 the +practice of showing its daily average cash holding, thus demonstrating +that it was not in the habit of preparing a statement which did not +represent its position fairly throughout the month. It has been stated +by a president of the English Bankers' Institute that the proportion of +cash to liabilities shown by country banks ranges down to a point as low +as 2.2 per cent. No one can contend that this is an adequate cash basis +for banking to work on, and as long as certain members of the banking +community conduct their business on these lines an obvious hardship is +involved on those which keep a more prudent and strong reserve of cash. +It is contended by the big strong banks that their smaller brethren +compete with them by providing more credit than they have any right to +create, relying on their assistance in times of difficulty. + +Apart from this danger of the over-multiplication of credit on an +inadequate cash basis, the complete absence of any legal or other +restrictions on the operations of English banking enables it to work +with extraordinary ease and readiness. As long as good unpledged +security, whether in the form of bills of exchange, commodities, or +Stock Exchange securities, are available in the hands of customers the +banks can advance against them to any extent that they consider prudent. +Prudence dictates in the case of a great majority of them that a certain +proportion of cash to liabilities shall be maintained, but, as was shown +above in dealing with the Bank of England, the cash of English banking +consists partly of credits with the Bank of England. These credits with +the Bank of England, and consequently the cash credits of English +banking, can be multiplied as rapidly as the Bank of England is prepared +to make advances or discount bills, and so give credit in its books. The +Bank of England must publish its account weekly, and it watches over its +proportion of cash to liabilities with a vigilance which is greater than +that of the rest of the banking community as a whole. Nevertheless, its +prudence in this respect is the only restriction on it, and we thus +arrive at the conclusion that the chief function of the English joint +stock banks, that of providing the mercantile community with currency +and credit, can be carried out to any extent as long as their customers +have security to offer and their proportion of cash remains adequate to +their sense of prudence. And further, their proportion of cash can be +increased as rapidly as the Bank of England is prepared to make +advances, which it can and does to an extent which again is only limited +by its own prudence. + +Besides this absence of outside regulation, the English monetary system +is also distinguished by a remarkable lack of cohesion and co-operation +among the members of its own body. Except to a certain extent in the +country districts, where the rates allowed to depositors and charged to +customers are to a certain extent a matter of convention, English +banking works almost entirely at the mercy of very keen internal +competition. This extreme development of competition leaves the market +liable to pronounced depression in rates at times when slackness of +trade or other causes decrease the demand for credits. At these times +the adroit bill brokers and discount houses, which are in some respects +the most important borrowing customers of the banks in London, are +enabled by the use of this weapon of competition to obtain loans from +the banks at rates which are often below the price that the bankers are +paying to their depositors. Hence, it follows that in these times of +monetary ease the credit machine goes on turning out its product at +rates which are quite unremunerative and have a detrimental effect on +the market rate of discount, and so on the foreign exchanges, thus +increasing the difficulties of the Bank of England, which at these times +of extreme ease is without any control of the position. Against this +weakness of the system, however, must be set the advantage which the +unrestricted and fiercely competitive manufacture of credit confers on +the mercantile and trading community. + +A few words should be said concerning the form of cheques with which the +English banks provide their customers as currency. Legally a cheque is a +bill of exchange drawn on a bank and payable on demand. That is to say, +it is an order signed by a customer of the bank directing it to pay a +certain sum to another party or to himself. The form, however, can be +varied in various methods, increasing or diminishing the ease with which +the cheque can be turned into cash. The cheque can be made payable to A +B or bearer, and in this form can be taken to the bank drawn on and +immediately turned into cash. When drawn to A B or order, a cheque has +to be indorsed, or signed on the back, by A B before the bank drawn on +will pay it. A still further restriction is the English system of +crossing cheques, that is to say, of drawing two lines across the face +of the cheque, by which mark it is shown that the cheque is not to be +paid in cash across the counter by the bank drawn on, but must be paid +into a bank by the payee, and so only becomes credited to him in his own +banking account through the operations of the clearing house. It is +evident that this protection greatly increases the safety of the cheque, +since if it fell into the wrong hands its chance of being made +fraudulent use of is greatly diminished. As the lines drawn across the +face of the check by the bankers' customers are often faint and +irregular, it has been found in practice that they lend themselves to +the ingenuity of the fraudulent, who are easily enabled to erase them +and so obtain possession of money that is not meant for them. Some of +the banks therefore print these crossing lines on all of the cheques +that they issue to their customers to be filled in, and when the +customer wishes to obtain cash from his bank on one of these cheques he +is consequently obliged to write upon it "Please pay cash," and sign +this note upon it. The extensive use of crossed cheques thus tends to +make the cheque still further an instrument which merely transfers +banking credits from the books of one bank to another, since every +crossed cheque implies that it can not be turned into cash directly, but +can only transfer credit with one bank to credit with another. Another +restriction with which custom has protected the English cheque is the +system of writing "Not negotiable" on the face of it. These words do not +mean that the cheque is really not negotiable, but their legal effect is +that the holder of the cheque can not establish a better right to it +than the party from whom he received it. If therefore the party from +whom he received it had no right to it, his claim against the paying +bank is _nil_. With these safeguards, and with the enormous convenience +of being drawn to any amount to fit the exact requirements of each +transaction, the cheque, although not legal tender, has been enabled to +supersede the bank note in English currency. + +The chief function of the joint stock banks having thus been shown to be +the provision of currency for the English community, it may further be +noted that a remarkable development of their activity has been the +rapidity with which they have covered England with branch +establishments. It was estimated in 1858 that the total number of bank +offices in the whole of the United Kingdom was just over 2,000; at the +present moment the aggregate branch offices of four of the English joint +stock banks which are richest in respect of branch establishments have +exceeded this total. One bank in England has over 600 offices, one has +over 550, two have over 400, three have more than 200, twelve have more +than 100. This multiplication of branch offices has been carried out +partly by the absorption by the joint-stock banks of the smaller +institutions in the country, whether private or joint stock, and partly +by the rapidity with which they have opened branches in the great +provincial centres and their suburbs, and to a moderate extent in the +small country towns. The result of it is to give the English monetary +system the power of easily supplying the needs of the various parts of +the community as the requirements of others ebb and flow. At the same +time this rapid development increases the competition between the +various English banks, which we have already shown to be carried to an +almost excessive degree, and by the wide local distribution of their +liabilities enhances the possibility of strain on them in times of +difficulty. + +Some of the banks include under the heading "cash at call and short +notice" advances which they make to the Stock Exchange for the +fortnightly periods that elapse between its settlements. The funds that +they so use obviously have an important effect upon the marketability +and price of securities in London. On the first day of every settlement +it is usual to see rates quoted as those at which the banks are lending +to their stock exchange clients for the financing of speculative +commitments. In the arrangement of these rates a certain amount of +combination and co-operation among the banks, or some of them, has grown +up as a matter of custom, but since for this class of accommodation the +bankers are subject to competition on the part of the agencies of the +foreign banks and the big finance houses it is often found difficult to +maintain even this amount of harmonious working among the bankers. + +It has been shown that the rate at which the banks make advances to the +discount houses has an important effect upon the market rate of discount +in London, but the banks exercise a still more important and direct +effect upon this discount by being themselves large buyers of bills. It +is impossible to gauge exactly the extent to which they hold bills among +their assets, since many of them in their balance sheets include their +discounts along with their loans and advances. Among the many +suggestions that reformers have put forward in the matter of English +banking, one is that this item of the banks' holding of bills should be +separately stated. But though this obscurity in the statements of the +English banks makes it impossible to know the precise extent to which +they hold bills, there is no doubt their purchases of them are on the +whole the most important influence upon the market rate of discount in +London. Nearly all the discount houses, whose functions will be +described later, buy bills, largely with the intention of reselling +them to customers, among whom the joint-stock banks are the largest and +most important and most regular buyers, and it is contended by the +discount houses that the market rate of discount, for which they +themselves are generally supposed to be responsible, is really and in +fact regulated by the price at which the big joint-stock banks are +prepared to buy. This being so, since the market rate of discount is +perhaps the most important influence on the foreign exchanges and so on +the inward and outward movements of gold, it will be seen that this +function of the bankers is one of the greatest possible importance from +the point of view of London's free market in gold. + +Besides thus regulating the price at which bills of exchange can be +discounted in London, the banks have in recent years taken an +increasingly large and important part in the creation of bills of +exchange by placing their acceptances at the disposal of their +customers. The increasing extent to which the bankers have in recent +years intruded into this class of business is a grievance that is +resented rather keenly by the merchant firms, or accepting houses, as +they are often called. It is contended by the latter that the business +of acceptance is a special function for which special training is +required, and that the joint-stock banks rarely have available the +special abilities that make for its proper conduct. On the other hand, +the high standing of the joint-stock banks and their big reserve +resource in the shape of their uncalled capital makes their acceptances +an exceptionally fine credit instrument, and it seems natural enough +that they should, to a certain extent and within moderate limits, place +these facilities at the service of their customers. + +Finally it may be added that the English joint-stock banks are now +showing a disposition to engage to some extent in the business of +dealing in foreign exchange which has hitherto been left to the finance +houses and foreign firms established in London. The London and County +and the London City and Midland banks have now established regular +foreign exchange departments. This development is generally welcomed as +a sign of a desire on the part of the banks to widen their horizon and +to come into closer touch with the affairs of the financial world at +large, but, as in the case of the banks' increasing interest in +acceptance, there are some critics who consider that it is better for +the bankers to stick to their obvious and highly important function of +providing the community with credit and currency, and taking care of the +money of their customers. + + +THE PRIVATE BANKS + +Any differences that exist between the private and joint-stock banks of +England lie in their ownership rather than in their functions. Their +functions are the same, but the manner in which they carry them out is +perhaps influenced to a slight extent by the fact, which really +distinguishes them, that the private banks are owned by a few partners +who generally conduct the business for themselves or exert more or less +influence on it, while the joint-stock banks are managed by salaried +directors and officials on behalf of a large body of shareholders formed +into a public company, the shares in which can as a rule be bought and +sold on the London Stock Exchange. + +Since private enterprise naturally precedes joint-stock institutions, it +goes without saying that the private banks of England were the pioneers +of the banking business. There are still in existence private firms +which were founded before the Bank of England. A goldsmith called Child +was doing business of a banking character soon after 1660, and Child's +Bank still exists. Hoare's Bank was instituted in about 1680, fourteen +years before the Bank of England received its charter. Modern +developments have almost driven them out of the field, and among the +leading banks in the city of London only two are left which can still be +called private in the old sense of the word. There are one or two other +institutions which are on the borderland: and at the west end of the +town several old firms, including Child's and Hoare's, have retained +their old constitutions. + + +THE MERCHANT BANKERS AND ACCEPTING HOUSES + +The most important function of the merchant bankers is not that of +banking, but of accepting. Banking, in the strict sense of the term, +they do not engage in--that is to say, they are not prepared to meet +claims upon them by an immediate payment of cash or legal tender over +the counter, but by payment of a cheque on one of the banks in the +stricter sense of the term. The function of the London accepting houses, +though of enormous importance, is still to a certain extent subordinate +to the judgment of the English banks. They finally decide whose paper is +most readily negotiable, and, in times when the credit machine is felt +to be somewhat out of gear, the bankers occasionally discriminate +against the paper of firms which they consider to have been giving their +acceptance too freely. In this respect, as in so many others, the Bank +of England remains the final arbiter, since the paper of an accepting +house which is questioned by the other banks can be negotiated at the +Bank of England through a discount house, and the Bank of England has +before now intervened with effect when it considered that questions +raised concerning certain acceptances have been without justification. + +This business of acceptance is one into which the other banks have +themselves recently intruded with considerable effect, accepting bills +for their customers, home and foreign, for a commission; and there is a +certain apparent anomaly in the position which makes them guardians of +the volume of acceptance created by the private firms and acceptors +themselves on a steadily increasing scale. Nevertheless, this anomaly +has little or no untoward effect in practice. The bankers are naturally +extremely cautious in raising any question as to the security of general +credit in London, and they are in many ways closely connected with the +private accepting houses, so that the system, which appears to be full +of uncomfortable possibilities on paper, works easily enough in +practice. + +Other functions of the merchant firms and accepting houses are their +activity in general finance and in exchange business. Both these +functions arise out of their old business as merchants, which gave them +close connection both with the governments and the business communities +of foreign countries. + + +THE DISCOUNT HOUSES + +The great volume and diversity of the bills of exchange which come into +the London market to be melted and turned into present cash before their +date of maturity has caused the existence of a class of dealers in bills +(bill brokers) who specialise in handling them and may be regarded as +intermediaries between the holders of the bills--that is to say, +originally, the drawers of them, or their representatives, or any one +else into whose hands they may have passed them on--and the bankers, who +are the ultimate buyers and hold them as investments until maturity. It +is the business of the discount houses to buy these bills on a wholesale +scale, using for this purpose funds largely lent them by the banks, and +to meet the requirements of the bankers with regard to the date named +and quality of the bill, providing them out of the store that they keep +constantly replenished. + +We have also seen that the discount houses fulfill a very important +function by borrowing funds from the bankers at call and short notice. +These funds are regarded by the bankers, and actually described in their +balance sheets, as cash, cash at call, and short notice. It is a +somewhat elastic extension of the term "cash" to apply it to money that +is being lent to any borrower, even of the highest credit and against +the most liquid possible collateral. But it is always assumed by the +bankers that these funds placed in the discount market can be called in +readily at any moment. That they can be called in is practically a fact; +but it arises chiefly from the ability of the discount houses when +pressed for repayment of these loans by the bankers to fill the gap in +credit by an appeal to the Bank of England and the production of fresh +cash, as it is called, by borrowing from it. The discount houses take +security to the Bank of England and raise with it the right to draw +cheques. These cheques they pay to their bankers, whose cash at the Bank +of England, which we have already seen to be regularly used as a part +of the basis of credit in England, is thus increased. + +Besides the money that they habitually borrow for short periods from +bankers, the discount houses also have considerable amounts placed on +deposit with them by other lenders, some of which they employ, +especially in times when the volume of bills is comparatively small, by +loans to the Stock Exchange for financing the speculative commitments of +the public, and by holding or carrying securities of a reasonably liquid +character. They also take some part in the underwriting of new loans and +in the general financial business of the London market. + +[154]It is impossible to exaggerate the importance of the functions +which the bill brokers discharge in the London money market. They are +only about twenty in number, including three joint stock companies. One +or two of the brokers work on commission, as your brokers do, but the +majority are really dealers in bills. That is, they buy or discount, and +sell, or rediscount, bills of exchange. + +Let me illustrate their method of working: A bank in New York may buy +$1,000,000 worth of sterling bills drawn on England and send them +forward to its London agent to be discounted with the bill broker. The +bill broker will discount these bills at, say, 4 per cent. If he thinks +rates are likely to fall, he will hold the bills; if he thinks them +likely to rise, he will try to sell the bills at about 3-3/4 per cent. +or 3-7/8 per cent. discount, thus making a profit on the transaction of +1/4 per cent. or 1/8 per cent. per annum. Similarly he may discount +large parcels of bills for Eastern and South American banks. Many of +these bills will be bills drawn on and accepted by banks and finance +houses. These are known as "bank bills." But on the other hand, the bill +brokers are free buyers of "trade bills." The trade bill in England +arises in the following way: Trader A sells goods to trader B. He will +draw a draft on trader B at, say, three months date. Trader B will +accept the draft and return it to trader A, who will discount it with +his banker or with the bill broker. The rate of discount for trade bills +is usually 1/2 per cent. per annum higher than the rate for bank bills. + +The essential feature of almost all the bills on the market is that they +represent a commercial transaction, such as a sale of goods, where value +passes. It is this that lends them their self-liquidating quality; for +they are usually liquidated by the acceptor out of the proceeds of the +resale of the goods during the currency of the bill. + +The bill broker not only employs his own capital in buying bills, but +also money which he borrows from the banks and others at call or at +short notice. Enormous sums are employed in this way. + + +INTERVIEW WITH THE GOVERNOR AND DIRECTORS OF THE BANK OF ENGLAND + +[155]Q. When does your present charter expire? + +A. The bank's exclusive privileges of banking continue subject to one +year's notice and to repayment by the Government of the debt of +£11,015,100 and of all other public debt held by the bank at the time. + +Q. What is the par value and present selling price of your shares? + +A. The bank's capital is in the form of stock, £100 of which is at +present quoted at about £267. + +Q. How many stockholders have you? + +A. There are at present over 10,000 accounts. + +Q. Is the stock fully paid? + +A. Yes. + +Q. Have your shareholders any liabilities in addition to the ownership +of shares? + +A. Legal opinion is to the effect that there is no further liability on +bank stock. + +Q. Is there any limit to the number of shares which may be held by any +one person, and is your approval required before a transfer of your +stock can be made? + +A. There is no limit--the bank's approval is not required. + +Q. Does every share have a vote at shareholders' meetings? + +A. To have a vote a proprietor must hold £500 of stock, but no matter +how much additional stock a proprietor may hold he can not have more +than one vote. + +Q. Is there any custom restricting the class from which the directors +may be selected? + +A. There is no legal restriction as to the class from which directors +may be selected, except that they must be "natural-born subjects of +England, or naturalized," but in actual practice the selection is +confined to those who are, or have been, members of mercantile or +financial houses, excluding bankers, brokers, bill discounters, or +directors of other banks operating in the United Kingdom. + +Q. How many branches have you? + +A. There are eleven branches--two in London and nine in the provinces. + +Q. Is the business conducted at your branches of the same class as at +your main office in London? + +A. Yes. + +Q. Do your branches have business relations with merchants, farmers, and +all classes of people in their respective localities? + +A. There are no restrictions of any kind as to the class of people with +whom the bank has business relations. + +Q. Is the Bank of England a member of the London Clearing House? + +A. Yes; but "on one side only," as it is termed. The Bank of England +presents, through the clearing house, all drafts drawn on clearing +bankers paid in to it by its customers; but the clearing bankers do not +present, through the clearing house, drafts on the Bank of England paid +in to them by their customers. Such drafts are paid direct to the credit +of their accounts at the Bank of England. + +Q. Do you at any time allow interest on special deposits? + +A. It is not the practice of the bank to allow interest on any deposit. + +Q. Can you state approximately the average length of time and the +average size of bills discounted by you? + +A. Time, forty to fifty days; size, probably about £1,000. + +Q. What is the distinction between what are known as "prime bills" and +other bills? + +A. A "prime" bill we should define as a bill accepted by a London or +provincial bank in first-class credit or a merchant or merchant banker +of the first class whose business it is to grant credits. + +Q. Do you discount any prime bills? + +A. Yes. + +Q. Do you discount to any considerable amount for individuals and +merchants? + +A. The bank discounts all approved bills offered to it by persons or +firms having properly constituted accounts. + +Q. Is it your custom to employ surplus funds in purchase of bills from +discount houses? + +A. No. + +Q. Do you rediscount bills for the joint stock or other banks? + +A. The bank is always prepared to rediscount for other banks at its +official rate, and does a large business from time to time with the +colonial and foreign exchange banks who are from the nature of their +business always sellers of bills. + +Q. Would you charge a merchant house having a good account with you the +bank rate or the market rate for prime bills? + +A. The market rate. + +Q. To what extent does bank rate govern your discount and loan +transactions? + +A. The rates for discount and loan transactions at the bank usually +approximate more or less closely to the bank rate. + +Q. Do you at times discount bills for parties having no account with +you? + +A. No. + +Q. Are a considerable number of your loans on call? + +A. None. + +Q. When and under what conditions is the bank rate changed? + +A. The bank rate is raised with the object either of preventing gold +from leaving the country, and lowered when it is completely out of touch +with the market rate and circumstances do not render it necessary to +induce the import of gold. + +Q. Does the bank sometimes borrow money in the open market for the +purpose of raising the market rate? + +A. Yes. + +Q. Do you sometimes sell consols for the same purpose? + +A. Yes; on rare occasions. + + +INTERVIEW WITH SIR FELIX SCHUSTER, GOVERNOR OF THE UNION OF LONDON AND +SMITH'S BANK LIMITED + +[156]Q. Your bank is organised under the General Companies Acts as are +all joint stock banks in England? + +A. Yes. + +Q. You are not under government supervision or examination? + +A. No. + +Q. The authorised par of your stock is £100, and £15 10_s._ have been +paid on each? + +A. Yes. + +Q. Are your shares held by individuals and corporations? + +A. By individuals, not by corporations. There are upwards of 8,600 +different shareholders. + +Q. In the transfer of shares, do you require the name of the transferee +to be submitted and approved before the transfer is made? + +A. Yes. + +Q. That of course is in order to insure the responsibility of your +stockholder? + +A. This is in order to insure the responsibility of our stockholder, and +to prevent one holder from securing too large a holding. Furthermore we +give no single proprietor more than 20 votes, however large his holding +may be. Every 10 shares carry one vote, so the holder of 200 shares has +a maximum number of votes. + +Q. Is that the usual custom with the joint-stock banks of England? + +A. I am afraid I cannot answer offhand. I suppose it is so in some +cases, but the practice varies. + +Q. In London there is usually a difference between the rates charged on +loans and bills in favor of bills, is there not? + +A. Yes. + +Q. Would you say that that difference is perhaps from one-half to 1 per +cent. in favor of the bill? + +A. It depends so very much on the circumstances of the moment that it is +very difficult to generalise. At the present moment I would say a three +months' bill is worth 1-7/8, and a three months' loan would be worth +perhaps 3-1/2. + +Q. Were most of your branches organised by you or were most of them +other institutions purchased by you? + +A. Some of them were other institutions; some of them were organised by +us; most of them were those old banking firms which were carried on as +private businesses and have since become branches of our bank. + +Q. The tendency is for the consolidation of banking in Great Britain, is +it not? + +A. Yes. + +Q. Very strongly in that direction? + +A. Very strongly in that direction, yes. + +Q. As a matter of fact, a large part of the commercial banking in +England is done by about a dozen institutions, is it not? + +A. In Liverpool and Manchester there are very important local banks. +However, it is no doubt the fact that four or five banks do about half +the banking business. + +Q. In the main you believe that the banking situation is stronger and +better and the country is better served through the system of branches +than through the independent banks? + +A. I am quite convinced of that, if only for one reason, that I do +believe the indiscriminate granting of credits to the individual is +injurious to himself, the private bankers being too much in the habit of +regarding old family associations and not so careful as the joint-stock +company would be, and he has accustomed people to trade on the credit +that they get from the banker. I do not think that is banking business. +The bank ought never to supply the trader with working capital. I think +it is bad for the trader. + +Q. Is it not quite essential to the success of a financial institution +doing a commercial business to become a member of the Clearing House if +it is to meet with a large degree of success? + +A. No. After all, there are only seventeen banks, I believe, now in the +Clearing House, but there are a great many other institutions who are +not members of the Clearing House and who do not suffer from that fact. +Scotch banks with branches here who do a large banking business are not +members of the Clearing House. There are all the colonial banks with +head offices or branches in London and other large institutions; those +are not members of the Clearing House. There are Barings and +Rothschilds; they are not members of the Clearing House. + +Q. Would you say the Bank of England is in any way a competitor of the +other banks in England? + +A. Yes. That is a source of very grave complaint by the other banks. + +Q. The Bank of England do not pay interest on any accounts? + +A. No; but in some cases they act as intermediaries for lending money. +It is a very subtle distinction. + +Q. While the bank rate is fixed and is to-day, say 2-1/2 per cent., is +it not a fact that the Bank of England does some business for its +customers and also purchases bills for their account at a lower rate? + +A. That is so, and that is one of the matters of complaint. By fixing +the rate at 2-1/2 per cent., or 3 per cent., or 4 per cent., they can +regulate the rate we fix for our own customers. We regulate our deposit +rate in accordance with the bank rate. We also regulate the rate we +charge for our loans in accordance with the bank rate, and we are bound +by it to a certain extent, and they themselves feel at liberty to depart +from it. + +Q. What does the bank rate mean; what does it govern in fact? + +A. It means the general charge to the trade of the country, because +although we say that bills in the market are discounted at a lower rate +than bank rate, yet there is a vast number of trade bills which are +purely governed by the bank rate. + +Q. We found both in Germany and in France the question of the amount of +reserves, either in specie or in bank, was regarded as of little +importance by the bankers. They depend on the Reichsbank and the Bank of +France for rediscount in times of need. + +A. Both in France and in Germany banks are much more dependent on the +central institution than we are here. They lean on their central +institution to a very great extent; for instance, the rediscounting of +bills and borrowing from the central institution is, I believe, quite a +usual occurrence. Here it is an occurrence which would only take place +in the last resort. As far as I am aware this bank has never as long as +it has been in existence had one penny from the Bank of England, whether +by way of advance or by way of a discounted bill. We do not rediscount +our bills in the market either; so every transaction we enter into we +have to see through to the very end. + + +INTERVIEW WITH MR. CHARLES GOW, GENERAL MANAGER OF THE LONDON JOINT +STOCK BANK, LIMITED + +[157]Q. Your capital stock is £100 authorised, £15 paid? + +A. Yes. + +Q. Does your board pass upon a new stockholder? + +A. Yes. + +Q. Who really conducts the business of the bank? + +A. The managers, who are appointed by the directors; that is to say, +myself and all those belonging to me. + +Q. Are most of your acceptances secured? + +A. Every one. + +Q. How are they secured, generally speaking? + +A. They are secured in the great majority of cases by bills of exchange, +by first-class securities with plenty of margin, even by cash in hand to +a moderate extent, and to a very small extent by bills of lading for +produce shipped. That is a very small item. + +Q. Can you state the reason for accepting bills instead of furnishing +the cash? + +A. We accept those bills because it happens to be the custom of the +particular banks to draw a long bill. The customer himself who buys +cotton in Bombay, or wherever it may be, acts according to the custom +there to draw a bill to a certain usance. Now, for instance, with regard +to an inland bill, we would not give credit of that sort to a man in +London, but wherever there is a regular course of business abroad to +draw at long usance we comply with it. + +Q. What is the character of your bills discounted? + +A. Those are all marketable bills, trade bills; you know what they are; +they are between the manufacturer and the man to whom he sells. + +Q. You always require two names? + +A. Always. + +Q. What does the form of obligation by the borrowers upon collateral +take? + +A. Just the same form as your promissory note. + +Q. You have branches, have you not? + +A. We have about forty-odd branches all in London and close to London. + +Q. You do not then endeavor to acquire a country business through your +branches? + +A. For this reason, that we commenced as a purely London bank, and we +have so far kept to that original determination of not launching out +into country business, because, as I say, it differs from the ordinary +London business. Country business is not quite so liquid, and can not +be. + +Q. If you had an account of a man running, say, a hat store, his account +was satisfactory in character and had been carried with you for several +years, and he wanted to stock up on hats, there would be no way in which +he could go to you and borrow the money with which to buy those goods +unless it was through a guarantor? + +A. No. He would go then to the wholesaler from whom he would buy the +goods, and give that wholesaler his bill, and that bill would be a +discountable article, and that is how the money would be raised. + +Q. Do you ever allow overdrafts, as they do in Scotland? + +A. They are not unheard of, but not a principle of our business. +Overdraft is a principle of country banking. + +Q. My observation leads me to believe that the banking situation in +London is practically controlled by twelve or fourteen of what are known +as the London joint-stock banks, through their offices and through their +branches? + +A. Yes; I think that is right. However, there are still independent +banks in the country, and I doubt whether amalgamation will go very much +farther than it has gone. You see, these amalgamated banks have already +become so large that they begin to get a little unwieldy. Lloyds Bank is +an enormous thing, with $350,000,000 of current and deposit accounts. + +Q. Would you say that the public are better served through these +branches than they were through the independent banks? + +A. Some say that they are not so well served, that accommodations are +curtailed now as compared with what they used to be, and that I can +understand to some extent, because, working a very large concern from +one centre, you see, fiats will go forth, "Cut that man's credit off," +and not listen to taking a large view. They say, "I have enough of that +kind of accommodation; I have 100 shipbuilders or shipowners; I am not +going to give out more than a proportion of my money into that +particular trade; therefore, I will not have any more," whereas the +independent banks would be perhaps a little more accommodating. + +Q. If I were to go to you to-day with a ninety-day trade bill, the +acceptor known to you as good, and also with a loan secured by +Pennsylvania Railroad bonds, my loan to mature in ninety days, what rate +would you charge me on those separate items? + +A. The bank rate to-day is 2-1/2 per cent. You are a good customer, and +I should charge you 2-1/2 per cent. for discounting that trade bill, and +I might charge you 3 per cent., or even perhaps 3-1/2 per cent. on the +Pennsylvania Railroad collateral for this reason, that one is not as +realisable as the other. When the bill becomes due it has to be paid, or +I give it back to my customer, and say "Give me the money for that." I +can not quite say the same to him about his collateral. + +Q. What per cent. of earnings on your capital did you show last year? + +A. Roughly, our net earnings were 20 per cent. It cost us 50 per cent. +of our gross earnings to run the business. + +Q. What taxes do you have to pay? + +A. We pay income tax on all our earnings, and deduct from our gross +profits. We are entitled to deduct, roughly speaking, our expenses, and +then upon the remainder we have to pay the income tax, or whatever it +is, at 1 shilling in the pound, for instance, now. + +Q. Would you say that the Bank of England is a popular banking +institution among other banks in England? + +A. Yes, I should say so decidedly. Its popularity goes to this extent, +that it is absolutely indispensable to them. Some of them may grumble at +this proceeding or that proceeding, but they have one and all to own +that the Bank of England is indispensable to them. + +Q. As a matter of fact, if you had presented to the Bank of England last +fall some bills which had been negotiated through you which appeared to +be finance bills, do you not think they might have gently hinted that it +was not agreeable to them to have you negotiate any more finance bills? + +A. I may say they have that recourse, and they might say to me if I gave +them any just cause for doing it, just the same as anybody else. + +Q. In other words, the Bank of England has such a commanding position +here among the financial institutions which control all the finances of +Great Britain that they dominate it when they choose to? + +A. When they choose. + +Q. It is the custom of the bank to co-operate very cordially with the +other banks, is it not? + +A. Oh, yes; we are as free as free can be. There is very little +conference, or anything of the kind; we are all pretty good friends all +round. + +FOOTNOTES: + +[150] F. Straker, _The Money Market_, pp. 7-16. Methuen and Company. +London. 1904. + +[151] _Ibid._, pp. 28-40. + +[152] [The fourth suspension occurred August 6, 1914.] + +[153] Adapted from Hartley Withers, _The English Banking System_, +Publications of the National Monetary Commission, Senate Document No. +492, 61st Congress, _2nd Session_, pp. 3-64. + +[154] James H. Simpson, _Some Leading Features of the London Money and +Discount Markets_, an address delivered at the annual banquet of the +bankers of the city of New York, Jan. 19, 1914. (In Banking and Currency +at Home and Abroad, Distributed with the Compliments of the National +City Bank.) + +[155] Adapted from _Interviews on Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_, +Publications of the National Monetary Commission, Senate Document No. +492, 61st Congress, _2nd Session_, pp. 7-29. + +[156] _Ibid._, pp. 34-55. + +[157] _Ibid._, pp. 60-91. + + + + +CHAPTER XXIII + +THE SCOTCH BANKS + + +[158]The functions performed by the eight Scotch banks and their 1,245 +branches[159] are essentially similar to those already described as +being carried out by their English brethren. The differences between the +currency systems of the two countries are in degree rather than in +essence. In Scotland the note issue has made a harder fight for its +existence than in England, owing no doubt to the fact that the Bank of +England's monopoly did not extend to Scotland and that the great Scotch +joint-stock banks therefore extended the system of using notes as +currency, while the development of joint-stock banking in England was +necessarily opposed to it, since joint-stock banks in England with an +office in London were unable to issue notes. Nevertheless, even in +Scotland the advantages of the cheque have told in its favour, and, as +will be seen below, liabilities of Scotch banks under note issue are now +much smaller than those under deposit as current accounts. + + +DEMOCRACY OF SCOTCH BANKING + +The Scotch note circulation increased from £5,332,000 in 1872 to +£7,173,000 in 1908. This increase, when compared with the fact that the +note issues of the English country banks have during the same period +diminished almost to vanishing point, shows that the bank note is much +more tenacious of life north of the Tweed. This is partly owing to the +fact that in Scotland notes may be issued of the denomination of £1, +whereas in England the smallest allowed is of £5, so that the note was +thus circulated more easily among the poorer classes in Scotland and so +gained and retained a hold upon a much wider circle of the community. In +this respect, as in others, Scotch banking is more democratic than +English, and provides its facilities for a poorer and lower class of the +community, though this distinction between the banking systems of the +two countries is being rapidly diminished. Especially in its early days +it laid itself out much more readily to the encouragement of the small +capitalist and borrower, often granting him facilities against security, +or an absence of security, which would have been only regarded as +feasible under quite exceptional circumstances in England. A very +interesting system was at one time fairly general in Scotland, and is +even now by no means obsolete. It was the system described as that of +cash credits, by which borrowers were able to go to banks and obtain +advances against the joint personal security of themselves and one, or +two, or three friends. By this means, in which a kind of co-operative +responsibility was recognised as a security by the Scotch bankers, very +poor borrowers were enabled to obtain banking facilities, and many +instances are recorded in which by a loan of this kind, of quite small +importance from the banking point of view, foundations of fortunes have +been laid and the general commercial prosperity of the community has +been furthered in a very satisfactory manner. And even now the essential +difference between Scotch and English banking is this readiness of the +former to take into consideration the personal standing of the applicant +rather than the stuff or paper which he brings to it as security for an +advance. + + +USE OF NOTES AS "TILL MONEY" IN RELATION TO THE ESTABLISHMENT OF +BRANCHES + +Banking by branches in Scotland has proceeded even more rapidly than in +England, and the percentage of branches per head of the population is +higher in the northern part of the Kingdom. This wide diffusion of +banking facilities in Scotland has been largely brought about by the +fact that its banks, having the privilege of note issue, were able to +hold their own notes as "till money," so economising in the matter of +cash. The following passage is from a work entitled _Scottish Banking, +1865-1896_, by A. W. Kerr, author of a _History of Banking in Scotland_: + + Were it not for the power to issue notes, and the readiness + with which the public receive them, the banks could never + have afforded to open a third of the branches which have + been established. The reason for this is a very simple one. + Without the right of issue a bank must, at every one of its + offices, hold the whole of its balance of cash in the shape + of coin, or of notes of other banks, which, as far as it is + concerned, are as unprofitable as coin. Such balances entail + a complete loss of interest which can only be borne where + the amount of business is of considerable extent. There are + probably not above 100 (at most 200) localities in Scotland + that would satisfy such conditions. When, however, a bank + can hold its till money in the shape of notes, it is enabled + to extend its operations into districts which would + otherwise be quite inaccessible.... + +The authority of a practical Scotch banker is equally emphatic on the +point. Mr. Robert Blyth, general manager of the Union Bank of Scotland, +read a paper at the thirty-first annual convention of the American +Banking Association, in October, 1905, on the subject of Scottish +banking. In the course of this very interesting paper he made the +following statement: "It is in another quarter altogether that the +Scotch banks find the value of the £1 note. It is the unissued notes in +the tills of the branch offices, forming the till money at more than a +thousand branches, wherein the real value lies. Without them the banks +would require to keep £8,000,000 or £10,000,000 of gold coin, not as a +reserve but as till money. It is these £1 notes which have enabled +branch offices to be planted in every part of the country." + +It thus appears, from the highest possible authority, that the Scotch +banks are enabled by their right of note issue to economise gold to the +extent of £8,000,000 or £10,000,000, and it is amusing to observe how +the objects aimed at by Peel's legislation with regard to note issue +have thus been defeated even more completely in Scotland than in +England. In England banking turned the flank of Peel's Act by developing +the use of cheques, which superseded the note as the common form of +payment in daily transactions. In Scotland, banking evaded the spirit +of Peel's regulations, which were intended to insure that every addition +to currency should be secured on an addition to the bullion held by it, +by actually economising bullion to the extent of £8,000,000 or +£10,000,000. + + +EVASION OF PEEL'S ACT + +Scotland used the same weapons as England, namely, the cheque and the +development of deposit banking. The eight Scotch banks have, according +to their latest balance sheets, £7,000,000 of notes outstanding, and +£108,000,000 of liability on deposits and drafts. With regard to the +latter item Peel's regulations had nothing to say, and since ordinary +banking prudence demanded that some cash should be held against it, and +since the gold held against notes was not specially earmarked as such, +Scotch banking was able to treat its cash against deposits as the basis +both of its notes and deposits and so produce the economy which is +boasted of by its champions. The law says nothing concerning cash to be +held against deposits, and the metallic basis of these is probably +extremely slender, if the cash held against notes is set on one side; +but it is impossible to detect its actual amount, since the Scotch banks +include with their cash their balances at the Bank of England, etc. And +the net result is, that when the proportion of its cash to its total +liabilities on notes and deposits is worked out it is found to be +decidedly low, even when compared with English practice. For the eight +banks taken together, gold and silver coin, notes of other banks, cash +at Bank of England, and cheques in course of transmission represent +almost exactly 10 per cent. of their note and deposit liabilities. + +It should be observed that the notes which the Scotch banks hold as till +money do not appear in their statements, for until they are issued they +are not a liability, and though they are treated by the banks in +practice as an asset, they can not figure as such in a balance sheet. +That they are practically treated as such is witnessed by Mr. Blyth, as +quoted above, when he says that without them the banks would require to +keep £8,000,000 or £10,000,000 of gold coin. And it is, of course, this +habit of regarding unissued notes as a banking asset in the shape of +till money that accounts for the low reserve of actual cash that the +Scotch banks show. + + +DEFECTS + +Scotch banking is so generally regarded as one of the highest +achievements of the banking intelligence that some hesitation is natural +in criticising the system by which, according to its own evidence, it +has obtained most of its success. At the same time, it is difficult to +avoid the conclusion that a serious danger lurks in a system which +regards a banker's unissued promise to pay in the light of a banking +asset. Mr. Blyth points out that these unissued notes are "not a reserve +but till money," but the distinction between till money and reserve is +one upon which it is possible to lay too much stress. In assessing the +strength of a bank it is usual to compare the amount of its cash in +hand, as a whole, with the amount of its liability to the public on +deposit and current account, etc., and note circulation if any. The cash +in hand, as a whole, consists of the till money and cash reserve. If the +till money consists to any extent of the bank's own promises to pay, it +follows that the bank's cash reserve as a whole is to that extent +weakened, for it need not be said that in case of serious trouble, which +is a contingency of which all provident bankers have at all times to +beware, a bank's own promises to pay would be of little service to it. +If a bank's credit were doubted, these promises to pay would not be +available for it in meeting demands upon it. At such periods the public +requires from its bankers not promises to pay but physical gold. In +Scotland the confidence of the public in its bankers is so great, and +the readiness with which it circulates their promises to pay appears to +be so ingrained in the national character, that the contingency of the +demand of the public for gold seems to be extremely remote. The +criticism therefore which detects a weak point in this asset upon which +Scotch banking prides itself so highly may be said to be merely +academic. Nevertheless, when we examine Scotch banking by the test of +figures, we find that it does actually work, as indeed would be expected +from the statement of its exponents, on a cash basis which is decidedly +narrow. + +Though the functions that they perform are practically the same as those +of the English bankers, Scotchmen have succeeded in avoiding the +excessive competition in carrying them out which is a weakness of +English banking. In Scotland, on the other hand, cohesion and +co-operation among the banks are carried to an extreme of which the +mercantile community frequently complains. The banks are few and stand +together like a close corporation; they agree absolutely and arbitrarily +among themselves as to the rates they will allow to depositors, the +rates at which they will advance or discount, and the terms and +commissions for which they will do business for customers. The extent to +which this regulation of the price of the product that they turn out is +carried, is almost incredible from the English point of view, and though +it is contended by the champions of the Scotch system that it encourages +that wholesome democratic influence in Scotch banking which is in favor +of the small borrower of limited resources, who is thus able to obtain +accommodation on the same terms as much larger and more important +customers, yet it must be obvious that the Scotch banks, by making these +hard and fast agreements among themselves as to the price of the +accommodation that they will give, and maintaining it in every case, are +in fact putting the same price upon a very different article. The result +of it is beginning to tell upon them a little in these days, since, when +the big Scotch merchants and manufacturers find that their local bankers +charge them the same rates for accommodation as the small tradesmen of +the towns, they are naturally impelled to make arrangements to provide +themselves with monetary facilities somewhere south of the Tweed, where +rates are ruled by the circumstances of each case, and competition and +higgling often in times of monetary ease deliver the bankers into the +hands of the borrowers. As it is, the Scotch banks in regular conclave +fix their rates in accordance with those current in the London money +market or the Bank of England's official minimum, and, having fixed +them, stick to them. The system is very profitable to themselves, and +their customers certainly can not complain on the whole of the +facilities with which they provide them. Nevertheless, the cast-iron +rigor with which they work hand in hand in combination appears to be an +excessive development of banking unity, and an ideal banking system +would seem to lie somewhere in the middle between the excessive +competition of the English bankers and the cast-iron combination of +their Scotch brethren. Finally, it may be added that it is a little +inaccurate to speak of a Scotch banking system, if the phrase be taken +to imply that Scotch banking stands by itself and works on its own +resources. In fact, it is only an appendage of the English system and +relies habitually on drawing gold from the Bank of England, as its +centre and the keeper of its reserve. + + +BANK OF SCOTLAND + +INTERVIEW WITH SIR GEORGE ANDERSON, GENERAL MANAGER[160] + +Q. When was the Bank of Scotland founded? + +A. In 1695. + +Q. When does your present charter expire? + +A. By act of Parliament the "governor and company of the Bank of +Scotland" have "perpetual succession." + +Q. How many branches have you? + +A. One hundred and sixty-three branches and twelve sub-branches in +Scotland: also an office in London. + +Q. How are your branches managed? + +A. By agents (managers at London and Glasgow) appointed by the +directors. + +Q. Do your branches have business relations with merchants, farmers, and +all classes of people in their respective localities? + +A. Yes. + +Q. What is the law governing your note issues, and how are note issues +limited and how secured? + +A. The bank is authorised to issue, without holding coin against them, +notes to the value of £396,852, but for any excess beyond that amount we +must hold, at the head office, an equivalent value in gold coin, +one-fourth of which may, however, be in silver coin. + +Q. Will you state (a) the class of bills usually discounted by you, +giving the number of names required; (b) the minimum size; and (c) the +maximum length of time to run? + +A. Mercantile bills, also a few accommodation bills, usually two names; +minimum, say, £10. The maximum length of time to run is six months. + +Q. What classes of collateral are accepted by you for loans? + +A. Personal security, marketable securities, life policies, mortgages +over ships, shipping documents, etc. In the important banking centers of +Scotland lending against collateral security has become largely +prevalent. + +Q. Do you rediscount bills from other banks? + +A. No. + +Q. Explain the phrase "cash credits," and upon what conditions are they +given? + +A. A "cash credit" is a credit allowed, in virtue of which a customer +may draw cheques on the bank until the balance due to us reaches a +certain fixed limit. The account is an ordinary operative one, and +interest is charged on the balances actually due to the bank from day to +day. + +Q. Have you in mind how many branches you had ten years ago? + +A. One hundred and twenty. + +Q. Do you ever buy any shares of railroad or industrial companies? + +A. Yes; of the highest class. + +Q. Do you ever own bank shares? + +A. No. + + +ROYAL BANK OF SCOTLAND + +INTERVIEW WITH ADAM TAIT, CASHIER AND GENERAL MANAGER[161] + +Q. When was the Royal Bank of Scotland founded? + +A. In the year 1727. + +Q. When does your present charter expire? + +A. It is perpetual. + +Q. How many branches have you? + +A. One hundred and fifty-two. + +Q. Are all your branches of the same class, or have you main and +subsidiary branches? + +A. In some cases there are sub-branches. Some are mainly or almost +entirely deposit branches; others have few deposits, but a large advance +business. + +Q. Is the business conducted at your branches of the same class as at +your office in London? + +A. No; the London office is itself a branch office and much of the +ultimate settlement of balances takes place there. The conduct of the +ordinary London business is on the same lines as that of any other +London branch bank. No notes can be issued in London. + +Q. Do your branches have business relations with merchants, farmers, and +all classes of people in their respective localities? + +A. Yes, they have business relations with all classes of people. + +Q. What is the law governing your note issues, and how are note issues +limited and how secured? + +A. The act of Parliament of 1845 governs our note issue. There is no +limit to the amount of notes that may be issued, but the bank is +required to hold gold (and silver to an extent not exceeding one-fifth +of the total) against the notes in the hands of the public on the +average of each month, and that at its head office in Edinburgh--gold +held at branch offices does not count--to an amount sufficient each week +on Saturday to cover the notes in the hands of the public in excess of a +certain amount specified, £216,451. + +Q. To what extent are your notes legal tender in Great Britain? + +A. Our notes are not legal tender at all. + +Q. What other banks have the right of issue in Scotland? + +A. The Bank of Scotland, the British Linen Bank, the Commercial Bank of +Scotland (Limited), the National Bank of Scotland (Limited), the North +of Scotland and Town and County Bank (Limited), the Union Bank of +Scotland (Limited), the Clydesdale Bank (Limited). + +Q. Are the notes of your issuing banks secured; and if so, how? + +A. They are not secured. In case of the liquidation of the five +last-named banks, however, their shareholders are unlimitedly liable for +their notes and they are liable to contribute a sum necessary to restore +to the general assets the sums that may have been paid out of the same +in respect of claims under notes. + +Q. What is the total amount of their outstanding issues? + +A. About £7,500,000. + +Q. Do you pay the Government in the form of taxes or otherwise, either +directly or indirectly, for your privilege of note issue? + +A. Yes, we all pay a license duty of £30 for each place at which notes +are issued, and a tax of 8_s._ 4_d._ per £100, or a penny per £1, on the +average amount of notes in the hands of the public at the close of each +week. + +Q. Is it your custom to carry a fixed amount in government securities? + +A. Yes, but the amount is not rigidly fixed. + +Q. Do you discount any but prime bills? + +A. Yes; we do all classes of business. + +Q. Is it your custom to employ surplus funds in purchase of bills from +discount houses? + +A. Yes; bills accepted by London banks. + +Q. Do you rediscount bills for other banks? + +A. No; except for foreign or colonial banks who are correspondents. + +Q. Is the bank, through its branches, employed by other banks to any +considerable extent for the transfer of funds from one city to another? + +A. Yes. + +Q. What, if any, artificial means are taken by you to secure changes in +the volume of currency (notes and coin) to make it responsive to +business demands? + +A. None are deemed necessary. Our system works automatically. Our note +issue is unlimited; we are only required to provide gold to cover the +amount in the hands of the public at the close of each week and on the +average of each four weeks. + +Q. What is the customary charge for acceptance of a ninety-day bill? + +A. Five shillings per cent. + +Q. Your acceptance constitutes what is known in London as a prime bill? + +A. Yes. + +Q. Do you pay interest on both current accounts and deposit accounts? + +A. It is our custom to pay interest on deposits only. In London, +however, it is different; there interest is allowed in special cases on +large balances on current accounts if left for some time. + +Q. How does the bank rate affect the rate allowed by you on deposit? + +A. The Scotch banks all allow the same rate and charge the same rates +for discounts and overdrafts, and these are fixed relatively to the Bank +of England rate. Our deposit rate is usually 1-1/2 per cent. under the +minimum bank rate. + +Q. Were most of your branches organised by you or were most of them +other institutions purchased by you? + +A. Most of them were originated by ourselves. + +Q. Have you in mind how many branches you had ten years ago? + +A. About 136. + +Q. What relations do the Scotch banks bear to the Bank of England? Do +they deal with it directly? + +A. The Royal Bank of Scotland has an account with the Bank of England, +which has been in operation since 1728, and it collects bills and +cheques for the Bank of England all over Scotland. + +Q. Do you regard your system of currency issue as sufficiently elastic +for your needs? + +A. Yes; there never has been any difficulty. Moreover, no Scotch bank +has ever failed to pay its creditors, including the holders of notes, in +full. + + +COMMERCIAL BANK OF SCOTLAND (LIMITED) + +INTERVIEW WITH ALEXANDER BOGIE, GENERAL MANAGER[162] + +Q. When was the Commercial Bank of Scotland (Limited) founded? + +A. In the year 1810. + +Q. When does your present charter expire? + +A. It is not limited in point of time. + +Q. Has the Government any voice in the management of the bank or any +interest in it through the ownership of shares? + +A. None. + +Q. Have the managers of the branches full control of the business in +granting discounts, etc.; if not, what discretion is usually given them? + +A. Agents have power to grant advances, but subject to the approval of +head office. In advances of considerable amount, an agent's duty is to +get authority from the head office before granting it. The discretion +allowed is dependent on the size of the branch and the nature of the +business and the class of customer, and on the record of the agent. By +our system of reports on advances (weekly, monthly, and quarterly) we +keep in close touch with the advances and means of borrowers. The London +branch is, of course, on different lines, and our manager there has +greater powers than an agent at a branch in Scotland. + +Q. Is the business conducted at your branches of the same class as at +your main office in Edinburgh? + +A. Yes; very much the same. The head office has administrative work and +supervision of branches, investment, etc., which does not, of course, +arise elsewhere. + +Q. Do you discount to any considerable amount for individuals and +merchants? + +A. Yes; it would perhaps be well to point out that in Scotland a large +portion of advances made to traders are granted in the form of +overdrafts on current accounts. _The number and amount of bills in +Scotland are less now than in former years. Cash payments for the +purpose of obtaining discount are more frequent, and the number of +bills discounted by wholesale houses is reduced in consequence._ + +Q. Is it your custom to employ surplus funds in purchase of bills from +discount houses? + +A. Only occasionally, when rates suit. + +Q. Do you rediscount bills for other banks? + +A. It is not our practice to do so. + +Q. To what extent does bank rate govern your discount and loan +transactions? + +A. In ordinary transactions, altogether. In all transactions the bank +rate governs as regards the minimum. + +Q. Explain the phrase "cash credits," and upon what conditions are they +given? + +A. A cash credit account is an operative current account in security of +which the principal debtor and two or more co-obligants have granted a +personal bond in favor of the bank. The account is operated upon by the +principal debtor, but all the parties are bound as principals and are +jointly and severally liable to the bank.[163] + +Q. Is the bank, through its branches, employed by other banks to any +considerable extent for the transfer of funds from one city to another? + +A. We act as correspondents for the large English and Irish banks and +for colonial and foreign banks. + +Q. Do you favor the issue of £1 notes? Why? + +A. Yes; under the Scottish system, as it enables the banks to plant +branches at little expense and so to open up the trade of the country in +all districts and directions. + +Q. It is your practice to employ your surplus funds in the purchase of +prime bills through bill brokers? + +A. We occasionally have such transactions. + +Q. Were most of your branches organised by you, or were most of them +other institutions purchased by you? + +A. All of them were organised by ourselves. + +Q. Is the question of the amount of reserves, either in specie or in +bank, regarded as of importance by Scotch bankers? + +A. I should think so, though I only know positively my own opinion. + +Q. Do you ever buy any shares of railroad or industrial companies? + +A. No industrial company shares and only gilt-edged railway stocks. + +Q. Do you ever own bank shares? + +A. No. + + +UNION BANK OF SCOTLAND (LIMITED) + +INTERVIEW WITH ROBERT BLYTH, GENERAL MANAGER[164] + +Q. When was the Union Bank of Scotland (Limited) founded? + +A. In 1830. + +Q. When does your present charter expire? + +A. The bank has no charter expiring at any specified time. It is +incorporated under the companies acts. + +Q. Have the obligations of the bank to the public or to the Government +been changed from time to time? + +A. The liability of the shareholders was formerly unlimited, but when +the bank became registered under the companies act, 1879, the liability +of the shareholders--unless in respect of notes--was limited to the +amount of the uncalled capital. + +Q. The tendency is for the consolidation of banking in Great Britain, is +it not? + +A. It is, but this tendency set in at a much earlier period in Scotland +than it has done in England. + +Q. Do you rediscount bills for other banks? + +A. Yes; but only to a very limited extent. + +Q. Is private banking carried on in Scotland? + +A. Private banking ceased to exist in Scotland prior to 1845. + +Q. Do you ever buy any shares of railroad or industrial companies? + +A. No. + +Q. Do you ever own bank shares? + +A. No. + +FOOTNOTES: + +[158] Adapted from Hartley Withers, _The English Banking System_. +Publication of The National Monetary Commission, Senate Document No. +492, 61st Congress, _2nd Session_, pp. 41-50. + +[159] (September, 1915). + +[160] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland and Italy_, Publications +of the National Monetary Commission, Senate Document No. 405. 61st +Congress, _2nd Session_, pp. 142-155. + +[161] _Ibid._, pp. 127-139. + +[162] _Ibid._, pp. 172-185. + +[163] The cash credit system, sometimes pointed to as a unique feature +of Scotch banking, is by no means unknown in England.--EDITOR. + +[164] _Ibid._, pp. 157-170. + + + + +CHAPTER XXIV + +THE FRENCH BANKING SYSTEM + + +THE BANK OF FRANCE + +[165]The Bank of France was established in the year 1800, and was at +first an entirely private concern, with a capital of $6,000,000. Among +the first subscribers were Napoleon Bonaparte, Hortense Beauharnais, and +bearers of names which are still prominent in the French banking world, +such as Mallet, Hottinguer, Seillers, etc. + +At that time, the privilege of issuing notes was not confined to a +single bank. But in 1806 the Bank of France was placed under state +control, and, by and by, the other issuing banks disappeared, by +amalgamation or otherwise, and the Bank of France became, and has ever +remained since, the only issuing bank in Continental France. + +The present capital is $36,500,000, all paid, divided in $200 shares.... +[Francs are given in terms of dollars.] + +These shares are held by the public, the average being about 5-1/2 +shares for each shareholder. One-third of the shares are held by persons +possessing only one share. They are dealt in freely in the market, their +quotation being at present about 465 per cent. + +The profits go to the shareholders, as in every other company. In 1912 +the bank earned a net profit of $8,200,000. The last yearly dividend was +paid at the rate of 20.83 per cent.... + +The governor of the Bank of France and the two sub-governors are +appointed by the State. They are assisted by fifteen regents, nominated +by the meeting of the shareholders. The same meeting appoints three +censors whom you would call auditors. + +The board, composed of the governors and regents, decides all questions +concerning the rate of discount on loans, the issue of notes, etc. + +Three of the regents, assisted by twelve shareholders chosen from +amongst the prominent members of the commercial and industrial +profession, compose the "discount committee," which meets at least three +times a week and decides upon the acceptance or refusal of the bills +presented for discount.... + +The notes are ... legal tender, but, of course, may be exchanged, at +sight, against cash--I don't say against gold, as I will explain +presently. + +The denominations circulating at present are $10, $20, $100, and $200. +One dollar and $4 notes were issued at critical times, but have been +withdrawn since. In case of need, they would be resorted to again, and +in this respect I should like to mention the fact, demonstrated by +experience, that even where the circulation is already sufficient, a +supplementary issue of small notes--unless, of course, the amount be too +unreasonable--is much less likely to depreciate the currency than an +issue of larger ones. In a certain sense, we may consider that a country +which refrains from issuing small notes in normal times, possesses _ipso +facto_ a valuable reserve in case of emergency.... + +I need not recall the remarkable rôle played by the Bank of France, +under the leadership of its very distinguished governor, M. Pallain, +during critical periods such as 1907, when that institution succeeded in +keeping the French discount rate on an exceptionally moderate level, +while giving valuable and effective aid, at the same time, to the London +market. + +How is this successful policy of the Bank of France materially possible? +Precisely because it has the option to pay in silver as well as in gold. +When the situation is such that withdrawals of yellow metal are to be +feared, the bank quotes a premium on gold. At present, for instance, the +quotation is about one-tenth of one per cent. premium, that is to say, +you will only get $999 in gold against $1,000 in notes. If you want to +get $1,000 cash, you can get them, but in silver. + +As a consequence, there is no necessity to raise the discount rate in +order to protect the gold reserve, and French commerce has the +privilege of benefiting, as a rule, by the lowest rate of discount in +the world. Thus the average bank rate, in 1912, was 3.37 per cent. in +France, as against 3.77 per cent. in England, and 4.95 per cent. in +Germany. + +If we consider a period of fifteen years, from 1898 to 1912, the average +rates are: + + _per cent._ + France 3.8 + Holland 3.52 + England 3.62 + Belgium 3.65 + Switzerland 4.14 + Austria 4.22 + Germany 4.50 + + +CASH HOLDINGS OF THE BANK OF FRANCE + +[166]The undeniable characteristic of our present currency system is +that it presents a transition between the money system and the clearing +system, the ultimate form of which we are unable accurately to define. +This period of transition, which began when the idea of genuine credit +was conceived, will last for centuries before we can rid ourselves of +money as a medium. The system of purely fiduciary currency, which is in +process of becoming firmly established, is not yet sufficiently stable +to prevent us from being thrust rudely back into the old ways whenever +we exceed the limits of our resources. + +Crises afford a striking proof of this fact. The initial period, the +precursor of the crisis, is nothing but an abnormal extension of credit +and of speculation. At such times the need of leaning upon the solid +foundation of metallic currency is felt with a new intensity; and when, +with a blindness resulting from overconfidence, this need has been +neglected, when, from a disregard of the functions of money, a crisis is +brought about by the violent rupture of the equilibrium of credit, gold +at once resumes its rights, is sought for on all sides, and, according +to the seriousness of the offence, exacts complete amends, with the +honors of a premium as high as it may choose to make. + +It clearly appears, therefore, that this quest for simplification in the +means of credit, which each nation ardently pursues in the interest of +its own industrial and commercial development, demands the greatest +circumspection. In developing credit, metallic currency must not be too +much overlooked. We must not lose sight of the fact that "credit, in +order to be solid and permanent, must have a solid and permanent +foundation." + +The first care of the architect who is about to erect a great building +is to secure for it a broad and firm foundation. Likewise, in the vast +and continuous upbuilding of a nation's credit, the metallic base +requires the most attentive and enlightened consideration. To provide +for it, the entire resources of the State are not too great. It is +difficult to understand how, in certain countries, an undertaking of +such universal interest should be left to private enterprise. How can +the latter be powerful enough to accumulate holdings in currency which +may have to remain idle for long periods, and which can unflinchingly +resist all assaults and all storms? + +In France a system which has already passed the hundred-year mark and +has been particularly fortunate as to results, intrusts the Bank of +France with the duty of building up and preserving the metal holdings, +and this great organisation shows itself fully worthy of the confidence +which the Government has always reposed in it. During its long career +the bank has never ceased to control credit with rare foresight and a +remarkably steady hand. + +From 1870 up to the present time the cash holdings of the Bank of France +have not ceased to grow. But the bank, of its own volition, could not +have made such an accumulation. The exchanges are usually in our favor, +owing to our position as lenders to foreign countries and to the extent +of our exports, and this for many years past has resulted in the +continual flowing of the precious metal into the vaults of the Bank of +France. + +In thirty-five years the amount of our metallic reserves has increased +almost threefold. And it is worthy of note that while the amount of +circulation increases together with that of discounts, loans, and +current accounts, the fact is nevertheless established that the bank +note tends to be more and more exclusively represented by cash holdings. +The silver holdings are continually diminishing, while the total +holdings have increased. Indeed, the Bank of France avails itself of +every opportunity to relieve its coffers of this depreciated currency. +Since 1898 a considerable portion of the holdings have been absorbed by +the recoinage of a certain number of 5-franc pieces into subsidiary +coins. + + +PLACE OF THE BANK OF FRANCE IN THE DISTRIBUTION OF CREDIT + +We purpose now to investigate the organs of French credit, and to assign +to each of these organs its function, in order then to ascertain what +operations the Bank of France can perform and within what limitations. +We have therefore to examine (1) the function of local banks and of +financial institutions; (2) in what manner the Bank of France promotes +the free distribution of credit; (3) in what measure the bank must +control credit. + + +LOCAL BANKS AND THE FINANCIAL INSTITUTIONS + +The natural organs for the distribution of credit are the banks, but not +all are able to spread it or popularise it in the same degree. Thus the +"Haute Banque" (the great banking interests of Paris), solely engaged in +operations of higher speculation or in international financial +relations, does not interest us. The function of distribution is +reserved for the local banks and the financial institutions, while the +function of the Bank of France is to preside over this distribution. + +Local banks, pre-eminent less than one hundred years ago, have gradually +seen their field of activity growing smaller, and a large number of them +have been amalgamated with great institutions, possessed of much greater +resources, with branches over the entire country, and, it must be said, +free from the routine which caused the downfall of many provincial +houses. With their decline we greatly regret to see the disappearance of +personal credit, which it is more and more difficult to make available. +The _intuitus personae_ (the judgment of character), which may serve as +a basis for credit granted to a neighbor by a neighbor, can not be +considered by a corporation official who has almost no means of +estimating the solvency of individuals except from the material and +tangible side. + +The local banks, as far as they have survived, have adopted methods +which do not bring them into competition with their powerful rivals. +They have been obliged to grant long-term credits or content themselves +with being intermediaries for the Bank of France in granting credits to +parties known to them, generally farmers or small landed proprietors, +with a view to rediscounting the paper. On this point again there is +cause to regret, if not their disappearance, at least their effacement. +The institutions for agricultural credit, in spite of all the attention +they have received, have not yet been able to replace the local banks in +the distribution of personal credit applied to agriculture. + +The great financial institutions, of which the four most important are +the Crédit Lyonnais, the Comptoir National d'Escompte de Paris, the +Société Générale, and the Crédit Industriel et Commercial, have a much +more important part in the distribution of credit. Thanks to their +numerous agencies, to their attractive conduct of business, with the +service of a courteous and attentive staff, they have gradually taught +the people new habits in investment and confidence in credit, to such a +degree that he who but yesterday hoarded in a stocking prefers to-day, +if not to speculate on the Bourse, at least to make deposits in the +savings banks. The great financial institutions have done much to give +even the lowest classes confidence in credit, and to introduce a system +of clearing. + +In closer contact with the public than the Bank of France, which is +restricted by having to protect the reserve of which we have spoken, +these institutions are able more readily and effectually to reach and to +mould the public. But that is not their only service nor the only reason +for their existence. There are transactions which they alone undertake, +which they alone can undertake, and which must be performed because they +are in the line of progress. These operations are sources of profit in +the same way as are discounts and loans for the Bank of France. Such +are demand deposits, stock-market orders, and the flotation of +securities. These operations cannot be undertaken by the local banks. +Occupied for the most part with long-term dealings, they have no use for +deposits payable on demand. If they should have such deposits, their +total would never reach a sufficient proportion safely to permit the +investing of an important amount. + +On the other hand, the Bank of France does not and, even if it wished, +cannot compete with the financial institutions in undertaking such +operations. Neither the acceptance of interest-paying deposits nor the +flotation of securities can come within the province of a bank of issue. +The flotation of securities necessitates a certain contingent +responsibility, and the institutions which place securities on the +market sometimes engage their credit for very large sums, which are +sufficiently guaranteed by their capital, but the credit which is +intended to safeguard the stability of the bank note cannot be pledged +for that purpose. + +It happens that the Bank of France sometimes transmits subscriptions, +but this is a gratuitous and entirely voluntary service. In no case can +the bank take for its own account bundles of securities in order to +dispose of them to the public. The purchase and sale of securities, +which is so profitable a business in all financial institutions, could +never, it is clear, be a successful undertaking in the Bank of France. +The staff of the bank has no special information as to the various +securities dealt in on the Bourse, and cannot, therefore, give valuable +advice. Its rôle would apparently be confined to handing out the +financial journals and passively awaiting orders. If it should act +otherwise, the staff would engage the moral responsibility of the Bank +of France; but the bank, evidently reluctant to undertake such +operations, prefers to leave that field to its auxiliaries, the +financial institutions. + +However, at the present time, the Bank of France tends to compete with +these institutions for the purpose of maintaining sound conditions of +credit which inclines more and more to speculation. Thus it is extending +its department for the purchase and sale of securities in order to +safeguard a poorly informed public against the excesses of speculation +which dazzle with the hope of an always illusive gain. + + +IN WHAT MANNER THE BANK OF FRANCE PROMOTES THE FREE DISTRIBUTION OF +CREDIT IN FRANCE + +Thus the Bank of France must leave entire freedom of action to the +financial institutions and must not encroach, theoretically at least, on +their functions, which, as has been shown, differ materially from its +own. The bank even owes them its protection, since they are valuable +auxiliaries in pursuing its aim of extending credit as liberally as our +metallic base permits. In the interest of the public the cash holdings +are daily at their disposal. The help and protection of which we speak +are not mere passive professions. Unfortunately, there have already been +numerous cases where the bank has had to interfere in order to bring +effective assistance to private banks. The bank has, of course, acted +thus for the welfare of the entire community, but also for the +satisfaction of protecting its auxiliaries with all its power in the +fulfilment of a difficult task. + +Let us recall the failure of the Société des Dépôts et Comptes Courants, +in the beginning of 1891. + +"The Bank of France, after exacting such security as the concern could +still offer and, furthermore, the guaranty of several large banking +institutions, for the purpose of limiting possible losses, authorised +discounts to the amount of 49,228,206.87 francs. Thanks to this +assistance, all deposits were paid off, and the dreaded effects of a +panic were once more averted."[167] However, in spite of the precautions +that had been taken, the liquidation was slow. + +Whenever the financial institutions have found themselves in need of +effective pecuniary assistance, the Bank of France has regarded it a +duty to help them, and in normal times, by assisting them with its +resources, it facilitates liberal credits. + + +IN WHAT MEASURE THE BANK MUST CONTROL CREDIT + +It may happen that the great financial institutions expand too rapidly +or unwisely this or that branch of credit. Mindful, above all, of their +own interest, which is but natural, they have no especial regard for the +public welfare, their only aim being to make their capital bear fruit +and to pay large dividends to their shareholders. + +The Bank of France aspires to a nobler ideal, and many of its policies +are primarily for the public good. The development of credit is an +extremely delicate matter; there are many instances where the +application of this agency has led to great catastrophes. It is +undoubtedly impossible to exercise a strict supervision over the +financial institutions; any such measure would soon appear vexatious and +would be, moreover, contrary to our spirit of liberty and independence. +But we can quite justly ask whether these concerns are fully sheltered +against disasters; whether nothing can happen to them of a nature to +shake their credit; and in such a contingency what should be the +attitude of the Bank of France. + +The preceding instance, and others that might be referred to, inform us +sufficiently as to the possibility of failures. The house of Baring +Bros., the Union Générale, and others enjoyed an immense credit, thought +to be unshakable, and the events of a day flatly contradicted that +opinion. + +In the course of the discussion concerning the last renewal of the +charter of the Bank of France, much was said as to the possibility of +allowing a certain interest to depositors in the bank.... M. +Burdeau[168] has shown that it is impossible for the Bank of France to +become a bank of deposit. The issue of bank notes and the receipt of +interest-bearing deposits are absolutely incompatible services. Their +union in a single hand "would replace the present organization by an +entirely new one, which, in case of a crisis, would offer much less +vitality and power of resistance." For us it is sufficient to know that +the payment to depositors of 1 per cent. on deposits subject to check +would attract to the bank nearly all inactive funds, and that a sum in +the neighbourhood of 1,000,000,000 francs would leave the private banks. +This would be their death-blow--a result which we are unwilling to +contemplate. + +By their very nature the financial institutions are liable to weakness, +and for the public good there must be some means of supporting them. For +this reason the Bank of France, which presides over the distribution of +credit, can permit the expansion of its auxiliaries only up to the point +where its help would suffice to prevent the collapse of the market. Such +a measure appears imperative in a country where the protecting wisdom of +the Bank of France has always been relied upon. Fortunate land, +fortunate institution, which excites the envy of foreigners, especially +of England, where the least failure may result in disastrous +consequences. + +Thus the banks of deposit have contributed to progress by gathering and +giving life to sums previously lying scattered and idle. They are +valuable auxiliaries in the distribution of credit. For this reason they +deserve help and protection. The bank, the mission of which is of a +wider and loftier scope,[169] has shown on many occasions that its +helpfulness is not a pretence; daily, in fact, it assists them by +rediscounting their bills. The prosperity of the financial institutions +has continually increased. It is associated with the confidence and +growing security of our times.[170] But the bank must be ready to meet +even improbable contingencies in order to be in a position to recapture +the market with a sure hand as soon as danger threatens it. + +Under these circumstances, what can the bank do? In the first place, it +can utilise its powerful reserve which has been accumulated for this +purpose. It can, in the next place, curb the action of the banks by +competing with them when they appear to enter upon a dangerous course, +and by showing them what steps to take.[171] + +On the other hand, there is a whole series of operations which private +banks do not undertake, or do not tend to develop as they deserve. +Directed by self-interest toward the more profitable transactions, they +somewhat neglect the others. The Bank of France finds no one engaged in +these less remunerative operations, and is, moreover, the better able to +undertake them itself, because they are not incompatible with the duties +of a bank of issue. + +Foremost, perhaps, among these operations is the popularising of credit +by means of an ever increasing number of small loans, frequently +accepting as pledge securities such as State rentes, bonds of the Crédit +Foncier, of cities, railroads, and industrials. An enormous transfer +business is also carried on for both banks and the public at very low +cost. Moreover, the bank clears large sums, annually relieving the +clearing house of this burden. + +The small business man, much more than the small rentier, reaps +continually greater benefit from the advantages offered to the public by +the Bank of France. We shall here simply call to mind the dates of some +innovations favorable to the democratisation of credit. + +January 15, 1824.--Creation of transfer drafts. + +April 29, 1824.--Creation of transferable certificates of deposit. + +January 13, 1830.--Reduction of interest on loans against bars and coin +from 4 per cent. to 1 per cent. + +1834.--Loans against rentes and public securities. + +1837.--Daily discounting of paper except on holidays. + +Law of June 30, 1840, article 2.--Option of replacing the third +signature, exacted for discount, by deposit of any French public +securities. + +Decree of March 26, 1848.--Similar option of replacing by warehouse +receipts. + +Law of November 17, 1897.--Admission of bills for discount carrying the +signature of an agricultural syndicate. The minimum for bills discounted +is reduced to 5 francs. + +There is here a whole series of measures, which, with the assurance of a +cordial welcome, should induce the small business man to trade with the +bank. + +The bank accepts large quantities of small paper with small signatures, +and it finds itself, accordingly, in normal times deprived of first-rate +paper, of that which is as good as gold in international commerce. +Gilt-edged paper always finds its market at lower rates than in the +bank, and M. d'Eichthal, a regent of the bank, wrote as far back as +fifty years ago: "Whatever may be the discount rate, among the bills +discounted there will be found but few with the signatures of the +Rothschilds, the Hottinguers, and other houses of the same rank. Those +are delicacies which always command a premium."[172]... + +The bank has always resolutely undertaken to carry through a whole +series of operations which could not show great profit; above all, it +has unremittingly aimed to be of service to the greatest number. The +number of bills discounted grows continuously, while the total amounts, +smaller during the most prosperous periods, invariably increase in +periods of tight money. The average amount and term of bills is 600 +francs for twenty days. This result would be considerably modified, if +we were to take into account the bills handed in for collection only, +the average value of which hardly exceeds 200 to 250 francs. + + +TERRITORIAL EXPANSION OF THE BANK OF FRANCE + +With its growth in extent the bank has not only developed its services +to meet new business needs, by providing an increased staff, and larger, +more attractive, and better conducted offices, but it has also +endeavored to reach a more and more widely extended territory. Indeed, +the mere fact that the bank has entered a place, if only to make +collections there, gives a favorable turn to credit conditions; credit +becomes cheaper, in that the basis for money rates becomes the official +discount rate, because the financial institutions have then a more +economical method of replenishing their cash. The smallest provincial +town where the bank has entered is, therefore, in regard to low money +rates, as favored as Paris. + +Exchange between cities, particularly when joined with a special +commission, reaches sometimes a considerable sum. As soon as the bank +opens its branch, exchange is no longer possible. Therefore, whenever +the charter of the bank has been renewed, the legislator, in response to +the wishes of the public, has wisely required new territorial expansion +of the bank. If the bank has not always taken the initiative in this +mode of expansion, it is because it has been restrained by several +motives. In the first place, the opening of new offices entails +considerable expense. It is necessary to count upon several years of +deficit, during which the running expenses, including salaries of staff, +are just as high as if the profits were large. We could name several +cities which for years have shown constant deficits. It can therefore be +understood that the Bank of France, which is already established in the +200 towns most important from a commercial standpoint, and which, by +means of its collecting department, touches 265 towns of less +importance, extends its service only with caution to new localities, +since each new branch must necessarily produce a larger and more +persistent deficit. Thus territorial expansion is for the bank an +ever-increasing burden; it is equivalent to an additional tax imposed by +the legislature at every renewal of the charter. The bank submits to +this with good grace for the benefit of the public. + +In the second place, there is a limit to that expansion. Where the bank +has no branches, the financial institutions may take root and develop +among a population which appreciates their services. Their profits come +largely, it appears, from small towns, where competition is less keen. +We have already said enough concerning the service of these institutions +in the development of French credit to show the danger of inflicting +upon them fresh injury. On whatever side the bank desires to expand it +finds this limit. If the bank encroaches a little on all sides, the +result may be very appreciable. + +The territorial expansion is further perceptibly increased by what is +known in the bank as the exterior accounts. This system, of quite recent +origin, allows any person not residing in the town where the branch is +established to enjoy the same privileges as residents. Business may be +transacted by mail with the aid of certain accounting forms, which often +differ from those used for ordinary accounts. Each transaction is the +subject of a special report, addressed to the customer by the branch. +Not only is the transaction itself reported, but useful information as +to the position of the account is also given, thus permitting the +customer to follow the movement of the account until the half-yearly +statement is sent. + +This department is highly esteemed by the suburban public, and renders +many services to landed proprietors and to farmers, especially in the +cattle-raising trade. + +Thus the direct expansion, which, as has been seen, meets with serious +obstacles, is assisted by this indirect expansion.[173] + +Evidently we are far from realising the attractive dream of a France no +longer deprived in part of banking facilities, but with all bills taken +at par because the bank would reach everywhere. But for the sake of this +end, no doubt desirable in itself, is it worth while to go to extremes +for a scarcely perceptible advantage, to disturb an institution in other +respects strong and useful, and thus perhaps to risk disorganising the +general credit system of France? On the contrary, we should be content +with and even congratulate ourselves upon a progress which leads us, +slowly perhaps, but surely, toward the realisation of credit on low +terms everywhere and for all. + + +THE BANK OF FRANCE AND AGRICULTURAL CREDIT + +"There is no such thing as agricultural credit; there is only credit," +said M. Dupin in 1845.[174] Matters have not changed since. It is +certain, for instance, that Scotland, which for a long time was the +classical land of pauperism, owes its prosperity to the banks, which, by +developing credit in favor of agriculture, have entirely transformed the +soil and the country. Indeed, more than any other, the Scotch farmer +needed credit, and more than any other he has benefited by it. It may be +said that personal credit is peculiar to agriculture. Thus it suffered +as a result of the evolution already mentioned, which, by causing the +disappearance of local banks or by giving them a new direction, struck a +fatal blow to personal credit. + +We know that "agricultural credit" includes loans from seed-time to +harvest. The first labor done, the first loan made to the land can only +be repaid much later. The average time necessary for agricultural loans +is five or six months at least. Now, for other reasons the by-laws of +the bank prohibit the discounting of paper having more than ninety days +to run. By a special favor which would not be accorded in business, +where each loan has a different object, the bank allows the renewals +necessary for agricultural loans, which almost exclusively take the form +of bills payable to order. The bill returned to the maker on the day of +maturity is renewed the following day. The date of maturity alone is +changed. + +A very important agricultural industry, which we have already mentioned, +is that of cattle-raising. The cattlemen are, for the most part, +customers of the bank wherever it has a branch. This customer of a +somewhat special kind appears, by the very nature of his trade, to be +indicated as a suitable client for the bank and not for the financial +institutions. The bank permits the cattlemen to indorse each other's +paper, and thus can accommodate them without intermediaries. There +results a very useful co-operation. Moreover, by using the bank the +cattlemen effect great savings, the full value of which they alone can +estimate. + +After the law of July 18, 1898, and the legislation that followed, it +might have been expected that the use of agricultural warehouse receipts +would be greatly extended. This legislation makes a serious exception to +the common law for the benefit of agriculture. It "constitutes the +landowner, so to speak, a public warehouse. It is he who, without any +other controlling appraisement, makes declaration as to quantity and +commercial value to the clerk of the justice of the peace. In short, the +agriculturist enjoys a confidence which so far has been denied to +industry and commerce." Notwithstanding this favor, the agricultural +warehouse receipts are little used,[175] and the bank, despite its +willingness to take them freely, regrets to find them among its +discounts in such very small number. + +Our survey would not be complete should we fail to say a word concerning +the agricultural credit associations, of which also much was expected +and which have only in a very limited measure fulfilled the high hopes +of their founders.[176] + +For the support of agricultural credit the State draws from two sources +the funds required to supply the organs of distribution, the local and +regional associations. The first source is the loan of 40,000,000 francs +made by the bank on November 17, 1897, when the charter was renewed. +This amount, like the 140,000,000 francs already advanced in 1857 and +1878, bears no interest. The second source is the yearly payment made by +the Bank of France on the profit-yielding circulation. This payment +cannot be less than 2,000,000 francs yearly, and more often it is in the +neighborhood of 5,000,000 francs. + +All these sums, intended for agriculture, are distributed by the +Government, and are used in endowing the associations of agricultural +credit. The regional associations, which are the pivot of the present +organisation, are self-governing societies, with a capital of their own. +This capital, added to the advance made by the State, is invested in +first-class securities, which are then deposited in the Bank of France, +as discount guarantee to take the place of the third signature, if need +be. The local offices send their paper to the regional office, which +then takes it to the bank, as the needs of funds are felt. + +Such is the part of the Bank of France in the distribution of +agricultural credit. Effective intervention was obviously very +difficult, yet the bank has contrived, even beyond its legal +obligations, to give the benefit of its credit to agriculture, which so +justly deserves the care it is receiving. + + +THE BANK OF FRANCE + +INTERVIEW WITH M. PALLAIN, GOVERNOR OF THE BANK OF FRANCE[177] + +Q. Is the Bank of France ever attacked in the controversies between +political parties? + +A. No charge has ever been made that the bank favored or aided any +political party. There is never any claim that politics enters in any +degree into the management of the bank. + +Q. Is the capital entirely private property? + +A. Yes. All the shares are divided between 30,000 shareholders, of whom +about 10,000 have not more than one share. + +Q. How are your branches managed? + +A. All branches are managed by a manager, assisted by a local board of +directors, selected from among the best qualified commercial, +industrial, and agricultural representatives in the region. + +Q. Do the branches have business relations with the merchants, farmers, +and all classes of people of the locality? + +A. Yes, they are open to everybody. + +Q. You have, I suppose, in the branches regular clients who have an +account with you? + +A. Yes, and a considerable number of them. + +Q. Do your branches do the same kind of business as the branches of the +Crédit Lyonnais? + +A. The Bank of France and its numerous branches do all banking business +consistent with the laws properly regulating a bank of issue. + +Q. A bill drawn in New York on France, on a bank, for instance, the +Crédit Lyonnais, at Paris, and accepted by it, would it be admissible +for discount? + +A. Yes, if it bore, besides the signature of the French establishment +accepting it, at least one other French signature; that of the person +presenting it, for instance, having a current account at the Bank of +France. + +Q. A part of your portfolio comes from rediscounting for banks? + +A. Certainly, and it is an important part. + +Q. Could you give us an estimate of the proportion of bills which are +discounted for banks and those discounted for other customers? + +A. I should estimate that about 70 per cent. of the paper now held bears +the signature of some bank as one of the indorsers; but it is manifest +to us that the number of merchants and manufacturers who appreciate the +facilities given by the bank for direct discounting and who profit by it +increases perceptibly every day. + +Q. Does the Bank of France make the same charge for the discount of +bills and for loans upon collateral? + +A. The bank usually charges somewhat more for loans upon collateral than +for the discount of bills. The rates at present are 3 per cent. and 4 +per cent., respectively. + +Q. Could we obtain an estimate of the percentage of the deposits of the +other banks at the Bank of France in comparison with the whole of such +deposits? + +A. In the credit establishments which you will visit you will be able to +establish the fact that the liquid cash is, in comparison with their +turnover, relatively very small. In France we consider that the strength +of a bank consists more in the composition of its portfolio, _i. e._, in +the value of its commercial bills, rather than in the importance of its +cash reserve. + +Q. Is the amount of all taxes paid by the bank to the State included in +your report? + +A. Yes. The public charges of the bank in 1907 were more than +11,000,000 francs, whereas the profits distributed were 31,000,000 +francs. + +Q. Have you a system of transfers similar to that used by the +Reichsbank? + +A. Yes, this system, in France, dates as far back as a century or more. + +Q. What is your method of transfer? + +A. Transfers from place to place are made by simple notification to +branches. + +Q. Are the other banks accustomed to use the Bank of France in order to +transfer their funds? + +A. The greater part of the banks use no other method, even to increase +the cash in one of their branches in a remote part of France. + +Q. Is the Bank of France subject to examination by the Government? + +A. There is no regular system of examination, but the Minister of +Finance has the right to ask for information whenever he chooses. + +Q. Is the Bank of France regarded as a bank for banks or as a bank for +the people? + +A. The Bank of France remained for a long time, indeed, the bank for +banks, but since it has covered so much territory with its numerous +branches; since the minimum amount of all its operations has been +lowered; since it has opened deposit accounts to all, it is already and +it tends to become more and more--as you ask--the bank of all the French +public. + +Q. Is there any contention in banking or economic circles that it is +necessary to restore or extend the right of issue to banks, other than +the Bank of France, to enable them to increase their own profits or to +afford adequate facilities to borrowers or to meet legitimate business +demands? + +A. The unity of issue was achieved in France in 1848, and at no time +since then has there been any question, in responsible circles, of a +possible return to plurality of issue. The same tendency is leading, +little by little, to an absolute monopoly in England, Germany, and even +in Italy. I think that it would also be interesting for you to examine +the recent example of Switzerland, which had its note-issue system +founded, as in America, on the plurality of banks and which has now +substituted for this system one single privileged bank. This +transformation has received popular approval by referendum. + +Q. Does the export of gold reduce the volume of notes? + +A. Not necessarily. It may happen that among our assets a certain +fraction of the gold is replaced by an equal amount of bills in our +portfolio, and that without changing the total of notes in circulation. + +Q. There is nothing in the law requiring your notes to be covered by a +certain proportion of gold? + +A. No regulation of this kind exists in our legislation. + +Q. Do you rely upon raising the rates of discount to stimulate the +importation and to prevent the exportation of gold? + +A. It is a principle consecrated by experience that the supreme means of +defence for an issue bank, to protect its metallic reserve, is to raise +the rate of discount, and we never lose sight of this principle. +However, the extent of our reserves allows us to contemplate without +emotion important variations of our metallic stock, and we only +exceptionally have recourse to a measure which is always painful for +commerce and industry. The stability and the moderation of the rate of +discount are considered as precious advantages, which the French market +owes to the organisation and traditional conduct of the Bank of France. + +Q. Would you like to express an opinion as to why the Bank of France is +able to hold its gold with a bank rate of 4 per cent. when the rates +elsewhere are higher? + +A. The causes of this phenomenon are multiple. Theory teaches us that +capital goes where it can obtain the highest remuneration, but in +considering this remuneration account must be taken of risks; these are +numerous and of different kinds; I mean, of course, commercial risks; +risk of losing on exchange when the capital is brought back, etc. This +at once explains why it is possible in France to maintain a rate of +discount lower than elsewhere. French capitalists might fear, perhaps, +that the higher interest obtainable outside might be offset or more than +offset by the risks incurred. Account must be taken, secondly, of the +situation always held by France as a creditor nation, and which by the +constant income of capital which it assures to us certainly contributes +to counter-balance the current of exportation which might result from +the lowering of the rate of discount. + +Q. Does the Bank of France sometimes take steps to maintain the bank +rate by the purchase of bills in the market or otherwise? + +A. No, never. + +Q. The tradition and the reputation of the Bank of France make it +important that it should hold a larger reserve than any other bank in +the world? + +A. It is true that France keeps locked up in its bank a proportionately +larger amount of specie than any other country, but this policy is not +without important compensations. Suppose the French public, changing its +mind, should reduce by one-half its monetary reserve of which the bank +is the guardian. It would gain thereafter the interest on perhaps two +milliards of francs released and which would have become +productive--that is to say, a saving of from 80 to 100 millions of +francs per year at the maximum--but if one reflects that it would lose +the advantage of the reduced rates of discount which the extent and +character of our reserves enable us to maintain and from which all +French production profits; that it would lose, in addition, the +sentiment of absolute security, of complete financial independence, +which every crisis has strengthened, one would be less tempted to +conclude--with certain critics--that the policy of maintaining heavy +reserves, the natural expression of the country's instincts, is an +unwise policy from an economic and practical standpoint. + +Q. You have, I believe, no requirement of law by which the Bank of +France is obliged to purchase gold at a certain fixed price? + +A. The bank buys gold according to the tariff of the Mint, but it is not +obliged to do so. Private individuals, instead of having their money +coined for themselves, find it more advantageous to sell their ingots to +the bank, which has them coined when needed. + + +THE CRÉDIT LYONNAIS + +INTERVIEWS WITH BARON BRINCARD, ADMINISTRATEUR DÉLÉGUÉ, AND OTHER +OFFICIALS OF THE CRÉDIT LYONNAIS[178] + +Q. What is the date of the organisation of the Crédit Lyonnais? + +A. July 6, 1863. + +Q. Under what law was it organised? + +A. We are under the general law, a general companies law. + +Q. What is the minimum amount of capital required? + +A. There is no minimum, but at least one-fourth of the capital is +required by law to be actually paid in. + +Q. How many shareholders have you? + +A. Our capital is divided into 500,000 shares, but as many of these +shares are issued to "bearer" we do not know how many shareholders we +have. + +Q. The cash in hand is merely carried for the necessities of business? + +A. Yes. Any bank, if it has need for additional cash, may present for +rediscount at the Bank of France the bills and other commercial paper +which it has in its vaults. + +Q. What per cent. of your deposits do you intend to carry in cash either +in your own vaults or in other banks? + +A. Eight to 10 per cent. on the average. + +Q. Does the Bank of France ever loan below its published rate? + +A. No. It never does. + +Q. It is not, I believe, the policy of your bank to buy public +securities in large amounts? + +A. No. Our idea is to buy all the commercial paper that we can get. That +is our business. At present it is almost impossible to get any +commercial paper because business is so slack; therefore, we are obliged +to go outside and buy treasury bills. + +Q. To what kinds of banks do you lend on collateral? + +A. Mostly foreign banks; for instance, banks in New Orleans during the +cotton season. It is not to our interest to lend to French banks. We +lend money to foreign banks and to French merchants, but never to +foreign merchants or to French banks. We never lend on real estate. That +is the business of the Crédit Foncier. + +Q. Do you own all of the securities you sell, or do you take orders and +buy and sell them on commission? + +A. The greater part of our transactions are made on commission. + +Q. In your statement of liabilities you show deposits about +$132,000,000, and current accounts about $168,000,000. Will you kindly +explain the difference between these two accounts? + +A. Deposits are sums of money deposited, especially by private people. +Accounts current represent the balances to the credit of business +people. + +Q. If I come here and open an account with you and make a deposit and +say I want to transact business with you, borrowing money from time to +time, and depositing and drawing daily, would you put that account in +your "accounts current"? + +A. If you were not a merchant, you would have a deposit account opened +for your daily deposits and drawings. Your account could never show a +debit balance and the amounts which you might borrow would have to be +secured by deposit of securities and would be placed under the item +"loans on securities." If you were a merchant, an account current would +be opened for the requirements of your business, and this account could +become debtor. + +Q. Deposits and current accounts are payable on demand? + +A. Yes; on demand. Deposits are made up of sums deposited by customers +whose accounts are not active; they are more in the nature of reserve +deposits, whereas current accounts represent deposits made by customers +mostly in active business. + +Q. Do you pay interest on practically all of your deposits and current +accounts? + +A. Yes. + +Q. Do you find that the Bank of France competes with you in any way? + +A. In no way. + +Q. They receive accounts from individuals and small tradesmen in the +branches, do they not? + +A. Yes; but they do not grant uncovered credits. There is no competition +between the Bank of France and the other banks, because they do not do +the same kind of business. The Bank of France receives deposits, but +does not allow interest upon them; it only discounts bills with three +signatures; it is the bankers' bank; it acts as the regulator of the +money market. + +Q. Do its branches receive deposits? + +A. Yes; they receive deposits, without allowing any interest. In times +when money is cheap the rate of discount of the Bank of France is rarely +below 3 per cent., and in the Crédit Lyonnais and other banks the rate +may be sensibly below that of the Bank of France. + +Q. Can you state the number of employés in the Crédit Lyonnais? + +A. About 14,000. It varies according to the time of year. + +Q. Are all of the important banks in the City of Paris members of the +clearing house? + +A. Yes; about 13 of the most important. + +Q. How frequently are the clearings made? + +A. Three times a day. As a matter of fact, our clearing house is not so +important as yours in America. + +Q. The clearing houses in the cities of France are in no sense a factor; +they are merely the machinery through which the cheques are cleared, are +they not? + +A. To our knowledge there is but one clearing house; it is in Paris and +is merely a mechanism for settling balances. + +Q. Are you examined at any time and in any way by the Government? + +A. No. The control of the Government is limited to the supervision for +taxes, to which every company is subject. + +Q. Your relations with the Bank of France are very intimate and cordial, +are they not? + +A. Yes. + +Q. Is that true with all the banks in France? + +A. The Bank of France is quite impartial; it gives no preference to any +one; there is no favoritism. + +Q. I understand none of the farmers or peasants will use cheques. + +A. The use is extremely rare. + +Q. How about your tradesmen all through the small towns, and the doctor +and lawyer and professional man; would they draw the money out and pay +their bills in cash? + +A. Certainly; most of them. + +Q. When you establish a branch in a small town, you generally find a +local independent bank there. Can this local bank compete with you? + +A. There are certain places where the private banks have kept on, but +the tendency is for the private banker to disappear. We take small sums +and have numerous branches. One great distinction is that the private +bank is always in the hands of a family. A man who originally starts a +private bank may be a good banker, financier, and business man, but it +does not always follow that his son, who in all likelihood will inherit +the business, will be capable of running it. Our joint-stock banks do +not go from father to son, but are always under efficient management. + +Q. What proportion of your own payments are made in gold? + +A. A very small proportion. The people prefer notes. + +Q. Do the French people hoard money as much as formerly? + +A. No; it is becoming more the custom to put money in the banks. Thirty +years ago they kept the money at home. + + +COMPTOIR D'ESCOMPTE + +INTERVIEW WITH M. ULLMANN, DIRECTOR OF THE COMPTOIR D'ESCOMPTE[179] + +Q. One of the things that we have in mind is to inquire in regard to the +character of the business done by your branches. + +A. Yes. We are especially a discount bank and our customers are mostly +commercial people engaged in commerce and industry, so that our +principal business in our branch offices consists in discounting +commercial paper, in making advances against securities, goods, or +warehouse receipts, or sometimes giving blank credits to our customers +for commercial requirements. + +Q. Have you stock in other banks which you control? + +A. We are interested in the Banque de l'Indo Chine, which is an issue +bank in the French colonies, but we do not control it; we hold a certain +amount of shares. + +Q. Are there any other banks which you control? + +A. No. + +Q. You have not been in the habit of buying up other banks? + +A. No. The system here is to establish agencies of our own; the Germans, +on the contrary, control other banks in order to arrive at the same +result, viz., to get as much influence as possible throughout the +country. We try to come to the same result by establishing our own +agencies. + +Q. Is that true of the Crédit Lyonnais? + +A. The Crédit Lyonnais and the Société Générale have the same system. + +Q. Is it usual for large banks in Paris to confine their underwriting +operations to bond syndicates? + +A. Yes; banks receiving deposits, such as the Crédit Lyonnais and the +Société Générale, do not usually participate in syndicate operations +covering the _shares_ of industrial concerns; other banks, such as the +Banque de Paris et des Pays-Bas, do so, but they are not deposit banks. +They have more liberty to engage their own capital in any enterprise. + +Q. You are not restricted by law in doing any business you please? + +A. No; it is only the custom and rules of our society. + +Q. If there were a large industrial corporation in France which wanted +to develop its business and issue bonds upon it, and if they were +customers of yours of unquestioned financial standing, would you take +their bonds and sell them? + +A. Yes. + +Q. But not their stock? + +A. If they were a well-known concern we would sell their shares too; we +have done so. + +Q. Is there co-operation between the large banks? + +A. We meet very often and often have common interests in business. + +Q. Do you, in a sense, divide the field? I suppose you have a certain +field in which you do business and other banks do not; Turkey, for +instance? + +A. Turkey is reserved for the Banque Ottomane. + +Q. Take the electrical business, for instance. + +A. As far as we are concerned we are connected with the Thomson-Houston; +and it is natural if the Thomson-Houston and their friends have any +business to do, that they deal with us. + +Q. There is nothing in the law which restricts you to any class of +investment? + +A. No. + +Q. And nothing that requires you to keep any reserve; that is, any +amount of cash as against your liabilities? + +A. No. + +Q. Is the Bank of France your principal reliance in case you need money? +Do you think it necessary to carry any additional reserve? + +A. Under our French system we consider the commercial paper we keep in +the portfolio a cash reserve, as we can rediscount it at the Bank of +France. We know the Bank of France will discount these bills and thus +enable us to convert the bills instantly into cash; this is the basis of +the French banking system. + +Q. Outside of Paris it happens that you have branches at many of the +same places as the Bank of France; is there competition between the +branches of the Bank of France and your own branches? + +A. No; the Bank of France does more rediscounting than discounting, and +the Bank of France also has more conservative rules than the other +banks. We may lend under the Bank of France rate, so our clients have an +interest in keeping their accounts with us. + +Q. You do not consider the Bank of France as an active competitor? + +A. No; competition is greater with the Crédit Lyonnais and with the +other private banks than with the Bank of France. + +Q. You do considerable rediscounting of bills, I take it? + +A. Yes. + +Q. At a lower rate than the Bank of France? + +A. Frequently. + +Q. Is the development of branches a matter of recent times? + +A. Yes; we began the system of establishing branches about twenty years +ago. + +Q. How many employés have you? + +A. Including the country, something like 5,000. + +Q. Have you a pension system for your employés? + +A. Our clerks consent to a rebate of 5 per cent. on their salaries, and +we duplicate this rebate by a voluntary contribution, in order to +constitute a pension fund; it amounts now to about 7,000,000 francs. + +Q. If a new bank were to be organised here, would it be admitted as a +member of the clearing house? + +A. Certainly. + +Q. You have no new banks except the Union Parisienne? + +A. There is also the Banque Française, managed by M. Rouvier, who +formerly was Premier. + + +BANQUE DE PARIS ET DES PAYS-BAS + +INTERVIEW WITH M. MORET, MANAGER OF THE BANQUE DE PARIS ET DES +PAYS-BAS[180] + +Q. We assume that your business is in many respects quite unlike that of +the other joint-stock banks? + +A. Yes; in some respects. + +Q. What is the difference? + +A. The Société Générale, Crédit Lyonnais, etc., receive deposits from +the public; they invest these deposits and try to make the most of them, +paying a small rate of interest on them; they also loan money on +commercial paper which can be rediscounted at the Bank of France. Here +we are more a business bank; we do not care for deposits from the +public; we work with our own money, with the money which is the capital +of the bank, and we are occasionally assisted by the capital of the +directors, the people who sit around this table, who are all rich people +and some of them bankers. As a rule we do not receive deposits from the +public. + +Q. But you do receive some deposits? + +A. We receive the deposits of big companies which we have created or +promoted or whose stocks we have issued--they are our customers--but we +do not receive deposits of small accounts from the public. + +Q. What is your capital? + +A. 75,000,000 francs. + +Q. You have current accounts--190,000,000 francs? + +A. They are current accounts, from manufacturing concerns, railway +companies, big organisations of any kind. + +Q. You have a considerable foreign business? + +A. We have connections all over the world, and very often we take an +interest in business abroad. + +Q. Do you operate more particularly in one part of the world than in +another? + +A. No; although we have only three branches--one in Brussels, one in +Amsterdam, and one in Geneva. + +Q. Do you endeavor to carry any special amount of cash at the Bank of +France? Or are you indifferent as to the amount of balance you have +there? + +A. We always calculate what sum each day will be likely to be withdrawn; +besides which we always have a large amount of commercial paper which we +could rediscount at the Bank of France at once. Therefore we keep just +enough cash in vault to meet any cheques which may be presented. + +Q. Do you carry an account in New York? + +A. We lend money to bankers there. Different kinds of loans, some are at +sixty days or ninety days. + +Q. You are not restricted in any way as to the character of the +undertakings you may make? + +A. No; we can do as we like. + +Q. Do you specialise in practice or do you consider propositions of +various kinds? + +A. All sorts of propositions, railway building, harbors, tramways, +electrical enterprises, etc. + +Q. Do you sometimes take an interest in business such as placing +Pennsylvania Railroad and Union Pacific bonds? + +A. Yes. + +Q. You frequently act as managers of syndicates which might include the +other banks of France? + +A. Very often we take the head of syndicates. + +Q. You are the leading bank in that business in France? + +A. They say so. + +Q. Is there cordial co-operation between the banks of Paris and the Bank +of France, generally speaking? + +A. Yes; business as a rule is done, when it is a big business, with +several of these big societies or banks, and perhaps with all of them +together. + +Q. Are there particular corporations in which you have a permanent +interest? + +A. Yes; so as to have some control in certain large companies. + +Q. What do you think of the attitude of the Government toward the Bank +of France? That is to say, are they exacting more and more from it? + +A. I do not think that they exact too much from it. The shares of the +Bank of France are always very high in price; it has not hurt at all the +development of the bank. + + +CRÉDIT FONCIER DE FRANCE + +INTERVIEW WITH M. TOUCHARD, SECRETARY[181] + +Q. Is the Crédit Foncier a public institution? + +A. Yes, it is a mixed institution; it is at the same time a joint-stock +company and a society under the control of the Government by reason of +privileges which the Government has granted to it. + +Q. Who are the shareholders? + +A. Any one; the shares are dealt in on the Bourse. The firm capital is +at present 200,000,000 francs; the shares are issued at 500 francs. + +Q. What dividend do you pay? + +A. We now pay 6 per cent.; for several years it was only 5 per cent. + +Q. Does the Government receive no income from it? + +A. No; on the contrary, the Government began by giving us a subsidy of +10,000,000 francs; that was at the beginning, in 1852, in order to help +us make loans at a rate advantageous for that time. This subsidy was not +renewed, and the State does not intervene now, except occasionally to +exercise its control. + +Q. Does the company appoint the officers? + +A. The Government appoints the governor and the two sub-governors. There +must also be three treasurers-general among the 23 members of the +council of administration. These treasurers, as well as the other +administrators, are named by the general assembly of stockholders; but +before presenting their names to this assembly, it is customary to +obtain the approval of the Minister of Finance. + +Q. Do you pay the same taxes as the other banks? + +A. Yes. We are treated like any ordinary bank. We have the special +privilege of issuing bonds secured by mortgages. It is a very +complicated system in France; there are legal complications which would +render it impossible for any corporation to undertake the business +unless it had special privileges. + +Q. Are you confined by law to business with mortgages? + +A. We have two principal kinds of operations--mortgage loans and +communal loans. The total business of the two branches of operations +amounts at present to about 4,000,000,000 francs. Operations on so large +a scale involve a considerable transfer of funds, and make necessary a +treasury service requiring, of course, the use of banking methods. Our +statutes, therefore, recognise our right to carry on ordinary banking +operations, within certain rather sharply defined limits. + +Q. How is your banking business limited? + +A. We are allowed to receive deposits up to a maximum of 100,000,000 +francs. + +Q. Do you invest in securities other than mortgages? + +A. We employ our deposit funds in discounting commercial bills on +condition that they have two signatures and can be presented to the Bank +of France; that is to say, they must not run over three months. + +Q. You take mortgages on private estates? + +A. Our mortgages may be on houses or on rural property. + +Q. What is the precise relationship of the stockholders to the business +of the company? Have they really a voice in the administration? + +A. The two hundred largest stockholders meet once a year to ratify +accounts, vote the dividend, and consider the questions docketed for the +day of the meeting. + +Q. What is the usual length of time for mortgages on real estate? + +A. Our statutes allow us to loan for seventy-five years on ordinary +rural or city property. In the case of summer resorts and certain other +property liable to depreciate rapidly, for the sake of prudence we do +not generally lend for more than thirty years; besides, the borrowers +always have the right to repay at any time, and they often avail +themselves of this right, so that the average length of our loans is +much less--hardly exceeding fifteen or twenty years. + +Q. What is the cost for amortisation in the long mortgages on property +in the country? + +A. The amortisation is spread over the whole duration of the loan, so +that the total of the interest paid and the capital reimbursed forms a +constant yearly annuity. + +Q. Do you employ your amortisation funds to buy new mortgages? + +A. Yes; we lend again. + +Q. May you call your bonds at par? Are they payable at par at your +option? + +A. In our recent issue we have put that clause in, viz., that we can +redeem our bonds at par. Generally we only redeem a certain portion of +them each year, which are drawn by lottery. + +Q. What is the minimum size of your mortgages on private estates? + +A. There is no minimum; but we do not care to make very small loans +because it costs too much to foreclose. + +Q. What percentage of your total business is in the country and what in +the city? + +A. About one-half in Paris, and our best business is in Paris. The urban +mortgages cause us less difficulty, and the tendency is for the +proportion of them to increase. + +Q. Who are the subscribers to the bonds, and what are the usual sums +subscribed? Are they small or large? + +A. They are bought by small people, and generally remain in the hands of +persons of small capital. This is one of the reasons why their +quotations show so little fluctuation. + +Q. Do you lend on farms? + +A. Yes. Up to one-half, except on forest land, vineyards, and the like, +on which we lend only one-third. We do not lend on mines. On factory +buildings we lend only on the value of the ground and of the building, +independently of its industrial value. + +Q. What other institutions of this character are there in France? + +A. There are no others; we no longer have a _legal_ monopoly, but we +very nearly have a _practical_ monopoly. There are private individuals +who make mortgage loans, but no large company makes this the principal +feature of its business. + +Q. How long has it been the privilege of the Crédit Foncier to add +lotteries to its loans? + +A. It has done so from the beginning, although we are obliged to ask the +permission of the Minister, but it is on that account that we have been +able to place our bonds so low. + + +CAISSE DES DÉPÔTS ET CONSIGNATIONS + +INTERVIEW WITH M. DELATOUR, GENERAL DIRECTOR OF THE CAISSE DES DÉPÔTS ET +CONSIGNATIONS[182] + +Q. We should like to know the general character of the business +conducted by your institution. + +A. The mission of the Caisse des Dépôts et Consignations is to receive, +hold, and repay all private funds intrusted to the State either +voluntarily or under compulsion. + +Q. You say that you also do an insurance business. What do you mean by +that? + +A. The insurance office, managed by the Caisse, issues policies of life +insurance, insurance payable after death or in case of accident, like +any private insurance company. As regards accidents to employés while at +work, it insures only against such accidents as cause death or permanent +total or partial incapacity for work. + +Q. Is this a corporation? + +A. The Caisse des Dépôts et Consignations is not a corporation. It is a +state organism, but, while charging the Caisse with the management of +all private funds, which may be turned over to it by the State under +different headings, the legislature bestows upon it full autonomy, in +order to avoid even a semblance of possible confusion in the handling of +private moneys with the handling of public moneys. Moreover, it has +placed the Caisse under the direct supervision and the guaranty of the +legislative powers. + +Q. What is done with the profits realised from the business? + +A. Profits earned by the Caisse on deposits of the savings banks are +turned over to the reserve and guaranty fund of savings banks. + +Q. What restrictions govern the investment of your funds? + +A. As long-term investments, we make loans to departments and +municipalities, sometimes to the State; we take government rentes, +treasury securities, guaranteed railroad bonds, etc. As short-term +investments, we take treasury bonds, bonds of the Monte de Piété of +Paris (municipal pawnshop), etc. Finally, we keep large sums in cash, +either in our own vaults or to our credit in the treasury and the Bank +of France, which, for that purpose, keep account currents on demand for +us. + +Q. You do not, as a rule, invest in mortgages? + +A. No; owing to the difficulty in disposing of such investments. + +Q. You purchase no bills and do no commercial business whatever? + +A. No; that rôle is played by the Bank of France. Sometimes we make +advances on securities, but only on treasury bonds. + +Q. Your organisation is quite unique in the world, is it not? + +A. There is nothing like it in England or America, but there are similar +institutions in Belgium and Italy, for instance. In France this +institution is highly appreciated by the lawmakers, who steadily +increase its functions, and the number of laws and regulations governing +the Caisse is ever growing. + +Q. It is customary in France for savings banks to carry their reserve +with this establishment? + +A. The savings banks are bound to turn over to us all they receive from +their depositors, except such sums as may be required to meet immediate +demands. + +Q. Then, as a matter of fact, this is a central bank for the savings +banks of France? + +A. Precisely. + + +CRÉDIT AGRICOLE + +INTERVIEW WITH M. DECHARME, CHEF DU SERVICE DU CRÉDIT MUTUEL ET DE LA +COOPÉRATION AGRICOLE AT THE MINISTÈRE DE L'AGRICULTURE[183] + +Q. What is the nature of the business of the Crédit Agricole and when +was it instituted? + +A. The first law was in 1899. The first bank was opened in 1900. The +Crédit Agricole is based upon local organisations. France is divided +into 86 departments, in each of which we are to have a regional bank +(_caisse régionale_); and we hope eventually to have a local office +(_caisse locale_) in each commune of each department. Among these 36,000 +communes there are many which are cities, which naturally would not have +agricultural banks. There are only 2 out of the 86 departments in France +which have not already established a regional bank. + +Q. Who furnishes the capital? + +A. The basis of the system is the local office of the Crédit Agricole in +which each member--local farmers--has one or many shares of 20 francs, +but on which he has to pay only 5 francs down. On payment of these 5 +francs he becomes a stockholder. When a local office has been +established it turns all of its capital over to the regional office. +Then comes the State which advances to the regional bank an amount four +times the capital which has been subscribed by the local banks. The +money given by the Government is not really given; it is lent without +charge, without interest. + +Q. For what purposes can this capital be used? + +A. The regional office does not lend directly to the farmers; it lends +to the local office, and the local office has a board of directors which +examines the demands of the various members. + +Q. Under what conditions do they make loans to farmers, and are their +loans confined entirely to people engaged in agriculture? + +A. The State loans to the regional office without interest; the regional +office loans to the local office at 3 per cent.: the local office loans +to the farmers at between 3-1/2 and 4 per cent.; in the northern region +at 3-1/2 per cent.; in the southern at 4 per cent. + +Q. Under what conditions? + +A. The farmer who wants to borrow from the local office draws a bill +upon himself, takes it to the local office, and the board of +administration there considers it. If they approve it, the president +signs it--and it has then two signatures--and then sends it to the +regional office; if the regional office has plenty of money they will +lend the money directly; if not, the president of the regional office +signs it--it has then three signatures and is bankable paper--and it is +taken to the Bank of France. During the crisis in the south of France +last year in the wine-growing region at Montpellier, the centre, the +regional office had one million capital; the Government then added 4; +that made 5, but they lent at that office all together 16 millions, and +the difference was obtained from the Bank of France in the way described +by using paper with three signatures. Before the founding of these +agricultural societies it would have been difficult for a farmer to +obtain the three signatures necessary to borrow from the Bank of France, +and what happened last year in the south of France could not have +occurred before the organisation of the Crédit Agricole. It should be +added there has never been one cent lost by the Crédit Agricole. + +Q. Are all loans made to members? + +A. Yes; exclusively to members. + +Q. Who can become a member? + +A. Farmers; agricultural workmen are excluded. We do not lend to people +for nourishment to support themselves. We lend them money to increase +the production of the land. + +Q. Must a man have some share in the crops? + +A. We lend money to buy a horse, a cow, or to buy fertilizer. We will +lend to a man who rents a farm, but does not own it, to buy machinery, +cattle, etc., but we will not lend to a man who wants to borrow the +money for his own consumption; we do not lend money for a man to buy a +coat, for instance. These local offices are in communities where +everybody knows everybody else, and they always ask what the man wants +to borrow for, and if he says he wants 400 francs to buy a cow, they +watch him, and if four or five days afterwards he has no cow, they know +it. As the liability is without limit, the other members of the locality +would be responsible. At the beginning the farmers were afraid of +unlimited liability, and on that account they had to make it limited, +but now, in all of the new offices, the responsibility is unlimited. + +Q. What are your co-operative societies? + +A. They are societies for the production, preservation, sale, or +transformation of agricultural products. There are co-operative +agricultural societies in the wine-growing regions which have their own +wine cellar; there are co-operative dairy societies for making butter +and cheese; there are also co-operative societies which use waterfalls +and electricity; co-operative mills to grind corn; co-operative railways +to bring beet roots to the sugar refinery; co-operative distilleries and +co-operative warehouses for corn. To these co-operative societies we +make loans for twenty-five years. The Government loans without charge to +the regional office and the regional office lends to these co-operative +societies for twenty-five years at 2 per cent. + +Q. What is the security? + +A. The guarantee is the consolidated liability of all of the members of +these co-operative societies and also a mortgage upon their real estate; +their responsibility is absolutely without limit. + +Q. Do you compete at all with the branches of the other banks or with +the Bank of France? + +A. No; we have an entirely different class of customers. + +Q. Is there any other institution of this character in France, or do you +practically cover the field? + +A. The members of these local offices are people who up to the time +these local offices were organised had never had any banking connection +at all. The only persons with whom the local offices compete are +individuals who used to loan to farmers at very high rates of interest. + +FOOTNOTES: + +[165] M. Robert Masson, Sous-Directeur du Crédit Lyonnais, _The Bank of +France_, an address delivered at the annual banquet of the bankers of +the city of New York, January 19, 1914. + +[166] Adapted from Maurice Patron, _The Bank of France in Its Relation +to National and International Credit_. Publications of the National +Monetary Commission, Senate Document No. 494, 61st Congress, _2d +Session_. + +[167] "Compte rendu de l'assemblée générale des actionnaires de la +Banque de France," 1891. + +[168] Burdeau, "Discours sur le renouvellement du privilège de la Banque +de France," June 29 and July 6, 1892, in the Officiel of June 30 and +July 7. + +[169] The Bank of France, during periods of quiet and prosperity, aims +at a gradual effacement, at a more complete retreat toward a very high +but very restricted sphere of economic activity. But as soon as the +least trouble appears ... the Bank assumes again its place at the head +of our great financial institutions. (Brouilhet, "Le nouveau régime de +la Banque de France." Revue d'Economie Politique, 1899.) + +[170] The discounts and loans of the financial institutions are growing +in importance, and are steadily increasing in proportion to those of the +Bank. This condition, revealed by statistics, is in itself not alarming, +but it once more justifies that intervention, so many motives for which +we have brought out. + +[171] It seems that this protective mission especially applies to the +department for stock market orders, originally reserved for the +customers of the Bank, and later opened to everybody. Thus it prevents +the financial institutions from driving us toward excessive speculation. +This purpose explains, according to our notion, the growth and +broadening of the business of stock market orders at the Bank of France. + +[172] P. Coq, "Les circulations en Banque," Paris, Guillaumin, 1865, p. +38. + +[173] The indirect expansion might be increased by wider use of the +"crossed check." It will be long before we may expect good results from +this practice, since we are as yet too far from the time when this +check, almost unknown in France, will be currently used. + +[174] Journal Officiel, 1845, p. 2471. + +[175] The main reason lies in the numerous formalities which the law of +April 30, 1906, has simplified but not suppressed, in the many expenses +caused by the organisation, and also, it appears, in the inexperience of +some of the officials. The clerks of the justices of the peace, +intrusted with the delicate and novel functions of registrars of chattel +mortgages, are, as a rule, little fitted to perform them. + +[176] The model of these institutions came to us from foreign countries; +but the foreign differ from ours materially, because of the diversity of +their origin. With our neighbors, the movement began slowly in the +lowest levels of the rural population. With us, on the contrary, the +system of agricultural associations began at the top. Thus, these +institutions penetrate only with difficulty into the rural districts, +where economic education has but just begun. + +[177] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_. +Publications of the National Monetary Commission, Senate Document No. +405, 61st Congress, _2nd Session_, pp. 189-218. + +[178] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland and Italy_. Publications +of the National Monetary Commission, Senate Document No. 405, 61st +Congress, _2nd Session_, pp. 219-248. + +[179] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_. +Publications of the National Monetary Commission, Senate Document No. +405, 61st Congress, _2nd Session_, pp. 249-267. + +[180] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_. +Publications of the National Monetary Commission, Senate Document, No. +405, 61st Congress, _2nd Session_, pp. 268-276. + +[181] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_, +Publications of the National Monetary Commission, Senate Document, No. +405, 61st Congress, _2nd Session_, pp. 277-291. + +[182] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_, +Publications of the National Monetary Commission, Senate Document, No. +405, 61st Congress, _2nd Session_, pp. 296-308. + +[183] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_. +Publications of the National Monetary Commission, Senate Document, No. +405, 61st Congress, _2nd Session_, pp. 309-322. + + + + +CHAPTER XXV + +THE GERMAN BANKING SYSTEM + + +BANKING ARRANGEMENTS IN GERMANY + +[184]Various systems can be adopted in the banking profession for the +transaction of business. The most lucrative method, at all events the +one in which the power of large capital is most effectively turned to +account, is that of the Rothschild firms, whose example was followed by +many large private concerns at home and abroad. These firms avoid +troublesome current business, maintain only a few connections, and +concentrate their whole energies on isolated but important ventures and +undertakings in which, owing to the large amount of means immediately +required, no competition worth mentioning existed before the growth of +capable joint-stock banks. Up to the middle of last century these firms +actually possessed a monopoly so far as the loan issues of most European +States were concerned, and they earned enormous profits according to +present-day ideas. In the course of the last decades, however, this +monopoly has been done away with so far as European States are concerned +and only prevails to a limited extent in some foreign countries. Since +that time the Rothschilds have devoted themselves to several large +industrial enterprises, such as the Russian naphtha industry, the +Spanish copper and quicksilver mines, etc. + +Another system consists in the division of work and specialisation, +customary in England, but which has been frequently abandoned of late. +In England the issuing and syndicate business is carried on by special +houses which, like Rothschild, do not call themselves bankers, but +merchants. Brokers and jobbers carry on stock broking on the stock +exchange and in the open market, the former (theoretically at least) on +account of third persons and the latter on their own account. It is the +exclusive business of other firms to place credit at the disposal of +home and foreign firms by giving acceptance to bills. These firms, +strange to say, are mostly of German origin (Frühling & Goschen, +Frederik Huth & Co., Kleinwort & Sons, etc.), and carry on business in +such a reliable manner that they are allowed to enter into bill +obligations amounting to more than five times their estimated means. The +clearing and deposit banks manage moneys on account of third parties. + +It must be noted that the division of labour and its operation are based +on free business practice in England without any legal compulsion. +Consequently, no opposition is offered in that country to the different +methods of carrying on business employed by the so-called foreign banks, +_i. e._, the numerous branches of continental banks, including the +branch offices of the Deutsche Bank, the Dresdner Bank, and the +Disconto-Gesellschaft, despite the fact that their competition is +unpleasant for the English institutions. In Germany, in consequence of +business requirements and also of the small amount of capital in the +country at the beginning of its modern economic development, the +peculiar system has developed that credit banks combine all kinds of +financial business (generally with the sole exception of mortgage-credit +transactions), so that every customer can settle all his financial +affairs in one spot on comparatively the cheapest terms possible. + +Account-current transactions form the fundamental branch of business. +The bank undertakes all the financial business of its client in return +for a moderate commission on the turnover calculated on that side of the +account which happens to be the greater, makes and receives payments, +collects bills, checks, and other documents, and pays, or charges, +interest on the balance, generally at 1 per cent. below the Reichsbank +discount rate for credit balances and 1 per cent. above the Reichsbank +discount rate for balances debited. The bank discounts the bills +received by its customers, special arrangements being made as to the +limit of the amount and terms, according to the quality of the bill, _i. +e._, according to the trustworthiness of the other persons figuring on +it. Should a customer require foreign bills to settle his liabilities +abroad, _i. e._, checks or bills payable in the country concerned, the +bank provides them from its own stock or draws bills or checks to the +amount desired on its agents or correspondents in the country in +question. + +Should the debit balance not be a merely temporary one, or one soon +covered by fresh receipts, the granting of special credit is necessary, +and arrangements have to be made as to the amount and conditions of the +same. Such credit is either covered or uncovered credit. The cover +consists principally of current securities with a margin against +fluctuations according to the nature of the security, and which is +higher for shares than for securities bearing a fixed rate of interest. +Uncovered credit is only granted in exceptional cases to others than +business men--as a rule only to first-class mercantile firms of repute, +whose affairs are in strict order. + +Bankers and other firms with large cash transactions keep a so-called +"cheque" account at their bank in addition to the chief account, in +which no debit balances may occur; no interest is paid on the amount +deposited, which is always kept in suitable proportion to the payments +made, but, on the other hand, no turnover commission is charged. + +Those customers are appreciated most who claim credit during their +buying seasons, but who not only pay back the borrowed money during +their selling season, but who have balances to their credit. This is the +case with a great number of commercial firms and in many branches of +industry, more especially in Berlin. The seasons in different branches +occurring at different times of the year, it follows that a large bank, +with branches and connections in all industrial parts of Germany, has +the advantage of a suitable distribution of accounts among all branches +of trade, etc., and the best possible adjustment of its debit and credit +arrangements. + +The debtors in a bank's balance sheet comprise not only those who have +received advances of ready money but also those to whom the bank has +granted credit by bill acceptance; the bill drawn by the debtor and +accepted by the bank is discounted elsewhere. It is the duty of the +drawer of the bill to cover it before it matures, and when the bill is +accepted he is booked simultaneously as a debtor to the bank under _the +date of maturity_. + +Whether the general public will make an extensive use of checks is +doubtful. In England the conditions necessary for check transactions +exist, as every one has a banking account, and all payments to be made +or received are effected through the banks. To Germans this seems very +strange; a large part of the public cannot keep a banking account, and +when it is in a position to do so either expects high rates of interest +or keeps no permanent balances and pays no commissions. Under such +circumstances there is no sense, from a business point of view, in the +shoemaker, who has no banking account, accepting a check, which he has +to cash, instead of ready money; for the shoemaker has to take an +unprofitable walk, and the bank has to examine the check, pay and book +it, and in some cases notify by letter the customer of its payment. The +ingenuous idea prevails that by some cabalistic method of procedure the +bank earns something by such transactions that in reality only cause +irksome work. + +The Reichsbank, with a creative and organising spirit, laid the +foundations of the system of payments by means of transfers to, and +deductions from accounts current that obtains in Germany, the so-called +giro system.[185] It was in every way preordained for this creative +work, for at the time of its foundation it was the only financial +institution whose activities extended over the whole Empire, while in +the territorially restricted and immature banking systems of those days +the conditions were lacking for the development either of a giro +business or of a system of payments by means of checks. In the giro +system, with its splendid organisation, the Reichsbank has created an +institution that has given the German system of payments its +characteristic stamp, just as the apparatus of checks and clearing +houses has imparted a typical character to the system of payments in +other countries, like England and the United States. The giro business +in Germany, however, is far from having attained the dimensions that the +use of checks has in England and America. + +The number of long-distance transfers is about double that of the +locals. This is as it should be, as it is mainly in the matter of +long-distance transfers that the giro system has the advantage over the +method of payment by check. In the matter of local transfers, on the +other hand, giro and check are probably about on a level with respect to +the number of transactions. + +To prevent themselves from being ruined by the competition of the +Reichsbank, the private banks of issue[186] have been obliged to offer +various inducements to their customers in the matter of the giro +business. They make no demands in regard to a minimum balance, pay +interest on deposits, do not oblige their customers to domicile bills +drawn on them at the bank, and exact no charge from persons having no +account with them who desire to have sums placed to the account of +depositors (to some extent also making cash payments free to third +parties who are nondepositors for account of depositors). The private +banks of issue sustained a severe blow in 1900 on the occasion of the +renewal of the bank laws through the provision prohibiting them from +discounting bills at a lower rate than the Reichsbank whenever its rate +reaches or exceeds 4 per cent. and not allowing them to go more than +one-fourth of 1 per cent. below the official rate and one-eighth of 1 +per cent. below whatever private rate the Reichsbank may have whenever +the bank rate is below 4 per cent. These trammels imposed upon the +principal business of the banks was bound to affect their giro business +injuriously in spite of the efforts made to counteract the mischief by +the establishment (especially in Württemberg) of many new branches and +agencies. These banks of issue have never had any great importance as +regards the giro business, and even at the present day the volume of +their transactions is relatively insignificant. + +The post-check system supplements in a most effective manner the giro +system of the Reichsbank in that it brings in connection with the five +hundred establishments (more or less) of the Reichsbank about 39,000 +post-offices and post agencies. As all the post stations are included in +the post-check system, the Reichsbank's network of branches is spread +out uniformly in a compact manner over the whole Empire. + +The post-check system, inaugurated January 1, 1909, would more +appropriately be termed the post giro system. For at bottom its purpose +is to become a giro system, a system of monetary transfers by means of +assignments to, and deductions from accounts current. What it is aiming +at is to make it unnecessary for German letter carriers to be lugging +around millions in cash every day. The money sent through the German +post-office in 1907 amounted to no less than 13-1/3 billion marks. The +post-check system has this in common with the giro system of the +Reichsbank that it extends over the whole length and breadth of the +German Empire, while the activity of all other institutions carrying on +a system of giro, as well as check, payments, with the exception of the +union of the Schulze-Delitzsch credit associations, is territorially or +locally restricted. The giro network and that of the post-check system +are connected with each other by certain channels that render it +possible for payments to travel unhindered from the one system over to +the other without the intervention of cash. + + +GENERAL SKETCH OF BANK AND CREDIT ORGANISATION IN GERMANY + +[187]Germany witnessed a tremendous economic expansion during the +twenty-year period 1888-1907. There occurred a considerable increase and +extensive circulation of capital. This movement of capital naturally +passes through the banks and is brought about by them. As collectors and +distributors of capital, the banks are, so to speak, the focal points of +economic life. + +We are here concerned with three kinds of credit institutions--the note +banks (banks of issue), the credit banks, and the land credit +institutions (mortgage banks and land mortgage associations). + + +BANKS OF ISSUE + +The present organisation of the note-bank system is based on the bank +act of March 14, 1875, and the supplement to this act of June 7, 1899. +Even previous to the founding of the German Empire the greater part of +Germany had become united commercially through the formation of the +Customs Union (Zollverein). Similar further movements toward union, +however, had met with but little success in the domain of currency and +with none whatever in that of banking. In the newly founded German +Empire seven different monetary systems were in existence, and as all +German States, with the exception of the free city of Bremen, were on a +silver basis, there was above all a great want of a well regulated and +adequate circulation of gold coin. The prevalence of paper circulation +was felt in the most annoying manner. + +Thirty-two banks had the right to issue notes, and in the absence of +adequate legislation, it was found on many occasions that the notes +issued were not sufficiently secured. + +The first step which the Government took to improve these conditions was +the act of December 4, 1871, concerning the coining of imperial gold +pieces. The coinage act of July 9, 1873, which proclaimed the gold +standard for the Empire, formally completed the organisation of the +German currency system. It was recognised more and more that, in order +to give effect to the gold standard, which for the time being existed +merely on paper, and in order to regulate and supervise the entire +currency circulation, the establishment of a central bank was an +absolute necessity. This consideration finally led to the establishment +of the German Reichsbank, which came into being on January 1, 1876, +absorbing at the same time the Bank of Prussia (note bank). + +The predominance of the Reichsbank over the private note banks was +secured through its considerably larger capital, further through the +volume of its tax-free note contingent, which exceeded considerably the +amount of all the other contingents, and which subsequently was to +increase still more through the accretion of the contingents of the note +banks which might renounce their rights of issue. + + +COMMERCIAL BANKS AND THEIR RELATION TO INDUSTRY AND COMMERCE + +The close relation of the so-called regular banking business to that of +the floating of enterprises, the trading in and the issue of shares is +typical of the organisation of the German credit-bank system. The +development of the railroad system beginning about the middle of the +last century, which caused a considerable demand for and circulation of +capital, and the greater extension of state credit, induced the banks to +turn to the flotation and issue business. + +The period following the founding of the German Empire, as mentioned +before, witnessed a vigorous development of German industry, especially +of the mining and (beginning with the nineties) of the electrical +industries, which required a continuous inflow of new capital. At the +same time German foreign commerce, particularly with oversea countries, +kept on steadily increasing. Under such conditions the economic policy +of the banks of placing the funds entrusted to them at the service of +the new development must be regarded as perfectly proper. The banks +furthered this development by forming stock companies, granting +long-term credit, assuming shares and bonds, placing the new industrials +on the stock market and selling them to the public. There is no doubt +that but for their policy of furthering the industries, the economic +development of Germany would have taken considerably longer than has +been the case. + +In order to obtain the means for granting industrial credit and to +dispose of the enormous amounts of newly created industrial securities, +it was and is necessary to attract in as large a measure as possible the +surplus funds of the community available for capital investments. For +this purpose the joint-stock banks spread a network of deposit branches, +destined to serve as reservoirs for the inflow of available funds, and +at the same time as distributors for the industrial securities created. +With the same end in view the large Berlin banks, either through the +acquisition or exchange of stock (for permanent investment), entered +into friendly alliances with the provincial banks. + +It cannot be said that the banks created our industries, since the funds +which are gathered by the banks in increasing volume are mainly the +result of the increasing productivity of capital invested in industrial +undertakings. It is true, however, that the creative power which in a +comparatively short time placed German industry in its present +commanding position took its origin with the men who put to practical +use and in the interest of economic progress of the nation the +achievements and inventions in the domain of science and technique. It +is the undisputed merit of the persons at the head of the banks that +they appreciated those endeavours and supported them by advancing the +requisite capital, oftentimes incurring great risks for the banks. It is +almost self-evident that the banks, which in carrying out their policy +of furthering industry had often to assume considerable risks, have +tried to secure, and in a large measure have succeeded in securing, a +lasting and decisive control over industrial corporations. + +Until the seventies of the last century the financial regulation of +German foreign oversea trade had been almost exclusively in the hands of +London banks. The establishment in 1870 of the Deutsche Bank at Berlin +meant a turning point in this regard. The founders of the Deutsche Bank +had recognised that there existed in the organisation of the German +banking and credit system a gap which had to be filled in order to +render German foreign trade independent of the English intermediary, and +to secure for German commerce a firm position in the international +market. It was rather difficult to carry out this programme during the +early years, the more so, because Germany at that time had no gold +standard and bills of exchange made out in various kinds of currency +were neither known nor liked in the international market. The +introduction of the gold standard in Germany in 1873 did away with these +difficulties, and by establishing branches at the central points of +German oversea trade (Bremen and Hamburg) and by opening an agency in +London the Deutsche Bank succeeded in vigorously furthering its +programme. Very much later the other Berlin joint-stock banks, +especially the Disconto Gesellschaft and the Dresdner Bank, followed the +example of the Deutsche Bank, and during the last years particularly the +Berlin joint-stock banks have shown great energy in extending the sphere +of their interests abroad. + +Among the customers of the joint-stock credit banks figure chiefly +members of the commercial and industrial classes, who obtain from these +banks both their long- and short-term credit, and in the second place +holders of medium-sized and large agricultural property, who apply to +them for short-term "operation" credit. The credit demands of the +members of the small-farm class and of the small independent producers +are generally met by the co-operative credit societies. + + +LAND CREDIT INSTITUTIONS + +As regards the credit on landed property there is hardly a country with +an organisation as perfect as Germany. The beginning of this +organisation dates back about one hundred and thirty years. The Prussian +State had emerged from the storms of the Seven Years' War (1756-1763) as +a recognised European power, but the sacrifices of the years of war had +completely exhausted the country. + +As the landed nobility was then the principal support of the State and +was so regarded by the Government, it became a matter of public +interest to relieve the financial distress of the landed proprietors by +enabling them to pay off systematically their mortgage debts. + +The efforts in this direction, in which the Prussian King, Frederick the +Great, personally took an active part, led to the creation of the +land-mortgage associations (_Landschaften_), which must be considered +the first important step toward the organisation of land credit. + +"Landschaften" are associations endowed with the rights of a corporation +and operating under state control. Their boards of directors have the +attributes of official authority. They are autonomous institutions +within the limits set by the state supervision. + +The Landschaften obtain the funds for the granting of credit through the +issues of letters of mortgage or mortgage bonds--_i. e._, as a rule, the +borrowers receive the loan in the shape of mortgage bonds of the +association, and it is left to them to negotiate these bonds on the +stock exchange. At first the letters of mortgage were made out on a +certain estate (estate debentures). But as the purchaser of such letters +of mortgage was forced to keep watch over the condition and management +of the mortgaged estate--even though the association itself maintained +permanent control of the debtor--the sphere of circulation and the ease +with which these bonds could be sold were naturally limited. + +It was only when the issue of corporate mortgage bonds was started, the +security of which was guaranteed either by the entire mortgage claims of +the association or the collective responsibility of their members, and +when these bonds were given a large market through their admission to +exchange transactions, that the highest degree of mobility was reached. + +It was mainly to meet the needs of credit on urban real estate that +mortgage banks (_Hypothekenbanken_) were created, and thus a special +organisation of city real estate credit was formed. The greater number +of the mortgage banks now in existence was founded during the decade +1862 to 1872; practically all the others were founded during the +building boom of 1894-1896. Most of the mortgage banks cater +exclusively to the demand for real estate credit; some others combine +this specialty with other lines of banking. + +While the land-mortgage associations are based on the principle of +co-operation and do not pursue a profit-making policy, the mortgage +banks have been founded as joint-stock companies. The capital stock +serves as working capital as well as guaranty fund. + +Bonds are issued against acquired mortgages and secured by the latter. +Almost all these banks issue their bonds to bearer, a privilege granted +them by the State. Inasmuch as the bonds are held in many cases by small +investors, the State, in order to protect the interests of these +bondholders, from the very beginning secured to itself the right of +control, limiting at the same time the field of operation of these banks +by certain legal enactments and regulations. + +On the whole, interest rates on mortgage loans are subject to but slight +variations. It should be remarked, however, that the borrower when +obtaining a mortgage loan has to pay a bonus the rate of which will be +considerably higher in times when money is scarce than in times when its +supply is redundant. + +In times of a large increase in the supply of bonds the mortgage banks +may go into the market to buy their own bonds. Such action prevents +serious fluctuations in the quotations of these securities and fits them +to be objects of permanent as well as temporary investments, including +the investment of funds which must be kept in liquid shape. + +In the present day when complaints are urged against the great +indebtedness of country landowners, the fact must not be lost sight of +that the transition from extensive to intensive operations in +agriculture could not have been accomplished without a wide use of +mortgage credit, and that such development was necessary to feed the +rapidly increasing population of the country. Moreover, through this +great growth in the population a basis was created for industrial +activity on a large scale. + + +RAIFFEISEN AND SCHULZE-DELITZSCH BANKS + +[188]The Raiffeisen bank is the Schulze-Delitzsch bank applied to the +country, with the variations required and justified by the difference of +environment. + +The model rules of the Raiffeisen societies state that: "the object of +the society is to improve the situation of its members both materially +and morally, to take the necessary steps for the same, to obtain through +the common guarantee the necessary capital for granting loans to members +for the development of their business and their household, and to bring +idle capital into productive use, for which purpose a savings bank will +be attached to the society." One word in the above, viz., "morally," +intimates at the outset a distinctive trait. Raiffeisen always kept the +moral aspect very prominently before him. He insisted that all the +members of his institutions should profess the Christian virtues. In his +propaganda he used to the full the one intelligent power in rural +districts, the parish priest or pastor. With their help he developed a +new parochial life around the village bank. With their help he touched +in the peasant the chord of neighbourly affection and stirred him to +give it practical effect. + +What is the structure of a Raiffeisen bank? and, first of all, whence +comes the working capital? + +The subscribed capital of the bank is practically nil; there is nothing +but the universal unlimited liability of the associating members. +Schulze-Delitzsch, dealing with industrialists subject to unseen risks, +who operated in trade matters out of sight and control of the society, +obliged his associates to subscribe a considerable share capital, not +only as a proof of thrift, but as a material guarantee for their +individual and corporate debts. Raiffeisen, dealing with agriculturists +and villagers, demanded no such security, since each member possessed in +his little farm, his cattle or implements, material guarantee far beyond +those of any subscribed share. In addition he avoided the danger to +which a share bank is always exposed, namely, that the concern may be +run for the benefit of a few non-borrowing shareholders, rather than +for that of the general credit-seeking members. + +Unfortunately this natural difference was elevated, or rather dragged +down, into an issue of principle; and the law of 1889, drawn up under +the guidance of the Schulze-Delitzsch party, insisted that every +co-operative society should have shares. The Raiffeisen societies comply +with this by nominal shares of (say) 10 marks[189] on which no dividend +is declared; though, occasionally, some of the annual profit is +indirectly returned to individuals in the shape of a slight addition to +deposit rates and a slight deduction from loan charges, calculated at +the end of the year. + +Because Raiffeisen wished to create credit among small agriculturists +out of the immaterial asset of mutual knowledge, he limited the size of +each society to a single village. For his purpose he was right, but his +partisans are not right when they look askance at the larger areas of +the town bank, where the nature of the members' business and the +society's control is different. + +All profits remain the collective property of the society, to be used +for the society's good. They are divided into two classes of reserve +fund--(1) reserve fund proper; (2) foundation fund. The former is +regulated in the same way as in town banks. The second corresponds to +the shareholders' dividend. It is undesirable to have nothing beyond an +ordinary reserve fund, because money thus placed can only be withdrawn +to cover losses: while if placed in the foundation fund it can be used +for positive improvements, such as the extension of premises or the +establishment of a burial fund. In actual figures, the reserve funds are +not so strong as in the town bank, owing in part to the lower loan +charges. + +The loan capital, as in the town banks, is made up of small savings and +deposits. It is drawn, either from within the area covered by the bank, +in which case it comes both from members and non-members, the former +being where possible rewarded at slightly higher rates in order to +encourage membership; or from without the area, in which case it of +necessity comes from non-members. Savings are received in sums from one +mark upwards: the smaller amounts being collected by penny stamp books, +similar to those used in the Post Office Savings banks of England. The +willingness with which the peasants bring their savings to the bank is a +triumphant proof of Raiffeisen's contention that the small +agriculturists by a combination of unlimited liability and close +supervision can become absolutely credit-worthy. No savings since the +foundation of the first village bank have ever been lost through +bankruptcy. + +In addition the bank obtains credit from a central bank with which it +has a current account. + +The funds thus raised are utilised for three kinds of credit--(1) Simple +loans; (2) current accounts; (3) property transfers. + +Current accounts are rare except in villages where there is a little +industry. With regard to the simple loan, the security, as in town +banks, is personal pledge, land mortgage, or (very rarely) deposit of +collateral. The personal pledge, as with Schulze-Delitzsch, is the most +frequent. But Raiffeisen interpreted it more strictly than +Schulze-Delitzsch. Not only must the credit-seeker produce an outside +testimony to his character: he must also convince his society that he +really merits this testimony. The member of the Schulze-Delitzsch bank +is accepted on the strength of his general business reputation, added to +his security, personal or material. The member of the Raiffeisen bank, +though he have the best of pledges, is rejected unless he is known in +his private life to be virtuous and industrious. The man of doubtful +sobriety has no chance of obtaining anything from a country bank. + +If it happen that an applicant is little known or new in the district, +so that no one will go pledge for him, then the society, provided it is +convinced of his good character, will grant a loan against land +mortgage. This is not to be confused with the real credit granted by a +land bank, where the value of the estate alone is considered. It is +personal credit with a material caution, and it is not a long-term loan. + +Furthermore, the society requires to know not only the character of the +borrower, but also the specific object for which his loan is destined. +It must be satisfied not only that the borrower wishes to employ the +loan in his business, but also that the operation proposed is likely to +turn out successful. + +Property transfers are not strictly credit business. They are in the +nature of investments for superfluous money, just as a town bank might +invest in railway shares, with the difference that the investment is +local and designed to meet indirectly the credit wants of members. The +nature of the operation is as follows: A dies, leaving his estate to his +heirs; and these, perhaps because they wish to leave the neighbourhood +or because they want ready money for other reasons, put up the estate +for sale in allotments. Or perhaps A during his lifetime wishes to get +rid of a part of his estate. X, Y, Z, neighbouring peasants, are buyers, +but they can pay only gradually--which they are allowed to do by law. +The credit bank steps in as intermediary. It pays to the heirs of A or +to A himself, as the case may be, the price of the estate minus a small +commission. X, Y, Z become the debtors of the credit society, paying off +their debt by regular instalments, which include principal and interest. +The bank cuts out small traffickers in land, usually Jews, to the +benefit of sellers and buyers. It benefits the sellers by charging them +a moderate instead of an extravagant commission: the buyers by saving +them from permanent relationship with land dealers who seek their ruin. +The bank insists on regular payment of the instalments, because it wants +its money back, while the dealer is constantly tempting the buyers to +fall into arrears in order that he may eventually acquire the land +himself. + +There is a second form of property transfer, where the bank not only +acts as intermediary but itself holds the estate for a time. Some land +dealer, having obtained a mortgage on the estate of A, demands payment. +A cannot pay and is forced to sell his estate by public auction. The +dealer forces the sale, just when the estate market is likely to be most +unfavourable, hoping to buy the estate for himself at an absurdly low +rate. Thereupon the bank steps in; it bids against the dealer, and if he +does not offer a good price, buys the estate itself and resells it later +in the year, when the market is more favourable. In this way A can pay +off his debts at once. Moreover, the bank does not keep the difference +between the price of purchase and final resale. After the deduction of +a moderate commission, it is handed over to A, who thus obtains a +further sum with which he can make a fresh start. + +These dealings in property transfers are confined to Southwest Germany, +where estates are sold to be split up into little lots. The banks only +enter on these transactions where the following conditions are +satisfied--(a) where they have a superfluity of money over and above +that needed in their ordinary loan business; (b) where some party to the +transaction is a member of the society: either the seller or the buyer +or the creditors of the seller holding second and third mortgages, who +would obtain nothing were the estate sold below its real value. + +What is the nature of the machinery by which this work is conducted? A +Raiffeisen bank is never what a Schulze-Delitzsch bank sometimes is; a +handsome building with barred windows, within which are a number of +clerks discharging a constant round of business, while the directors +interview special clients in a room apart. It is a small single room, +probably at the back of a farm building, opened twice a week and +presided over by a single occupant--the accountant. Business is apt to +proceed desultorily; a small child brings in a few savings; an hour +afterwards a palsied old man, signing by a cross, draws out a couple of +pounds, and so on to the end of the day. But this is the unimportant +part of the business. The really important part is the weekly meeting of +the directors, half a dozen in number, who meet to discuss the various +credit claims which have arisen. They are unpaid, as by the nature of +their work they can afford to be. The accountant, their executive clerk +who keeps the books, "the soul of the society," as Raiffeisen called +him, is the only salaried official. The committee of supervision and the +general assembly function as in the town banks; except that their +control is more decided, probably because their knowledge is more on a +level with that of the directorate, which is itself unspecialised. + +What are the results achieved by the rural bank, thus operating and thus +controlled? + +More than ten times the number of country banks grant only one-sixth of +the credit afforded by the town banks. The total membership of the +country banks is nearly twice as large, but the average membership per +bank is nearly seven times as small. + +The average credit advanced per member is 500 marks. The average rate of +interest is not exactly known; it appears to be between 4 and 5 per +cent., _i. e._, nearly 1 per cent. cheaper than in the town bank. The +duration of loans varies between one and ten years in accordance with +the requirements of agriculture. They are repayable in small +instalments, covering principal and interest, although the member may +repay in lump if he wishes. The loan can always be called on four weeks' +notice, but the right is never exercised, unless the borrower is +allowing his property to deteriorate or is becoming insolvent through +extravagance or has misapplied money lent for a particular purpose. The +inculcation of punctuality in payment, as a moral duty, was the hardest +of Raiffeisen's tasks, as it was his greatest triumph. + +If it be asked finally what Raiffeisen banks have done, which other +banks have not, it may be replied that Raiffeisen created out of +hopeless chaos the only kind of credit organisation possible for the +small agriculturist. Industry necessarily brings business men together +to some extent. Agriculture in itself holds the farmer apart, and +preserves him in lonely ignorance to be the victim of the perambulating +money-lender. To-day more than 50 per cent. of the independent +agriculturists of Germany are members of rural banks; and another 10 per +cent., chiefly the larger farmers, are members of town banks. The +non-co-operative agriculturist is becoming the exception. The Raiffeisen +banks are thickest in the southwest of Germany, the home of the small +peasant proprietors. Indeed the change wrought in many of these villages +is nothing short of a revolution. The experience of the parent village +bank may serve in illustration: + +"About an hour's walk from Neuwied on the Rhine is situated on a plateau +bordering the Westerwald the little village of Anhausen. The district is +not very fertile and the inhabitants are mostly small peasant +proprietors, some with only sufficient land to graze a single ox or cow. +An owner of ten acres is a rich man. Before the year 1862 the village +presented a sorry aspect; rickety buildings, untidy yards, in rainy +weather running with filth; the inhabitants themselves ragged and +immoral; drunkenness and quarrelling universal. Houses and oxen belonged +with few exceptions to Jewish dealers. Agricultural implements were +scanty and dilapidated; and badly-worked fields brought in poor returns. +The villagers had lost confidence and hope, they were the serfs of +dealers and usurers. To-day Anhausen is a clean and friendly-looking +village, the buildings well kept, the farmyards clean even on work days. +The inhabitants are well if simply clothed, and their manners are +reputable. They own the cattle in their stalls. They are out of debt to +dealers and usurers. Modern implements are used by nearly every farmer, +the value of the farms has risen and the fields, carefully and +thoroughly cultivated, yield large crops." And this change, which is +something more than statistics can express, is the work of a simple +Raiffeisen bank. + +Both town and country banks are formed into higher unions for general +organisation and educational propaganda; the country banks also unite +for credit business. + +The partisans of the town banks are apt to pride themselves on their +complete self-sufficiency. They forget that this is possible for them, +not because they have sufficient funds in their own coffers to supply +every credit need, but because an increasing part of their business is +conducted through the trade bill of exchange, which is a marketable +commodity that can be rediscounted by any outside bank, the Imperial +Bank, the Dresdner Bank or any other. But agricultural societies, +inasmuch as their loan papers cannot readily be bought and sold on the +open market, require a special organisation. Hence central organisations +act as money equalisers between the different societies. In some +districts money is superabundant, in others it is deficient. The central +bank acts as a channel through which the abundance of one district can +be drawn to supply the scarcity of another, the operations being +conducted by means of current accounts with both parties. In Germany as +a whole the societies of small agriculturists of the Southwest have +always an abundance of money, which is one reason why they dispense so +much of their funds in the purchase of property transfers. The societies +of large agriculturists in the Northeast (the Ost-Elbien Provinces), +where the capital employed on each farm is large and the population +thin, are as a whole in continual want of it. + + +INTERVIEW WITH HERR KLEEMANN, DIRECTOR OF THE DRESDNER BANK + +[190]Q. When were the first of your co-operative societies organised? + +A. In 1848. They were organised on a voluntary basis and for +philanthropic purposes. They developed very rapidly. The first form +which developed was for the purchase of means of subsistence, such as +sugar, coffee, grain, wine, cigars, etc. Then they bought agricultural +machinery, threshing machines, etc., which they would rent to small +farmers in the country who could not purchase such machinery. They also +formed societies to build houses for peasants and working people. There +might be six or seven with different purposes. Later on +Schulze-Delitzsch came to the conclusion that it would serve working +people and small tradesmen to have co-operative societies founded simply +for the purpose of extending credit to them. That was the last +development in the system. + +Q. How many kinds of co-operative societies are there in Germany? + +A. It is very difficult to classify them. The Raiffeisen societies are +confined to Prussia. There are other organisations in Saxony, Bavaria, +and different States in Germany. + +Q. The attitude of the Reichsbank is the same toward them as toward any +other bank? + +A. Yes; and their bills are frequently offered and taken by the +Reichsbank as from other institutions. + +Q. Do they carry their reserve with the Reichsbank or with the Dresdner +Bank? + +A. Principally with the Dresdner Bank, because they get interest upon +it. + +Q. Do they pay interest on deposits? + +A. They pay an average of 4 per cent., which may be considered as an +almost permanent rate. The money they get is in most cases money for a +long period. They have to compete with the savings banks. + +Q. Are the small societies at all in competition with the Reichsbank, +where they have a branch? + +A. No. There is no competition. They do a business which the Reichsbank +would not do. They give credit to people who would not suit the +Reichsbank, because they could not give the guarantee. + + +THE REICHSBANK + +INTERVIEWS WITH HERR DR. VON GLASENAPP, VICE-PRESIDENT, AND HERR DR. VON +LUMM, DIRECTOR, OF THE REICHSBANK[191] + +Q. By whom are the shares of the Reichsbank owned? + +A. It is all private ownership. The shares are held mostly in Germany +and Holland, and distributed in small lots. + +Q. Would the bank discount a bill drawn by one merchant and accepted by +another? + +A. Yes. The Reichsbank is not only a bank for banks, but for the +commercial and industrial enterprises of the Empire. + +Q. If a railroad finds it necessary to make improvements and wants to +borrow money could they get money at the Reichsbank? + +A. Only on collateral acceptable by the Reichsbank. The railroad would +probably in such a case go to private banks to be financed. + +Q. Assume that there is a manufacturer in Bremen, making well-known +articles, which he ships to a merchant in Berlin and draws a bill +against that merchant, would it be a satisfactory bill to the +Reichsbank? + +A. Yes; but in that instance also the merchant would probably go to the +private bank, where he would get a better rate of discount. + +Q. If there were a severe money stringency, would he still go to his +bank? + +A. Yes; that would probably be the case, and his bank might afterwards +take his bills to the Reichsbank. + +Q. What is the smallest bill the bank will discount? + +A. We have no minimum. We discount bills as low as 10 marks. + +Q. Upon what kind of a bill does the farmer secure an advance from the +bank? + +A. He sells his produce, draws a bill upon the purchaser, and takes the +bill to the bank as any other man would do, or a bill might be drawn +upon a farmer and accepted by him. + +Q. When he borrows money in the spring with which to buy seeds, how does +he secure the cash? + +A. He goes to his own bank for that. There are co-operative societies +for this purpose, which are a great factor in Germany. + +Q. Will the manager of a branch of the Reichsbank renew a farmer's three +months' bill if desired? + +A. Yes; an exception is made for the farmer. Other bills are not +renewed. + +Q. The bank rate is 4 per cent. Does that mean 4 per cent. is charged on +three months' bills? + +A. The Reichsbank has only one rate of discount. There was a time when +the Reichsbank did a similar business to that which the Bank of England +does now, _i. e._, that they would purchase in the market prime bills at +a more favourable rate, but in 1896 it was decided to have but one rate +for everybody. + +Q. Please state the reason for the change of policy. + +A. The most important reason was that it was thought that a great +central institution like the Reichsbank, with its tasks and duties to +the whole of the community, ought not to make a distinction of any +class, or make an exception in favour of any one. It is the policy of +the bank to serve all alike. + +Q. Is the Reichsbank disposed to favour every application for discount +or loans if the character of the offering be satisfactory? + +A. It is their duty to listen to every one who comes for accommodation, +whether he has an account or not. The principle of the Reichsbank is not +to serve a part of the community, but the whole. The Reichsbank is for +everybody. + +Q. Are your deposits subject to check? + +A. The money is drawn against check. There are two kinds of check--white +and pink. The white is for withdrawing cash over the counter, the pink +for making transfers. + +Q. Have you different classes of deposits? + +A. No. + +Q. Do you pay interest on your deposits? + +A. The Reichsbank does not pay interest on money deposited with it. It +receives money on deposit and for transfer. Most large houses keep an +account with the Reichsbank. The Reichsbank does a large transfer +business for them. + +Q. Is it the custom for banks in Berlin and other important centres to +carry balances in the Reichsbank as a part of their reserve? + +A. It is the custom for the banks to keep a large part of their cash +with the Reichsbank. They keep only a small amount of cash in their +tills. + +Q. Is that true of banks in other cities than Berlin? + +A. Yes. + +Q. Does the Reichsbank pay the same taxes that the other banks do? For +instance, income tax and other taxes? + +A. No; we are free from the government income tax, and the license fees, +but we must pay the real-estate tax. + +Q. What is the relation between this bank and other banks, such as the +Deutsche and the Dresdner--that is, as to the character of business +transacted? Are you not competitors? + +A. It may be said that the Reichsbank is more restricted by law. At a +private bank the rate of discount may be much cheaper than at the +Reichsbank. The private banker knows his clients, and he may be willing +to accept from them a bill that the Reichsbank would not and could not +accept. + +Q. Then there is to some extent competition? + +A. Yes; but that competition is not large. It is not felt that the +Reichsbank is a competitor of other banks, but it is a public +institution. The Reichsbank has its official rate, which is higher than +the private rate. A bank will take bills on its own account running +three months or more and hold them, and in case of need will take bills +running ten days or less to the Reichsbank for discount. The Reichsbank +pays no interest and acts as agent for transfer of currency and credit +to all parts of the Empire without charge. + +Q. Has there been any feeling that your branches were supplanting the +private local banks in small towns? + +A. There may have been some instances where a banker may have been +dissatisfied at the Reichsbank opening a branch in his locality, but as +a rule the banks at such a place are quite pleased to have the +Reichsbank open a branch in order that they may have the benefits of its +facilities. + +Q. The government deposits are received and treated exactly the same as +the deposits of farmers? + +A. Yes. The business for the Government and its departments is handled +the same as for others, and no interest is paid on deposits. There is, +however, one exception; every private institution is required to keep a +minimum balance to its credit, but not so with the departments of the +Government. The Empire keeps in the aggregate sufficient to compensate. + +Q. Do you always charge a higher rate of discount for bills when you +have a large amount of taxed notes outstanding? + +A. No. On occasions the Reichsbank has not increased its rate of +discount above 5 per cent. At times we have discounted even at 3 per +cent., when we have had to pay a tax of 5 per cent. + +Q. It has been suggested to us as a matter of policy in times of stress +that it would be better for you to add the 5 per cent. tax to the rate +of discount. + +A. The Reichsbank must be considered in the first place as a public +institution which has to take care of the public interest, and +secondarily as a money-making institution. + +Q. Is there any restriction as to the percentage of silver in your +reserve? + +A. No; but there is another law, the coinage act, by which the amount of +silver coined depends upon the population. They do not coin more than 20 +marks per capita. + +Q. What steps do you take to increase your gold reserve or to protect +it? + +A. We always have a large amount of bills of exchange payable in foreign +countries, payable in gold. We also increase the rate of discount. We +consider that the latter measure is the only effective one. We also make +advances without interest to importers for the time the gold is in +transit; we do that even in times when the ordinary gold import point is +not reached. Then we may raise our tariff for the purchase of foreign +gold coins, as the Bank of England does. + +Q. Do you take any steps to prevent exports of gold? We have been told +that it is the habit of the Reichsbank, in case of large exports of gold +from Germany, to suggest to the other banks that it is not agreeable to +have the gold exported. + +A. It has never been the case and never will be the case that any such +suggestion has been made by the Reichsbank to anybody. + + +KÖNIGLICHE SEEHANDLUNG + +(ROYAL SEA-TRADE SOCIETY) + +INTERVIEW WITH HERR GEH. OBERFINANZRAT LOTTNER, DIRECTOR OF THE ROYAL +SEEHANDLUNG, PRUSSIAN STATE BANK[192] + +Q. When was this bank organised? + +A. In 1772. + +Q. What is the capital of the bank? + +A. One hundred million marks. + +Q. By whom are the shares owned? + +A. There are no shares; the capital is owned by the bank, which may be +regarded as a juristic person, an independent legal subject. + +Q. Who invested the money? + +A. The money was originally invested by stockholders in the time of +Frederick II, but afterwards the shareholders gave up their stock, for +which they were paid. The shares were mostly owned by the King and by +his associates, and they handed them over to the bank, so the capital is +really owned by the bank itself. The proceeds in excess of all the +expenses are paid to the Prussian State. + +Q. Who is responsible for the conduct of the business? + +A. The president. + +Q. Has he associated with him directors? + +A. No; he is personally responsible. + +Q. By whom is the president appointed? + +A. By the King of Prussia for life. + +Q. What are the particular functions of the bank? + +A. In the first place, it is an organisation to help the State of +Prussia. The principal part of the business is to finance the loans of +the State. It may undertake the loans alone, but as a rule it heads a +syndicate of the large banks. + +Q. Do you compete for deposits from merchants, manufacturing concerns, +banks, etc., with the Deutsche Bank or the Dresdner Bank? + +A. Yes, to some extent. It is not our intention to do so, but of course +we practically compete in some ways. Our rates on deposits are less +favorable than those of these banks. + +Q. Do you take real estate mortgages? + +A. No. + +Q. You are known as the sea-trade (Seehandlung) society. Why is that? + +A. Frederick the Great founded the Seehandlung to promote Prussian +trade, especially the oversea trade. At one time this company had a salt +monopoly and a wax monopoly. The salt which came into the different +ports of Prussia and the wax which came from Poland were bought up by +the Seehandlung. At one time the Seehandlung also had mills, spinning +and weaving plants, iron foundries, and river steamers. We still own two +industrial establishments, the flour mills in Bromberg and a linen +spinnery in Landeshut in Silesia. + +Q. A large percentage of your funds is loaned on the stock exchange? + +A. Yes. + +Q. And your discount business is comparatively insignificant? + +A. Not insignificant, but small compared with our loans on the stock +exchange. + +Q. Do you receive promissory notes from customers? + +A. No. + +Q. Do you transact business of any other character than that heretofore +mentioned? + +A. We have a branch known as the Royal Loan Office, which lends money in +small amounts upon the pledge of different kinds of goods as security. +This was established in 1834. In 1906 we made 99,000 loans upon watches, +jewels, clothing, etc., at an average of 31 marks per loan. Two-thirds +of the borrowers are labourers; last year about 16 per cent. were widows +and spinsters, also a few were mechanics--occasionally professional +men--artists, actors, and the like. Our rate is very low, 12 per cent. +for the year, which is low compared with the ordinary pawnshops. No +other banks conduct a business of this class. + + +DEUTSCHE BANK + +INTERVIEWS WITH HERR PAUL MANKIEWITZ, DIRECTOR, AND HERR A. BLINZIG, +ALTERNATE, OF THE DEUTSCHE BANK[193] + +Q. When was your bank organised? + +A. In the year 1870. + +Q. How is your stock owned? + +A. By a large number of shareholders. Our shareholders are principally +in Germany, but also in England, France, Austria, and elsewhere. + +Q. What does the item "Shares in other banks," $19,000,000, represent? + +A. This represents the purchase by us of practically the controlling +interest in 13 independent banks in the Empire. We are represented upon +each board and we are kept closely informed of the business. Our return +is in the dividends. + +Q. A large percentage of the stock exchange business is really handled +through the incorporated banks, is it not? + +A. Yes. We ourselves have fifty members on the stock exchange. + +Q. You mean that the Deutsche Bank has fifty men, members of the stock +exchange, who trade there on the floor? + +A. Yes. There is quite a difference, however, in our method of handling +the business from that followed in New York. We do not have the margin +system. Most of our customers who do not pay in full pay at least for +half the amount involved in the purchase. + +Q. Are the clearing-house associations important factors in the cities +in Germany? + +A. No. They are not associations of importance or power, but merely +pieces of machinery through which cheques are cleared. + +Q. You all go to the Reichsbank to clear? + +A. Yes; once a day. There are 14 clearing houses and 160 members in the +Empire. + +Q. What taxes do you have to pay? + +A. We pay to the State 4 per cent. on our income remaining after +deduction of 3-1/2 per cent. of our share capital, which is exempt, and +to the city of Berlin 4 per cent. on our income. All banks pay on the +same basis. + +Q. Is there a limit to the amount of discretion given to the branch +directors on first-class bills? + +A. Each of the main branches has a fixed capital arbitrarily set aside +by the Deutsche Bank. They have a sum according to the importance of the +branch, and they must do business according to it. + +Q. The Reichsbank has branches everywhere? + +A. Yes; in every place where there is sufficient business. It has about +500 branches. We transferred through the Reichsbank last year +21,000,000,000 marks. Our strength is the Reichsbank. Our branch in +Bremen, for instance, wants money when cotton shipments start, and the +money is transferred to them. The importers in Bremen sell the cotton to +the large manufacturers. When they get the money the money comes back to +us. + +Q. In London the joint-stock banks usually pay interest at about 1-1/2 +per cent. below the bank rate. In the country they have to pay more. +What is the custom here? + +A. There is no strict rule. The bank rate is now 4 per cent. and we +allow 1-1/2 per cent. on call money. In the interior our branches allow +a little more. It is the same as in England. + +Q. Does the bank rate influence your rate for discounts? + +A. Yes; we are influenced. The bank rate is now 4 per cent. and our +private discount rate is 2-1/2 per cent. + +Q. If a mercantile customer came with a four months' bill satisfactory +in character, what would be the rate to him? + +A. We have no fixed rate. It depends upon the man and the bill. + +Q. How do you invest your surplus funds when you have no demand from +customers? + +A. We buy bills in the open market, or accept offerings made to us from +houses desiring to borrow. + + +DRESDNER BANK + +INTERVIEWS WITH HERR SCHUSTER AND HERR NATHAN, DIRECTORS OF THE DRESDNER +BANK[194] + +Q. What is the date of your organisation? + +A. 1872. + +Q. In practice, you and all other banks endeavour to fully employ all +available funds? + +A. Yes; we only carry in the Reichsbank and other banks sufficient cash +for the conduct of business. + +Q. You regard your item "Bills discounted" as one of practical reserve? + +A. Yes; it is immediately convertible into cash at the Reichsbank. + +Q. Referring to the item "Shares in other banks," $6,662,753, do you +control all banks in which you have any interest? + +A. Yes; practically. We probably have not the majority of the stock in +any bank; but our holdings are sufficiently large to give us control. + +Q. Is the tendency toward bank consolidation? Are the smaller banks +becoming more closely affiliated with the larger banks? + +A. Yes; because it serves a mutual advantage. The smaller bank needs +better facilities to take care of the increasing business. If a bank +wants to increase its capital, and the shareholders do not care to +subscribe for the increase, the new shares are frequently offered to us. +We look out for the business of these banks in the centres and give them +participations in some of our important undertakings. + +Q. In Great Britain we found that banking interests were practically +controlled by from 15 to 20 large banks. Does that condition prevail in +Germany? + +A. No; but the tendency is in that direction. One difference between the +banks of England and Germany is this--in England the primary purpose of +the banks seems to be to secure large earnings for their shareholders. +In Germany our banks are largely responsible for the development in the +Empire, having fostered and built up its industries. + +Q. Would it be any reflection upon a bank if it should go to the +Reichsbank for discounts or loans in easy times? + +A. No; we seldom go in easy times, however, because there is no need of +our doing so. + +Q. Is there strong competition between the important banks of Berlin or +do they work more or less together? + +A. Of course there is strong competition between the large, important +banks, but there is no lack of harmony, and they very frequently work +together in syndicate operations. While it is the desire and endeavour +of each bank to build up its business, it must be recognised that each +institution has more or less its own field of operation, which is in a +measure respected by the other banks. As, for instance, the Deutsche +Bank has done a very large volume of business with Turkey, and business +emanating from that source is expected to and naturally does go to the +Deutsche Bank, while another institution may have been largely +identified with Roumania, or another with some large local interest. We +ourselves are recognised as representing the Krupp interest and have +just recently formed a syndicate to finance one of their operations. + +Q. Our understanding is that a merchant, a customer of yours, may +arrange with you for a credit of, say, 100,000 marks, which may or may +not be secured, and may draw a ninety-day bill upon you for that amount. +He may send that bill to the Deutsche Bank for discount. If the Deutsche +Bank will discount it, they present it to you and you accept it. Will +you kindly state why this custom prevails? + +A. One reason is that it makes a bill which is acceptable at the +Reichsbank and is a prime bill. We receive one-fourth of 1 per cent., or +more, for our acceptance, and the Deutsche Bank, or any other bank +discounting, invests its money at a rate for the period. It might be +that we would prefer to give our customers a cash credit rather than to +accept his bill, in which event we would so arrange. + +Q. Then this practically enables you to sell your credit without using +your cash? + +A. Yes. + +Q. We understand this is the usual custom in Germany. + +A. Yes. + +Q. Is it not a fact that in the last analysis the customer who uses the +money usually pays more than the bank rate--that is, would it not cost +him, in such a transaction to-day, say 5 or 6 per cent., while the bank +rate is 4 per cent.? + +A. Yes. + +Q. Is it your endeavour to reach the small country towns? + +A. No. + +Q. In the United States we have brokers who handle commercial paper, and +many of the banks purchase it to employ their surplus funds. In London +we found discount houses whose sole business was to handle paper for +sale to banks to employ their surplus funds. What corresponds to that +agency in Berlin? + +A. In Berlin there are two brokers who handle prime bills, but they are +not an important factor. + +Q. How do you employ your surplus funds? + +A. We buy bills in the market or through these brokers. + +Q. In employing your surplus funds do you buy any other bills than those +which the Reichsbank would accept? + +A. No. + +Q. Would you consider the issue of taxed notes by the Reichsbank in a +sense an evidence of an abnormal condition? + +A. No: on the contrary, it is quite normal. Last year it happened +twenty-five times. + +Q. In times of trouble do the large banks, like your own, the Deutsche +Bank, and Disconto, co-operate with the Reichsbank in an endeavour to +prevent the exportation of gold? + +A. Yes. Opinions are divided as to whether it is for the good of our +country to do so or not. Last year, for instance, many people asked for +gold. It was refused at first in some quarters; later we shipped freely. + +Q. Are you members of the stock exchange? + +A. All banks and bankers are members of the stock exchange. + +Q. By virtue of their being banks? + +A. Yes; they have to pay a tax for the exchange. + +Q. Are the seats expensive? + +A. No. You do not buy a seat. There is no limit to the number of people +admitted. We have from twenty to thirty people go to execute our orders. + + +BANK DES BERLINER KASSEN-VEREINS + +INTERVIEW WITH HERR HOPPENSTEDT[195] + +Q. When was this bank organised? + +A. In 1823, under the general companies act. + +Q. What are its particular functions? + +A. This bank might be called strictly a clearing bank. It clears +transactions made on the stock exchange and also cheques on banks which +do not clear through the Reichsbank Clearing House. As you know, our +banks do a large stock exchange business. It is their custom to send to +us all securities sold to others clearing through us with a list of the +purchasers. We charge the purchasers the amounts due from them and +credit the amounts received from them, balancing every night. The +securities are delivered to the various purchasers. _Some settlements +are made daily and others monthly._ A large volume of cheques and bills +are also cleared. This is simply a clearing business. + +Q. You show loans and discounts in your statement. What is the character +of these? + +A. We invest our funds in first-class loans and prime bills. + +Q. Is this bank owned by the other banks? + +A. It is partly owned by other banks. There is also a commission of +shareholders of the bank, among whom are the first banks of our city. +These are members of our board. + +Q. Is it the custom for all banks which clear through you to have a +balance in order to facilitate the payment of debits through clearing? + +A. Yes. + +FOOTNOTES: + +[184] Adapted from Geh. Oberfinanzrat Waldemar Mueller, _The +Organization of Credit and Banking Arrangements in Germany_; Max Wittner +and Siegfried Wolff, _The Method of Payment by means of Bank-Account +Transfers and the Use of Checks in Germany_. Publications of the +National Monetary Commission, Senate Document No. 508, 61st Congress, +_2nd Session_, pp. 117-271. + +[185] In order to facilitate its giro business and reduce the friction +to a minimum, the Reichsbank has special printed forms prepared for the +various kinds of transactions, the use of which is made compulsory on +the public. For a simple transfer of money from one customer to another, +whether they be in the same town or in different places, the "red check" +is employed, which is filled out by the party making the transfer and +handed in to the bank. It is not a check in the proper sense of the +term, but is so called because the printed forms resemble checks and are +put up in books in the same way as checks. The word "check" does not +occur in the printed matter of the blank; neither is the instrument +transferable. When a number of payments are made simultaneously the +party making the transfers is furnished with a blanket form on which the +names of the individual firms and the various sums are entered and which +has to be accompanied by a red check covering the aggregate amount. For +the so-called "great banks" of Berlin, some of which have a volume of +transfer transactions amounting to as much as one hundred transfers for +each bank per diem, there are blanket forms which are of a different +colour for each bank. When cash is wanted the so-called "white check" is +employed. This is a legally constituted check. There are special printed +forms for the use of those who have no account with the Reichsbank. + +[186] Banks of issue were formerly numerous in Germany. Gradually, +however, nearly all of them renounced the privilege of issue, as the +laws relating to banking made their existence as banks of issue more and +more difficult. At the present time there are only 4 such banks besides +the Reichsbank, viz.: the Bayerische Notenbank, the Wurttembergische +Notenbank, the Sachsische Bank, and the Badische Bank. + +[187] Adapted from Robert Franz, _The Statistical History of the German +Banking System, 1888-1907_, Publications of the National Monetary +Commission, Senate Document No. 508, 61st Congress, _2nd Session_, pp. +7-115. + +[188] Adapted from C.R. Fay, _Co-operation at Home and Abroad_, pp. +42-51, 56. P.S. King and Son, London. 1908. + +[189] Occasionally even as low as 1_d._ or less. + +[190] Adapted from _Interviews on the Banking and Currency Systems of +England, Scotland, France, Germany, Switzerland, and Italy_, +Publications of the National Monetary Commission, Senate Document No. +405, 61st Congress, 2d. Session, pp. 452-468. + +[191] _Ibid._, pp. 335-358. + +[192] _Ibid._, pp. 359-370. + +[193] _Ibid._, pp. 371-391. + +[194] _Ibid._, pp. 392-418. + +[195] _Ibid._, pp. 486, 487. + + + + +CHAPTER XXVI + +BANKING IN SOUTH AMERICA + + +[196]The special interest in South American banking which exists at this +time is the product of at least four distinct factors: + +First. It has been evident for some years that the trade between North +and South America is rapidly developing. In the ten years, 1903-1913, +the exports from the United States to the ten Republics of South America +increased 274 per cent. against an increase of all our exports during +the same period of 73 per cent. In spite of inexperience, crude methods, +lack of banks and of ships we have made notable gains in South American +trade. There seems to be no reason to question the probability of a +continued rapid increase during the next few years. + + +OUR GROWING SURPLUS FOR FOREIGN INVESTMENT + +Second. Other forces have gradually been bringing this country more and +more into the position of looking for investment opportunities abroad. +While it is true that the United States is a debtor nation in the sense +that a large amount (estimated at $3,000,000,000 to $6,000,000,000) of +European capital is invested here, it is also true, on the other hand, +that the national income has for some years been sufficient to meet +annual payments abroad, to make large fresh investments in our own +enterprises, and still to leave a considerable surplus for investment in +neighbouring countries. It is estimated that American capital in Mexico +and Canada amounts approximately to $1,500,000,000. In South America +there are already American investments of perhaps $300,000,000 to +$400,000,000. + +As the national income and savings expand and as the opportunities for +exceptionally profitable investment within this country decrease, it is +clear that there must be a stronger and stronger tendency toward +investment abroad. The immense sums, for instance, that have been +flowing into railroad construction and rebuilding will not be needed to +so great an extent in future. A considerable proportion of this overflow +of capital may certainly be expected to spread into South America. + + +GREATER LENDING POWER OF BANKS + +Third. The adoption of the federal reserve system has made a remarkable +improvement in the handling of gold and of credit. It has released and +made available for other forms of financing great sums which were +formerly tied up in scattered reserves. We have only to look at the +monetary history of the German Empire during the last forty years to see +how powerful an influence on industry, trade, and investment is exerted +by the centralisation and control of bank reserves. The London _Statist_ +has calculated the ultimate increased lending power of American banks, +under the federal reserve system, at $3,000,000,000. + + +EUROPEAN WAR + +Fourth. The European war has suddenly stimulated the tendencies which +were previously evident. It has temporarily cut off a considerable +amount of European trade in South America, thus leaving an opening for +even more rapid development of our trade than would otherwise have taken +place. It has deprived South America for a period of several years of +the steady inflow of European capital. It has enormously increased the +exports and decreased the imports of this country, thus placing suddenly +at our disposal greatly enlarged financial power, possibly as much as +$1,000,000,000 per annum above normal. Its ultimate effect, we may +safely assume, must be to increase considerably rates of interest the +world over, thus stimulating the tendency toward an enlarged outflow of +capital from the United States into neighbouring countries. + +By reason of the war the same kind of a situation that would otherwise +have developed slowly in a period of years now confronts us suddenly +when we are as yet in a state of financial unpreparedness. The new +machinery provided by the federal reserve act is not yet fully utilised +or adjusted in its final form. It will require careful study, combined +with prompt action, to utilise the financial opportunities now before us +with greatest advantage to all concerned. + + +ENGLISH BANKS IN SOUTH AMERICA + +Although English interests have share holdings in other institutions, +there are only five banks in South America that stand out as +unmistakably British. In the order of their development, these are the +London and River Plate, London and Brazilian, British Bank of South +America, Anglo-South American Bank, and Commercial Bank of Spanish +America. Each institution, with one exception, has concentrated on one +country, in which it has established most of its branches and to which +it has devoted its first efforts. The exception is the British Bank of +South America, which has followed the contrary policy of having only a +few branches strategically located in important cities; in other words, +this bank has concentrated on selected cities rather than on a given +territory. + + +ENGLISH TRADE AND BANKS DEVELOP TOGETHER + +The development of commercial banking by British interests has +everywhere gone hand in hand with the development of British investment +and British trade. The accounts of the railways, mercantile firms, +steamship lines, public utilities, and other enterprises conducted by +their fellow countrymen form the great bulk of the business of the four +leading institutions; the Commercial Bank of Spanish America is, +however, operating under different conditions. Indeed, it may even be +said--again speaking in broad terms--that the English banks have made +comparatively little effort to secure the accounts of domestic +enterprises. It is certainly safe to say that they have not made efforts +in this field at all comparable with the efforts of the German, Spanish, +French, and Italian banks. It is interesting to note also in this +connection that the management and even the clerical force are, with +few exceptions, brought over from England. After more than fifty years +the three leading institutions remain as distinctively British as they +were at the beginning. + + +GERMAN BANKS IN SOUTH AMERICA + +To understand the energetic development of German banks in South America +during the last forty-five years we must consider the conditions +prevailing in Germany during that period and the strong forces working +toward industrial and banking expansion. + +Beginning immediately after the Franco-Prussian War of 1870-71, German +industrial interests, with the strong support of the German Government, +began to struggle more vigorously and more effectively than ever before +for a larger share of trade in international markets, particularly in +the Far East and in South America. It was clearly realised that Germany +needed a large and rapidly growing export trade in order to maintain her +own prosperous development. In order to get this trade it was necessary +to follow a definite programme which included the provision of better +shipping facilities and of better facilities for financing. Up to that +time Germany had been fully as dependent as the United States is to-day +upon foreign ships and foreign banks. + +It was also clearly realised that the tendency was toward large scale +production in most industries and that those concerns which could secure +large sales in the world-wide markets would soon come to enjoy an +overwhelming advantage over smaller competitors. The German industries, +in conjunction with the great German banks, began to follow, therefore, +a programme of concentration, which has since gone steadily forward. + +These two forces--expansion in foreign markets and concentration at +home--have had a controlling influence on Germany's foreign trade, and +incidentally on her foreign banking. + + +OTHER INFLUENCES IN BANK EXPANSION + +Another influence of importance is the fairly well-marked division of +German industrial interests into a small number of groups, each one of +which centres about and is allied to one of the great banks. To some +extent this is true in other countries, especially where banking is +centralised--notably in Canada, for instance--but it is especially clear +and well recognised in Germany. Hence each one of the great banks is +under especially strong pressure to foster and develop the interests of +its important clients, even at the expense of some temporary risk or +sacrifice for itself. This is doubtless the primary motive which has +induced the great German banks one after another to enter foreign +fields. + +There is a wide-spread notion outside Germany that the German Government +has itself actively intervened for the purpose of stimulating foreign +trade expansion and has brought pressure to bear on German banking +interests, leading them to push ahead more rapidly than their private +business interests would have required. This idea may or may not be +correct; so far as the writer is aware there is no special evidence +pertaining to South American banking development to sustain it. At any +rate, it is easy to explain the policy of these banks as being based +upon purely business considerations. + +As a matter of fact, there has probably been much exaggeration of the +thought that the German banks are primarily self-sacrificing instruments +of an ambitious national programme rather than ordinary business +enterprises. The statement is frequently repeated that the English banks +in South America aim first and all the time for profits, while the +German banks aim for development of their national interests. + +Of the four large German banks in South America only one is remarkable +for energetic and successful expansion. The others have been moderately +successful. The difference is to all appearances chiefly due to +management. + +Although these four banks were presumably designed primarily to advance +the business interests of the banks which organised them, they have +incidentally had a powerful influence on investment of capital and on +trade. The German manufacturers of machinery, steel products, and the +like, have been especially helped by the ability of the German banks, +both in South America and at home, to help in finding capital and in +financing. + +The German banks have not found political or economic conditions in +South America which were insuperable obstacles to sound or profitable +banking. + + +OTHER BANKING INSTITUTIONS + +Other nationalities besides the English and the Germans have invaded the +banking field in South America. The French, the Italians, and the +Spanish have all been active, particularly on the east coast, and are +represented by large institutions. + + +AMERICAN BANKS + +Only after the federal reserve act went into force in November, 1914, +was it possible for any bank organised under the national-bank act of +the United States to establish branches abroad. The act restricts this +privilege to institutions having capital and surplus of $1,000,000 or +more, and gives the Federal Reserve Board discretion to withhold its +consent. Up to this writing the only institution which has taken +advantage of the powers granted by the federal reserve act to enter +South America is the National City Bank of New York, which has +established branches in Buenos Aires, Montevideo, Rio de Janeiro, +Santos, and São Paulo. Other branches will probably be established in +the near future. Especial attention is being given to the collection of +credit information. The bank also maintains a foreign trade department, +which gives information and advice to its depositors as to building up +business abroad. This department is now equipped to make specific +reports on trade openings in Argentina, Uruguay, Brazil, Colombia, and +Venezuela. + +The Buenos Aires branch, which was the one first established, is +understood to have done a satisfactory amount of exchange business. It +stood ninth in volume of clearings in January, 1915, among the +twenty-odd commercial banks of that city. The other branches have not +been in operation long enough to show clear results. The branches in +Argentina (including the subbranch at Montevideo) and Brazil have each +$1,000,000 allocated to them--though this is purely formal, as the +bank's whole capital and surplus are behind the obligations of every +branch. + +The expansion of the National City Bank in South America has been much +more rapid than that of any preceding institutions, including even the +aggressive German banks. As a natural result, there is apparently less +effort at this stage to build up local connections and influence in each +city. So far the policy of the National City Bank appears to be to +furnish foreign trade facilities to American exporters over as wide a +territory as possible, rather than to concentrate its activities in any +restricted region. + +Other national banks in this country are known to be desirous of aiding +in the financing of foreign trade, but have not up to this time found it +practicable to take action under the provisions of the banking law as it +now stands. + + +DOMESTIC BANKS + +There are many important and successful banks in South American +countries which are strictly domestic institutions, not only +incorporated under the laws of the country in which they do business, +but owned and managed by local interests. The notion sometimes seriously +put forward that South American banking is almost wholly in the hands of +foreigners is quite unfounded. It is true that trading operations are +generally handled either by foreign houses or by houses in which there +is a strong foreign influence and that the financing of nearly all +foreign trade and of much local trade is likely to go to foreign banks. +But the accounts of the rest of the domestic trading firms, of land +owners, and of governmental corporations, as a rule, gravitate toward +the domestic banks. + +Following is an approximate statement of the total of deposits and +credits in account current in each South American country on or about +December 31, 1913, and an estimate of the distribution between foreign +and domestic institutions: + +---------------------+-------------+------------------+------------------ + Countries. | Total bank | In | In + | deposits. | European banks. | domestic banks. +---------------------+-------------+------------+-----+------------+----- + | | Amount. | Per | Amount. | Per + | | |cent.| |cent. + | | | | | +Brazil | $190,000,000| $78,000,000| 40|$112,000,000| 60 +Uruguay | 42,500,000| 14,000,000| 33| 28,500,000| 67 +Argentina | 626,000,000| 173,000,000| 28| 453,000,000| 72 +Paraguay | 3,500,000| | | 3,500,000| 100 + +-------------+------------+-----+------------+----- +Total, east coast | 862,000,000| 265,000,000| 30| 597,000,000| 70 + | | | | | +Chile | 104,500,000| 29,500,000| 28| 75,000,000| 72 +Bolivia | 8,800,000| 1,500,000| 17| 7,300,000| 83 +Peru | 28,500,000| 7,500,000| 26| 21,000,000| 74 +Ecuador | 4,000,000| | | 4,000,000| 100 + +-------------+------------+-----+------------+----- +Total, west coast | 145,800,000| 38,500,000| 26| 107,300,000| 74 + | | | | | +Colombia | 5,800,000| | | 5,800,000| 100 +Venezuela | 6,200,000| | | 6,200,000| 100 + +-------------+------------+-----+------------+----- +Total, north coast | 12,000,000| | | 12,000,000| 100 + | | | | | +Total, South America |1,019,800,000| 303,500,000| 30| 716,300,000| 70 +---------------------+-------------+------------+-----+------------+----- + +The great Banco de la Nación Argentina (Bank of the Argentine Nation) is +an official institution, all the shares of which are owned by the +National Government. It is a successor of the former national bank, +which was driven into insolvency in the great financial crisis of 1890 +and was afterwards liquidated. Although it was organised during a period +of disaster and there were many prophecies of its certain failure, the +Bank of the Argentine Nation has had a wonderful development and to-day +ranks as the seventeenth in size among the great banks of the world. + +The bank pays no dividends, but carries 50 per cent. of its profits to +the credit of capital account and 50 per cent. to reserves. Entirely +through this process the capital and reserve funds have increased from +approximately $22,000,000 in 1892 to over $100,000,000 at the present +time. During the same period deposits have grown from $21,000,000 to +$205,000,000, and discounts and advances from $47,000,000 to +$208,000,000. There are now more than 150 branches. + +The bank differs from most other governmental institutions in that it +carries on distinctly a commercial banking business more or less in +competition with private commercial banks. Until the crisis of 1914 it +did no rediscounting for other banks, and even during the crisis its +activities in assisting other banks were much restricted. + + +LAND MORTGAGE BANKS + +In several of the South American countries there is a well-organised +system of land-mortgage banks following European models. In some cases +the banks are owned and operated by the National Government and in other +cases receive some special support or guarantee. The plan under which +they all operate is the following: The owner of land who desires to +raise money on mortgage approaches the bank and requests an +investigation and appraisal, the expenses of which he usually pays. If +the property is shown to be unencumbered with prior claims and meets +other conditions, the bank delivers to the owner the mortgage bonds in +convenient denominations up to a given proportion, usually 50 per cent., +of the appraised value. These mortgage bonds are part of a series and +are themselves secured, not by any specific piece of property, but by +all the property covered by the series; they are also backed by the +credit of the issuing bank. The owner of the property then offers the +bonds for sale through a broker, and in this way obtains the desired +funds. He pays the bank a small commission, from one-fourth of 1 per +cent. to 1 per cent., for its services. + +In Argentina, where this system is developed to its highest extent, +these land-mortgage bonds are known as "cedulas," and are issued by the +Banco Hipotecario Nacional (National Land Mortgage Bank). At the present +time the Argentine "cedulas" tend to sell on a 7 per cent. basis, more +or less. + +Uruguay, Brazil, and Chile all have similar issues, which sell on bases +ranging from 7 to 9 per cent. or even higher. Broadly speaking, and +without attempting to assign a definite value to any one of these +issues, they are sound, conservatively issued, well protected, and under +normal conditions readily marketable. The more important issues have +been widely sold in England, France, and Belgium. If they were properly +introduced and made well-known in the United States, there is no reason +to question their finding a good market here also. + +Side by side with the land-mortgage banks there are operating in the +Argentine a number of English mortgage companies, which directly invest +their own funds in land mortgages and have earned highly satisfactory +profits. + +In several countries there are state-owned savings banks, a large +portion of the funds of which also go into land mortgages. + + +CONDITIONS OF COMMERCIAL BANKING + +A banking business, like any other, must adapt itself to surrounding +conditions, including laws, business customs, precedents created by +older banks, and the like. In South America these conditions differ in a +number of respects from those which prevail in the United States. +Probably the first impression of most observers gives an exaggerated +idea of the differences. However, they should be fully and carefully +considered. + +The chief differences that directly affect banking operations are the +following: (1) Comparative absence of banking regulation on the part of +governments or associations; (2) national colonies; (3) social character +of business relations; (4) lack of highly developed economic +organisation; (5) relatively high and stable rates of interest; and (6) +in some countries fluctuating currencies. The first five of these +circumstances call for brief comment. + + +LITTLE CONTROL OR CO-OPERATION + +Not only is there a marked absence of laws directly applicable to +banking concerns, but there is also an equally noteworthy absence of +control exercised either by the Government or by associations among the +banks. Even the large governmental or semi-governmental banks in Brazil, +Uruguay, Argentina, Chile, and Bolivia are competitive with the other +banks. Whatever influence they exercise is secured through their active +and direct competition, not through any special authority over the other +banks conferred upon them. In the fall of 1914, for the first time, +there was some rediscounting of the paper held by other banks on the +part of the Bank of the Argentine Nation and of the Bank of the +Republic of Uruguay; but this tendency did not go far. The other banks +objected to placing information as to their relations with customers in +the hands of the governmental institutions. In other countries there has +not been even this much of an attempt toward fulfilling the functions of +a central bank of rediscount. + +It is difficult to secure in most of the South American cities even the +most elementary kind of co-operation among the banking institutions. How +is it possible that they should continue to stand apart when they would +obviously gain so much by coming together? A partial answer is to be +found in the peculiarity that has already been pointed out, namely, the +fact that many of the more powerful institutions are the offspring of +European countries. Each one is fighting to support the trade of a +certain well-defined group of clients. The national antagonisms among +them are deep-seated and sometimes virulent. All this was true even +before the European war. It will be tenfold true for a number of years +to follow. + + +NATIONAL COLONIES + +This leads to mention of the second condition, one which operates in +favour of European-owned banks to the relative disadvantage perhaps of +American banks. This condition is the presence in some of the large +South American cities, notably Buenos Aires, of a large colony +representing each one of several important European nations. Naturally +the tendency of each colony is to support banks of its own nationality. + +On the whole, although this matter of national affiliations is +undoubtedly a factor to be reckoned with, it appears to be by no means +decisive. The German banks, for instance, have been able to expand with +much greater rapidity than we should have been justified in expecting on +the basis of their national trade and national colonies alone. This is +true likewise of the Italian and French banks. A great proportion of the +business men of South America, even those of foreign origin, are +governed less by their national sentiments than by their business +interests. + + +PERSONAL CHARACTER OF BUSINESS DEALINGS + +To an observer accustomed to European or American methods, one of the +most striking features of business life in the South American cities is +its strongly personal and social flavour. We are accustomed in this +country to emphasise the principle that friendship is not a safe guide +in business dealings. In South America the contrary is more nearly true. +Family ties are apt to be a controlling factor in choosing partners and +employés. If one's ultimate object is to have business dealings with a +firm, he must first cultivate the personal friendship of the head of the +firm. Social relations and business relations become confused, and it is +hopeless to expect the purely impersonal view of a business proposition +that is considered correct in this country. Like all sweeping +statements, this one is subject to exceptions. There are many American, +German, and English firms, especially in Buenos Aires, which prefer what +we denominate "businesslike methods," but they are not numerous enough +to give the tone to business life. + +This is a condition which directly affects banking practice. It makes it +very difficult, for example, to introduce the custom of securing full +financial statements from all applicants for credit. The request for a +statement is apt to be construed (as was the case in this country not +many years ago) as a reflection on the personal honesty and credit +standing of the applicant. For the same reason it is difficult, and may +frequently be poor policy, for a bank officer to ask a customer a direct +question as to the status of his business. He is likely not to take an +impersonal attitude toward the question, but to resent it as if it were +an attempt to pry into his purely personal affairs. Consequently, all +business men, including bankers, are forced to rely to a great extent in +estimating the credit standing of individuals and firms on their +personal impressions, on such information as they are able to secure +through indirect hints and questions and on the business gossip which +they pick up. It must be remembered that, except for Buenos Aires, most +of the business communities are comparatively small and isolated. There +is little opportunity, therefore, for long-continued fraud. A man who +shows traces of dishonesty is much more plainly marked than in larger +communities. As a consequence, the lack of the machinery and the customs +that we consider indispensable in extending credit does not prevent the +formation of correct ideas as to the wealth and character of a business +man. + + +UNDEVELOPED ECONOMIC ORGANISATION + +Most of the South American countries, we should keep in mind, are still +sparsely populated and have no need for the elaborate machinery of trade +and finance which exists in Europe and North America. The region +farthest advanced in its economic development, the River Plate Basin, +may be roughly compared to agricultural States like Iowa, Kansas, and +Nebraska as they were thirty years ago. Farming methods are usually not +economical. The small farmers have little money of their own, their +lands are heavily mortgaged, and they are "carried" from one crop to +another by the local general retailer, who makes advances to them both +in goods and in money. The retailer must in turn secure liberal credits +from wholesalers, who are in their turn partly "carried" by the banks. +There is no clear-cut distinction between dealers in commodities and +bankers, for the dealers are forced to finance most of their own sales. +Such an arrangement of course favours extravagant credits, high prices, +speculation, and crises, just as it did in the United States. It is +rapidly giving way to a more complex organisation, in which the farmer +has funds of his own, does his short-term borrowing at a bank, and pays +cash for his purchases. + +Without attempting to comment on intermediate grades of organisation we +may consider briefly the manner in which trade and finance are conducted +in the north coast countries. An officer of a bank there asserts that +banking in the north coast countries is not to any great extent a matter +of handling currency or money funds. The intermediary system of brokers, +merchants, and other middlemen between the producer and his market, to +which we are accustomed, is lacking, and the banker must take the place +of all of them. He must himself inspect and sell produce. Loans are +made, for instance, secured by growing crops; the bank sends a man to +the plantation to look over the coffee or cocoa, or whatever the crop +may be, and report on its condition and prospects; to protect itself the +bank sees that it is properly prepared for shipment, and takes care of +the sale in the New York, London, or Hamburg market. The bank collects +the proceeds and credits the customer with his share. Interest rates run +from 8 to 15 per cent. and commissions for selling from 1 to 3 per cent. + + +INTEREST RATES + +Interest rates average considerably higher--even making allowance for +increased risk--in South America than in the United States. They are, +however, much more stable and more uniform over the whole continent. The +uniformity is no doubt to be ascribed chiefly to the large English and +German banks, with their branches in several different countries and +their ready access to European financial centres. The stability in rates +over a period of years is presumably due in part to the relatively +gradual development of banking, commerce, and production, so that sudden +shifts in the demand for and supply of banking capital are not frequent. + +There are, however, a number of exceptions to the general stability. In +Argentina the crop-moving season creates, though to a much smaller +extent, the same kind of extra demand for currency as in the United +States, and tends to make some seasonal variations in discount rates. +They vary from as low as 6 per cent. to as high as 12 per cent., but do +not normally move far from 8 or 9 per cent. + + +COMPENSATION OF DIRECTORATE + +The German, French, Italian, Spanish, and many of the domestic banks, +especially in Argentina and Peru, follow the European custom of +compensating the home office directorate by allowing them a fixed +percentage of the net profits. The president, manager, founder, and +others may also be compensated in the same way. The net profits of the +Banco Español del Río de la Plata are distributed: 2-1/4 per cent. to +certain specified charities, 1 per cent. to the founder, 12 per cent. to +the reserve fund, 2 per cent. to the directors and managers, 2-3/4 per +cent. to the fund for employés, 80 per cent. to the shareholders for +dividends and dividend reserves; those of the Banco de Italia y Río de +la Plata: 1/2 per cent. to charity, 5 per cent. to the reserve fund, 7 +per cent. to the directorate, 1-1/2 per cent. to the fund for employés, +86 per cent. to the shareholders. There is apparently no general rule +which governs the distribution except possibly that the larger the bank +the smaller is the percentage for the directorate and management. In +England the directors are more likely to receive a fixed compensation. +Whether this plan of having a paid directorate works better than the +American method of having a directorate made up usually of some of the +larger shareholders, whose payment is purely nominal, is an open +question. It is largely a matter of national custom. + + +CLASSES OF BUSINESS OF FOREIGN BANKS + +First. The foreign banks in South America usually start by devoting a +large proportion of their energy and capital to operations in exchange. + +Second. In this connection they purchase and make advances against +commercial bills drawn on importers in the countries where they are +doing business. + +Third. At the same time the home office in London, Hamburg, or Berlin is +probably developing a business in acceptances which involves +comparatively little direct expense and allows considerable profits. + +Fourth. All South American banks are called upon to handle collection of +drafts and sometimes to take care of ordinary mercantile transactions, +both on a commission basis. + +Fifth. An activity which may be of some importance from the beginning +consists of underwriting and selling securities. + +Sixth. As quickly as possible the foreign banks build up a local account +current and loan and discount business. + +Seventh. Some of the banks, especially the German banks, have +participations in syndicates and in industrial enterprises. + +Eighth. In some branches they receive money and securities for +safekeeping or rent safe-deposit boxes. + +Ninth. Many banks have savings and mortgage-loan departments. + +None of the distinctively foreign banks in South America has as yet +issued circulating notes; this is being done, however, by some of the +domestic banks in which foreign capital is heavily interested. + +There may, of course, be other miscellaneous activities. + +FOOTNOTES: + +[196] Adapted from William H. Lough, _Banking Opportunities in South +America_, Department of Commerce, Special Agents Series, No. 106. +Washington. 1915. + + + + +CHAPTER XXVII + +AGRICULTURAL CREDIT IN THE UNITED STATES + + While agricultural credit has been a subject of intermittent + discussion in the United States for almost a generation, the + movement has had its main development within recent years. + In November, 1911, the American Bankers' Association created + a committee to study land and agricultural credit at home + and abroad. In March, 1912, American ambassadors and + ministers were instructed by the State Department to gather + information concerning rural credit institutions in Europe. + A year later the Southern Commercial Congress also + instituted a careful investigation. These acts, and reports + published gave the movement a national character and scope. + + Several states, such as Massachusetts, New York, and + Missouri, have recently made legislative provision for rural + credit institutions and during the last two years very + numerous bills pertaining to rural credit have been + introduced in Congress. It seems not unlikely that + legislation providing for the establishment of a federal + system of land banks and rural credit associations, + subsidized by the Government, will be enacted in the near + future. + + The functions and work of rural credit institutions in + Europe, briefly discussed in the first two selections of + this chapter, are treated more fully in connection with the + chapters on the banking systems of European countries, + notably those of Germany and France. + +[197]Various European nations, with soil naturally inferior to ours, +have established agricultural credit and thereby have greatly eased the +burden of the cost of living. Hitherto we have lived on the bountiful +overflow of our rich land, and the pinch of necessity has not been felt; +but now our population has grown enormous, our standards of living have +been greatly raised, and our land is showing the effect of generations +of taking out with very little putting back. We must do better or +suffer. + +By the installation of agricultural credit, farming will not only be +made more profitable, but it will in the end make country life more +attractive. The banking system of to-day is adapted to the needs of +manufacture and commerce. The processes of nature are so much slower, +however, that banking for farmers must be organised on a basis of credit +for much longer periods. + +Our present system of borrowing on land is by mortgages running from +three to five years, the entire principal coming due at one time. This +is expensive, involving renewals, and dangerous from the possibility of +the mortgage falling due at a time of restricted credit so that it +cannot be renewed. On the continent of Europe this business is handled +by so-called land-mortgage banks, or rather associations. + +The mortgages granted are pledged for the security of bonds which the +institution issues and sells in the general market. These bonds have no +fixed maturity, but can be retired at par or some small premium at any +time. When the borrower mortgages his land to the bank he agrees to pay +a certain fixed sum semi-annually. This is called the "annuity" and is +composed of the annual interest plus an amount, generally 1/2 per cent., +toward the reduction of the principal of the debt and known as +"amortisation," and an additional amount, about 1/4 per cent., toward +the expenses of the bank. The borrower, therefore, at once begins to +extinguish the principal of the debt; and as each year the principal +decreases, the interest, of course, decreases also, and, the annuity +being fixed, the proportion of it applicable toward the extinction of +the mortgage increases. Thus it happens that, beginning with a payment +of 1/2 per cent. toward principal, the mortgage bearing 4 per cent. to +4-1/2 per cent., which are the general rates, the entire debt is +extinguished in between fifty and sixty years. + +The mortgaging of land is known as long-term credit, and it may be +handled by joint-stock institutions or by associations of borrowers, but +in institutions furnishing the credit required by farmers for working +capital, such as the purchase of seeds, fertilizer, payment for labour, +etc., which is known as short-term credit, the aim that the borrower +should be primarily considered rather than the lender assumes +fundamental importance. + +On the continent of Europe a solution of the problem of short-term +credit is found in the organisation of banks by the application of +so-called co-operative principles. The purpose is to provide +organisations in which the borrower receives consideration rather than +the lender, also to keep the money of any body of individuals for the +use of that body. Under our present system a great deal of money +belonging to farmers finds its way into Wall Street. At present the +lenders are organised; whereas the borrower stands alone. + + +AGRICULTURAL CREDIT CONDITIONS IN THE UNITED STATES + +[198]The United States, although the leading country of the world in the +amount of its agricultural products and in the extent of its banking +business, is behind nearly every other progressive country of importance +in the development of agricultural credit, _i. e._, short-time +non-mortgage credit. Our manufacturing and commercial businesses are +financed largely by means of such credit, and the capital invested in +these industries is thereby rendered manifoldly efficient; not so with +agriculture. Most farmers apparently make little or no use of short-time +credit. There seems to be a wide acceptance in this country even among +the farmers themselves of the dictum of Louis XIV, that: "Credit +supports agriculture, as the cord supports the hanged." Is this a +correct description of the situation? If so, what is the explanation, +and what remedies if any are needed? The object of this paper is to +throw light upon the answers to these questions. + +First, as to existing banking facilities for agricultural credit, and +their utilization by farmers. It is well known that the banking capital +of the country is concentrated to a great extent in our large cities--to +a greater extent than it would be if we had a well-developed system of +branch banks like Canada--and that the banks of these cities are +prevented by reason of their location from making many agricultural +loans, even if they were so inclined. Of the 7,301 national banks in the +United States September 1, 1911, 191 or 2.6 per cent. were located in +the dozen largest cities of the country.[199] The national banks of +these twelve cities, representing but 14 per cent. of the population of +the country, had 37 per cent. of the national banking capital (capital, +surplus, and undivided profits), 33 per cent. of the individual +deposits, and 40 per cent. of the loans. It should be noted, however, +that since the act of 1900, authorizing the establishment of national +banks with a capital of less than $50,000 in small towns, there has been +a continual and rapid increase in the number of national banks in small +communities. On September 1, 1911, out of the total 7,301 national banks +there were 1,966 with a capital of $25,000, and therefore presumably +located in towns of less than 3,000 population, 372 with a capital +between $25,000 and $50,000, and therefore presumably in towns of less +than 6,000 population, and 2,297 with a capital between $50,000 and +$100,000. Except for banks in towns not exceeding 6,000 population, the +law as amended in 1900 does not permit any national bank to be organized +with a capital less than $100,000. + +Are the national banks which are accessible to farmers in a position +under the law to meet farmers' needs? The answer to this question must +be in the affirmative. Aside from the fact that national banks are not +permitted to make loans on real estate security,[200] there is no +restriction in the national banking act which would interfere with loans +to farmers for agricultural purposes. Personal security alone is legally +acceptable; the range of possible collateral security is practically +unlimited; and there is no limitation fixed by law as to the period of +loans. National banks therefore have a very free hand in regard to loans +to farmers. + +When we inquire concerning agricultural credit in banks under state +charters we find conditions varying with the different States, but, with +a few minor qualifications, it may be said that the state banking laws +are free from restrictions that would hamper state banks and trust +companies in extending credit liberally to responsible farmers. They +are in a much better position in one respect to deal with farmers than +are national banks, that is, in the matter of accepting real estate +security. No state denies state banks this privilege, and such +restrictions as exist upon its exercise are generally not onerous. + +If commercial banks are comparatively unhampered by law in making +short-time loans to farmers, it may be asked: To what extent are such +loans made? Unfortunately practically no information is available on +this question. In answer to an inquiry the Comptroller of the Currency +wrote, under date of May 27 of this year, that no information with +reference to short-time loans made to farmers by national banks had ever +been compiled by the comptroller's office. The writer has found no trace +of any investigation of this subject by state banking departments. For +about a year he has taken occasion to inquire at every opportunity of +individual bankers concerning their experience with regard to loans to +farmers in different parts of the country. The replies received are so +divergent that no conclusion can be drawn from them, except that the +practice varies widely in different sections of the country and even in +different communities in the same section, and that probably the farmers +of the North Central and Western States borrow of commercial banks more +than do those of the Eastern and Southern States. There is not +sufficient evidence, however, for this latter inference to make it much +more than a guess. In the absence of any comprehensive data, I shall +resort to the unsatisfactory but representative replies from different +parts of the country. + +Neither of the two national banks in the city of Ithaca, N. Y., makes +any appreciable amount of loans to farmers. Both claim to be willing to +do so, but say there is practically no demand. In some of the +neighboring cities, however, such loans by national banks are more +common. The cashier of a national bank in a town of about 800 population +in an agricultural section of northeastern Pennsylvania writes: + + Our farmers as a rule are not large borrowers and want loans + only in small amounts for short periods. + + Farmers in general will not go on each other's paper no + matter how good the parties are, for they have been so often + taken in by wild-cat schemes that they are shy when their + names are required to be placed upon paper. They realize + also that they are not familiar with business methods in the + commercial world and dare not trust themselves. + +There is a moderate amount of borrowing by farmers in western New +Jersey. Estimates made by bankers in Princeton as to the proportion of +farmers in that neighborhood who borrow for short periods of local banks +vary from 15 to 40 per cent. + +A former president of a national bank in Indianapolis writes: + + We came very little in contact with farmers. We made special + effort to secure such business by sending to a considerable + mailing list of carefully selected farmers, circulars and + personal letters ... but the business did not come. My + inference was that they dealt with the nearby small banks. + +Of the situation in Lafayette, Indiana, a former vice-president of a +national bank, writes: + + About 50 per cent. of our business was with farmers. They + borrow frequently from commercial banks, funds to be used + for crop planting, crop gathering, purchase of agricultural + machinery, improvements on the farm, purchase of cattle, and + the carrying of cattle or hogs to maturity. Through Indiana + these farmers' loans are very usual in the country banks, + many preferring state charters so they may make these loans + not only on personal but also on mortgage security. + + Farmers are seldom able to give any but personal or mortgage + security. A large percentage of them are sufficiently + responsible to be entitled to and to receive reasonable + credit without security. + + Farmers seem to endorse for each other much more readily + than do those of other classes.... The reason is, I think, + clear. Each knows pretty much everything about his + neighbor's financial status, the amount and value of his + land, his live-stock, and other visible personal property, + the amount of any mortgage and when due. So much being thus + in the open there is less of the secretive habit, so that + the extent of the invisible personal property and debts is + apt to be known. + +A similar report comes from a national bank in Lincoln, Nebraska, from +which the following extracts are taken: + + The farmers of this state have need of accommodations of + this kind to carry them through the crop season. As a matter + of fact, they use short-time credit to fully as great an + extent as do the business men in the city and smaller towns. + In fact, I think it is true that in the smaller towns the + bankers favor the farmers in preference to the small + business men.... + + There is no doubt about the average well-to-do farmer in + this state being able to furnish satisfactory security aside + from mortgaging his farm for such temporary loans within any + reasonable limitations. In some cases the banks take chattel + mortgages on cattle or other live-stock, and in some cases + where the farmer has a good equity in his farm they will not + hesitate to take his personal note. + + While I do not know that there is any particular difference + between farmers and other classes in this state as to their + willingness to go security for each other, yet very little + of this is done any more. There was a time when it was not + an uncommon thing, but it has become less and less until now + there is very little signing done for others. In fact, the + farmers feel that they are able to take care of themselves + and do not ask others to sign with them, and are able to + handle themselves without such an endorsement. This is true + of all classes in this state. + + I have never felt that in this locality farmers suffered in + any way from lack of credit facilities.... + +A former bank examiner in the state of California, himself a farmer, +writes: + + The farmers of California do not to any considerable extent + make a practice of borrowing money from local banks or money + lenders for short periods.... + + In reviewing the various bank examiners' reports on some 500 + state banks I recall very few instances of crop mortgages, + and it impresses me that in many of the cases the mortgage + was taken to obtain additional security for loans previously + granted and secured otherwise. + + I think it would be safe to say that the bankers as a rule + have not favored short-time unsecured loans to farmers. They + are, however, fast awakening to the fact that as a rule + these are the safest loans a bank can make, and are making + an effort to get in closer touch with the farmer. It would + also be safe to say that the average small farmer does not + as yet realize that he _can_ obtain such credit at a bank. + + Our farmers as a class are exceedingly reluctant "to go each + other's security." Two-name paper is mostly confined to + commercial transactions. + +A college professor in the state of Washington informs me that +short-time loans to farmers are common in that state, but that +frequently the rate of interest charged is 2 per cent. higher than that +on commercial loans--the explanation commonly given being that a farmer +borrowing generally reduces the resulting deposit credit more rapidly +than does a merchant. + +In the Southern States, particularly in the cotton, rice, and tobacco +sections, the use of crop liens for short-time loans appears to be much +greater than in other sections of the country.[201] Such meager +testimony as I have been able to secure seems to show that the amount of +short-time agricultural credit extended by banks in the South is +relatively small but rather rapidly increasing. The banks are catering +more and more to this class of business. + +Other evidence might be cited, but the above gives a fair picture of the +situation as revealed by all the testimony received--a confused picture +of widely varying conditions. Public opinion is now being aroused on the +subject of agricultural credit, and pressure is liable to be brought for +hasty and perhaps radical legislation. Obviously, the first step to be +taken in the interest of a sane solution of the problem is to find out +exactly what the problem is. To this end the writer would urge strongly +the need of investigations by the Comptroller of the Currency and by the +various state banking departments of the present facilities and +practices in the matter of agricultural loans. In view of the increasing +public interest in the subject the investigations cannot be undertaken +too soon. + +Although the farmers in any section of the country may not resort to the +banks for short-time credit it does not follow that they are not +receiving such credit. As a matter of fact they are often receiving it +on a considerable scale and in the most expensive way. _i. e._, in the +form of book credits with merchants. It is a common practice throughout +the country for farmers to run up book accounts with local merchants +during the spring and summer to be paid in the fall when the crops are +sold. When this is done on any considerable scale the farmer probably +pays more than bank interest under the guise of prices; and this is +particularly true when he obligates himself to sell his crops to the +creditor merchant. In the South this practice is carried to the extreme +in the familiar "store-lien" system which holds many farmers in the +cotton belt in a condition bordering on perpetual servitude. The custom +is for the farmer to buy supplies of the local general store on credit +for the year, agreeing to sell to the merchant his cotton crop in the +fall, thereby cancelling the debt. A crop lien is generally given, and +the merchant often dictates the character and the amount of the +planting. The prices paid for cotton under this system are liable to be +exceptionally low, and the prices paid by the farmer for his supplies +exceptionally high. The system has proven a curse to many sections of +the South. Witnesses before the United States Industrial Commission +estimated the interest rates imposed by this system at from 20 per cent. +upwards. Mr. George K. Holmes of the United States Department of +Agriculture testified: + + The rate of interest on the liens on the cotton crop of the + South, it is safe to say, probably averages 50 per cent. a + year. All cotton men will agree that it is at least that. + The store system of the South is a sort of peonage; that is + what it amounts to with the cotton planter.[202] + +Since the Industrial Commission's report was published the banking +facilities of the South have been greatly increased, and the banks are +coming into closer touch with farmers, with the result that the +store-lien system is gradually breaking down. + +Another form of credit to farmers is that obtained from dealers in farm +implements and machinery which the farmers frequently buy on time, +paying interest during the credit period. + +One informant, who has been a bank examiner, writes from California--and +his testimony is applicable to many other sections of the country: + + The new generation of merchants is not disposed to carry the + farmer as of old and insists that overdue accounts be + covered by promissory notes which are in turn hypothecated + with their bank. In other words a clearer demarcation of + function is being gradually brought about to the best + interests of all concerned. + +Such in general is the present situation in the United States in the +matter of short-time agricultural credit as evidenced by the very +indefinite and scant information available. What are the causes? Perhaps +in them will appear some suggestions for the remedy. + +The chief reasons for the backwardness of the United States as compared +with Europe with regard to agricultural credit may be briefly summarized +as follows: (1) Our wonderful agricultural domain where good land could +be had almost for the asking, and where for generations land was so +cheap and labor and capital so dear that intensive cultivation was +generally unprofitable. (2) The prosperity of our farmers who have not +been forced by dire necessity to resort to credit as were the farmers of +Germany at the middle of the last century when the Raiffeisen +co-operative banks were first organized. (3) The nomadic character of a +considerable part of our agricultural population as it has moved +continually westward in taking up of new lands, and more recently as it +has been retracing its steps or moving northward. (4) The isolation of +our farmers in this country of large farms and "magnificent distances." +(5) The rapid growth of the manufacturing and commercial business of the +country--and that largely in the hands of the same class of people who +control the bulk of the banking business.[203] + +Add to these circumstances the obstacles which farmers always encounter +in the matter of credit, as compared with manufacturers and merchants, +obstacles such as the uncertainty of crops and the strongly seasonal +character of the farmer's credit demands, and we have a sufficient +explanation for the backwardness of agricultural credit in this country. + +To emphasize most of these causes, however, is to brand oneself as +belonging to a past generation. Our domain of free arable land is +practically gone; good farms must be bought, and for them ever +increasing prices must be paid.[204] + +The era of hand cultivation is giving way to that of farm machinery +propelled by horse-power and even by steam, gasoline, or electricity, +with its resulting great increase in the efficiency of labor. Eleven +years ago the editor of _The Dakota Farmer_, in his testimony before the +United States Industrial Commission, put the matter tersely, and with +little exaggeration, as affecting his own section of the country, at +least, when he said: "When I first worked out it took five binders to +follow a machine, one man to rake off, and one to carry the bundles +together. Now the hired girl frequently drives a machine that does the +whole business."[205] Some idea of the extent of this increase may be +obtained by reference to the following figures compiled from census +reports: + + +VALUE OF FARM IMPLEMENTS AND MACHINERY IN THE U. S.[206] + + _Year_ _Value_ _Per Cent. + 000,000 Increase_ + + 1910 $1,265 69 + 1900 750 52 + 1890 494 22 + 1880 407 50 + 1870[207] 271 10 + 1860 246 62 + +The increase in the value of farm implements and machinery per acre of +land in farms from 1900 to 1910 was from $0.89 to $1.44, or 61.8 per +cent. + +An analysis of the figures for farm machinery by geographic divisions +shows a marked difference in the rates of increase, but the tendency in +all sections during the last forty years has been decidedly upwards, the +greatest growth having been witnessed in the decade ending 1910. During +that decade the lowest rate of increase in any section was that of New +England, 39 per cent., and the highest that of the Mountain States, 163 +per cent.[208] + +Another development which is making larger demands upon the farmer for +working capital is the increasing use of artificial fertilizers, the +expenditure for which in the United States approximately doubled from +1880 to 1900. + +As the result of such tendencies and of the rapid depletion of our free +domain, farming in the United States is losing its old-time kinship to +mining and becoming more like manufacturing. More and better machinery +and more power are needed on most farms in the interest of efficiency. +This calls for short-time credit. But a supply of good machinery +requires a fair sized farm for its efficient utilization--hence the need +for larger farms and for mortgage credit to make their purchase +possible. Upon this subject there are some very illuminating data in +Warren and Livermore's _Agricultural Survey_ of four townships in +Tompkins County, N. Y., from which the following is quoted: + + The value of farm machinery increases rapidly with the size + of the farm.... Any one who has ever made a list of the + necessary farm machinery will see at once how inadequately + these small farms are equipped. Yet their machinery costs + nearly twice as much per acre as that on the larger farms + that have nearly three times as much machinery. Machinery + can be used more effectively on large farms. One mower, one + hay rake, one tedder, one hay loader, one corn harvester, + one grain harvester, one grain drill, one manure spreader, + one potato digger, one potato planter, can do their work on + a 250 acre farm as readily as on a small farm. Few of the + small farms have half of these tools. If a small farm does + have nearly all the list, it cannot use them enough to pay + for the investment. The more efficient and numerous machines + become, the larger our farms should be. It is interesting to + notice how many of the tools are of very recent development. + Almost half of the value of farm machinery on a + well-equipped farm is invested in machinery that has been + perfected in the last few years. + +Much the same situation exists in regard to an adequate equipment of +horses. + + Three or four horses are the smallest number that can be + used efficiently with modern machinery.... The small farms + have not enough horses to make efficient teams and yet they + are over-supplied with horses compared with their area. On + these farms there are only 15 acres per horse. On the + largest farms, one horse farms three times this area, with + no resulting decrease in crop yields.... When we consider + the cost of keeping a horse we see what a great advantage + the larger farms have. + +Forces like these are counteracting what is commonly thought of as the +normal tendency of agriculture to move toward more intensive cultivation +_on small farms_, with the result that the average amount of improved +farm land per farm actually increased instead of diminishing in the +United States during the last decade. This does not mean less intensive +cultivation, in fact quite the contrary; it means more intensive +cultivation, but by the efficient utilization of good machinery and of +power. It means further, as said above, a demand for mortgage credit for +the purpose of enlarging farms--and that, at rapidly increasing farm +prices. + +The farming population is becoming more settled now that the free lands +are practically gone and the frontier has disappeared.[209] The +isolation of the farmer is rapidly becoming a thing of the past, with +the advent of rural free delivery, rural telephone, the automobile, and +the parcels post. The farmer no longer buys gold-bricks nor is duped by +fraudulent lightning-rod schemes except in the pages of the comic +supplements. + +When seeking credit the farmer can offer better security than ever +before. His markets are larger, better organized, more certain, and more +accessible. The risk of crop failure is less, thanks to the wonderful +progress of scientific agriculture. There are few pests which cannot now +be readily controlled by the intelligent farmer, who takes time by the +forelock. The problem of moisture is growing less serious every year +with the improvements in irrigation, dry farming, and the more +scientific diversification of crops. + +Conditions then point to an increasing need for agricultural credit, and +to improving circumstances for its safe development. + +If the time is ripe for a greater use of bank credit in agriculture, +how is that credit to be obtained? Broadly speaking, four methods may be +mentioned, only the last two of which are deserving of much attention at +the present time. They are: (1) Establish government agricultural banks; +(2) adopt the Egyptian plan of a government guaranty to an agricultural +bank established with private capital; (3) encourage the farmers to +organize co-operative credit societies on some such plan as the +Raiffeisen or Schulze-Delitzsch banks of Germany; (4) utilize more +effectively in the interest of the farmer our present banking machinery, +and improve it where it is defective. + +The suggestion of an agricultural bank owned and operated by government, +either state or federal, is not worthy of serious consideration in this +country at the present time. The history of such banks both in Europe +and America has generally been a disastrous one, although a few have +succeeded. Some exist to-day which are performing useful services to +farmers, notably in the line of mortgage credit, among which may be +mentioned those of the Australian States and New Zealand,[210] and the +recently established one in the Philippine Islands. The success of such +institutions is not such as to justify any attempt to establish them in +the United States, at least until every reasonable effort has been made +to solve the problem by means of private and co-operative effort. + +The other plan, commonly known as the Egyptian plan[211] from its most +important example, seeks to eliminate the evils of a purely government +bank and to take advantage of its meritorious features. In Egypt the +agricultural bank is owned and financed by private capital; it enjoys, +however a government guaranty of principal and of 3 per cent. interest. +Its administrative expenses are kept low by an arrangement with the +Egyptian Government by which the Government tax collectors make +collection of instalments on the Bank's loans at the time of the +collection of the regular land tax, for which the Bank pays a small +commission. The Agricultural Bank of Egypt has had a phenomenal success, +rendering an invaluable service to the Egyptian fellaheen, and at the +same time yielding good profits to its owners. It was this type of bank +that the United States Government authorized established in the +Philippines by the act of March 4, 1907, but the interest guaranty of 4 +per cent. has so far proved too low to attract capital into the +enterprise.[212] + +A bank organized on the Egyptian plan is well adapted to do pioneer work +among ignorant farmers, where the apparent risks and heavy +administrative expenses prevent private capital from entering the field. +A government guaranty, however, hardly seems necessary in the United +States, and our people would probably look askance at any proposal for a +great agricultural bank or banks of this type with branches scattered +throughout the country. It is contrary to our banking traditions, and, +like the plan for a strictly government bank, should not be thought of +until plans for meeting the need by private initiative have been fairly +tried and found wanting. + +When one considers the question of the improvement of agricultural +credit in the United States one instinctively thinks of the co-operative +credit banks of the old world, because of their phenomenal success for a +half century and more, the simplicity of their structures, the ease with +which they may be established, and their ready adaptability to the +widely varying conditions found in a great country like the United +States. The description of the wonderful success of these institutions +as told by Henry W. Wolff in his _People's Banks_ reads like a fairy +story. Although the success of co-operative banks has been great in +nearly every country of Continental Europe, nowhere else has it been so +great as in Germany, the country of their origin, and it is to Germany +one naturally turns first for suggestions. There we find four types of +co-operative credit banks, Landschaften, Ritterschaften, +Schulze-Delitzsch banks and Raiffeisen banks. The first two are +co-operative associations loaning money on land mortgages, and securing +funds largely through the issue of bonds against the collective +mortgages. Being concerned with long-time mortgage credit they do not +fall within the province of this paper. The other two types of banks +deal especially with short-time credit, the one chiefly in the towns and +cities, and the other with farmers in the rural communities. It is with +the latter that we are most concerned. Let us therefore consider briefly +the essential features of the Raiffeisen system. + +These features are: (1) Organization on the strictly co-operative +principle, none but members having the right to borrow, although +non-members may make deposits. (2) Limitation of loan operations to a +very small area in which all farmers are acquainted with each other. A +bank's field of business, the founder believed, should not cover a +parish of less than 400 people nor of more than 1,500. The banks were to +be, therefore, purely neighborhood affairs. There is a sympathetic but +well-informed neighborhood opinion which prevents the squandering of +loans. (3) Unlimited liability of all members for the debts of the bank, +a necessary corollary of which is the provision that membership is +obtained only by election by those already members. (4) The working +capital of the bank is obtained chiefly from the following sources: (a) +Small savings "drawn, either from within the area covered by the bank, +in which case it comes both from members and non-members, the former +being rewarded where possible at slightly higher rates in order to +encourage membership; or from without the area, in which case it of +necessity comes from non-members."[213] (b) Loans from the provincial +bank of the district, or more importantly from the central bank of the +Empire at which the local bank keeps a current account and with which it +may rediscount its paper. Funds are also sometimes obtained from other +banks or from private individuals. (c) A purely nominal share capital +which the banks did not originally have, and which they have been forced +against their will to issue. The requirement is now usually met by the +issue of a few low-priced shares of which no member can hold more than +one and upon which no dividend is paid. (d) Two surplus funds called +reserve funds; one used exclusively to cover losses, and the other being +the principal reserve fund (_Stiftungsfund_), commonly used for +"positive improvements, such as the extension of the premises or the +establishment of a burial fund."[214] In this fund must be placed +two-thirds of the annual profits. The fund cannot be distributed among +the members, even though the bank be dissolved. In such a case it is +held in trust for a time for a new bank, should one be established, and +if no such bank is established it must be used for some work of public +utility. A recent publication of the International Institute of +Agriculture[215] analyses the total working capital of the rural banks +of Germany for the year 1909 as follows: + + _Amount Percentage + in Marks + 000,000_ + +Share capital 22.4 1.2 +Reserves 51.0 2.6 +Deposits on current account 189.1 9.8 +Savings deposits 1,455.6 75.2 +Other liabilities[216] 217.5 11.2 +Total working capital 1,935.5 100.0 + +The striking fact brought out by these figures is that out of nearly two +billion marks placed at the disposal of farmers, less than[217] 11.2 per +cent. was furnished by outsiders, while more than 88.8 per cent., was +provided by the savings and other deposits of the farmers themselves and +of the local public. (5) A fifth feature of the Raiffeisen system is +that the bank's administrative organization is simple and democratic. +Final authority on local questions resides in the general meeting in +which every member has one vote. There is elected annually a committee +of management consisting usually of five or six directors who meet +weekly. As a check upon this executive committee there is also elected +annually a council of supervision consisting of from six to nine +members. A biennial audit is made of the accounts of each bank by an +accountant employed by the district or central union. The books of the +bank, except the individual deposit ledger, are open to the inspection +of all members. Officers of the local banks serve without compensation, +except the treasurer who has no vote in the making of loans.... (6) +Advances take two forms: the ordinary loan (of which the name is +sufficiently descriptive), and the current account which is similar to +the Scotch cash credit. The latter constitute about a third[218] of the +total and show a tendency to increase in proportion to the ordinary +loans. The period of the ordinary loan varies from six months to three +years; and in exceptional cases it may be even longer.[219] Loans are +repayable in instalments covering interest and part of the principal, or +in lump sums. Banks reserve the right to call a loan on four weeks' +notice. The average credit advanced per member is 500 marks, and the +average interest rate probably somewhere between 4 and 5 per cent. +Although mortgage and other collateral security is sometimes accepted, +the banks' chief reliance is personal security, and the great bulk of +the loans are made on two-name paper. + +The Raiffeisen banks are organized into provincial federations with +provincial banks at their head, and these in turn into a national +federation with a central bank at its head. These provincial banks and +the central bank "equalize the need of credit of the individual banks, +supplying them with money when required and employing their surplus +funds."[220] A large proportion of the German co-operative banks and +other co-operative agricultural societies are federated in a single +national organization, the National Federation of Darmstadt.[221] + +Such are the leading features of the greatest agricultural credit system +of the world. To the American the surprising thing about it all is that +such co-operative credit banks are practically unknown in the United +States, although there has been a remarkable development here in recent +years of other forms of co-operation among farmers.[222] This surprise +is the greater when one bears in mind that "whole counties have been +populated in the Northwest by European agriculturists who came from +neighborhoods where they were familiar with agricultural co-operative +credit, and yet not a society of co-operative credit for these +immigrants has been established from the beginning to the present +time."...[223] + +What is needed now--and possibly about all that will be needed in the +future--is a campaign of education among the farmers themselves rather +than one of legislation; although the development of such societies will +doubtless be furthered in many states by legislation, such as was +recently enacted in Massachusetts (ch. 419, Acts of 1909), freeing them +from some of the hampering provisions of the general banking act of the +state. Conditions are so widely different in different sections of the +country, and among different classes in the same section, that +co-operative agricultural credit societies will need to be given a +fairly free hand in such matters as limited or unlimited liability, the +amount of share capital, receipt of deposits, etc., so that they may +adapt themselves to local needs. A reasonable amount of government +supervision on the part of the banking departments of the states seems +desirable. + +Passing now to the question of the better utilization of our existing +banking machinery, we may consider it first from the standpoint of the +Government, then from that of the banks, and finally from that of the +farmers themselves. + +The provisions of the national banking act _(Revised Statutes_, Sec. +5137) are too rigid in the matter of loans on real estate security.[224] +National banks are, of course, intended to be banks for business men, +and their assets should be quick assets in so far as their liabilities +are quick liabilities. But it should not be overlooked that the modern +farmer is a business man, that he needs active credit for the efficient +conduct of his current business, and that land is the only kind of +collateral many farmers can give that is acceptable to bankers. Many +worthy farmers are not willing and some are not able to secure +satisfactory endorsers to their paper. Crop liens, except in the South, +are not usually very acceptable to banks. The ability of the farmer to +give mortgage security to national banks in case of need would often +prove a great help. Furthermore, now that a majority of our national +banks have savings departments, and that savings deposits might wisely +be made withdrawable subject to advance notice, it is not unreasonable +that these banks should be permitted to invest at least a substantial +part of their savings funds in the same kinds of mortgage securities +that are open to the investment of funds of savings banks; provided, of +course, that due care be taken to prevent the juggling of accounts +between the commercial department and the savings department of the +bank. + + +Another form of desirable legislation in the interest of the farmer +consists in the abandonment of our unscientific bond secured bank-note +circulation for a scientific system, and in the rendering of our deposit +currency more elastic. The more the farmer resorts to bank credit as a +means of financing his current business the more will he suffer from the +seasonal inelasticity of our bank-note and deposit currency. Farming +business is pre-eminently seasonal in character; the farmers over the +greater part of the country need funds most at about the same times of +the year, _i.e._, the fall and spring. A great increase in the demand +for currency and capital, say in the fall, under an inelastic currency +and credit system like our own, means to the farmer, highest interest +rates at just the time when he needs most to borrow, greatest scarcity +of cash at just the time when his need for cash is the most urgent, and +prices depressed by a tight money market at the time of the year when he +has most to sell. It is doubtful if any class of people in the country +would benefit more from a thoroughgoing reform of our banking system +than would the farmers. + +The apportionment of responsibility between farmer and banker for their +not having gotten together better is an impossible task. Although some +exceptions must be made, particularly in the Middle West, as a general +proposition neither has appreciated the opportunity which the other +offered. + +The banker must be brought to realize that one of the best kinds of +paper in the world is short-time business paper bearing the names of two +responsible farmers. He should be an adviser and friend to the farmer as +much as to the city customer. He should make the farmer feel that a +productive loan to him is not of the nature of a favor reluctantly +granted--as so many farmers complain--but rather a business proposition +profitable to both, as gladly given as it is received. He should further +co-operate with the local business men in preparing financial ratings of +farmers, to fill the gap left by the inability, to be hoped temporary, +of mercantile credit agencies to rate farmers as extensively as they do +other business men of like capital. + +The farmer, on the other hand, must be educated by the banker, the +press, and the agricultural school and college, to the advantages of +credit as a mean to the more efficient working of his farm. This should +be done with caution, for credit is a two-edged sword. The farmer should +be encouraged to borrow only when it is very clear that he can use +additional capital so productively that it will pay. But what +industrious farmer could not use profitably some additional capital +every year, could he obtain it at as reasonable rates as does the +merchant? The farmer must learn to keep careful accounts. He must be +made to realize that the banks are open to him as to other business men, +and that the bulk of the country's short-time commercial loans, as +likewise of the agricultural loans of Europe, are made on the very same +security he is capable of giving, _i.e._, two-name paper of honest, +industrious business men. + + +FARM CREDIT IN A NORTHWESTERN STATE[225] + + +LONG-TIME LOANS + +In North Dakota the average farm mortgage runs for 4.94 years; and the +average interest rate is approximately 8 per cent. (accurately 7.88 per +cent.). This 8 per cent. does not include the expense of abstracting +titles, examining the property, and the recording of the mortgage. These +fees are invariably paid by the borrower. Nor does this interest rate of +8 per cent. take account of the bonus that is frequently exacted, in the +newer regions, from the borrower for the privilege of securing a loan; +nor does it allow for the sum the borrower loses in paying his yearly +interest in advance, which is deducted from the principal. While the +practice of exacting a bonus is not common, it is generally the custom +to deduct the entire year's interest in advance; assuming an 8 per cent. +rate, the farmer therefore pays $80 interest not on $1,000 but on $920, +which brings the rate up to 8.7 per cent. + +While the average prevailing rate, according to our returns, is +approximately 8 per cent., the rate varies in different parts of the +state, depending upon the local conditions. The rates are lowest in the +eastern tier of counties, and rise gradually towards the western part of +the state, where the rate runs up to 10 and 12 per cent., which is also +the rate in the eastern part of Montana. That the 8 per cent. rate is +quite general for a large part of the state is evidenced from the fact +that 25 of the 45 counties report an average rate of 8 per cent. or +more. In only 4 counties is the rate less than 7 per cent., and in no +county does the average fall below 6 per cent. + +The above figures are conservative. They are based on returns submitted +by bankers who would naturally understate rather than overstate the rate +of interest charged in their respective localities. Furthermore, we have +a check on these bank returns in the replies received from farmers. As a +rule the rates reported by bankers and farmers are nearly identical in +their respective counties. It is safe to conclude, therefore, that the +average rate on farm mortgages for the entire state is about 8 per cent. + + +SHORT-TIME LOANS + +Short-time loans are of two kinds, bank loans and book credit advanced +by retail stores. The bank loan is made on the farmer's note, generally +unsecured, though often secured by a chattel mortgage. According to the +reports received from 125 banks, the average length of time for these +short-time loans is 8-1/2 months; and the average rate of interest is +10.75 per cent. The average rate reported by farmers residing in 22 +different counties was 11.07 per cent. + +An effort was made to compare rates paid by farmers with those paid by +business men on short-time loans in the same locality. The same banks +that reported an average of 10.75 per cent. to farmers averaged only +9.18 per cent. on loans made to merchants and manufacturers. Fully 95 +out of the 125 reporting banks stated that the rate was higher for +agricultural short-time loans than for commercial loans; 26 reported the +rate to be the same for both classes; and only 4 reported a lower rate +for the farmer. As North Dakota, however, is not a manufacturing nor a +jobbing state, commercial paper is scarce, and consequently comparisons +of the above nature are apt to be misleading. The significant fact +remains that the farmer pays from 10 to 11 per cent. on small loans, for +short periods of time. + +Store or book credit is a form of short-time loan which is perhaps more +important than bank credit. In a state where the bank charges a high +rate of interest, the farmer is more likely to buy merchandise on credit +than to borrow from the bank and pay cash. The North Dakota farmer is +rarely denied credit at a country store. To secure information on this +form of credit, questionnaires were mailed to implement and hardware +dealers, as well as to farmers. One question asked of implement dealers +was: "What percentage of farmers pay cash in buying farm machinery?" The +answer from 54 firms, located in 35 counties, was that only 13 per cent. +of the farmers pay cash, 87 per cent. buying on time. Out of 29 farmers +reporting only 6 pay cash in buying machinery and supplies. These book +accounts run anywhere from three months to two years; the average +account is carried about one year (12.37 months). The farmer +contemplates making payment immediately after his prospective crop is +marketed. In case of crop failure the retailer will carry the account +over until the next harvest season. + +It is quite common for the dealer to obtain a note from the farmer--the +note generally bearing a 10 per cent. interest rate from the date of +issue. Often, however, the note does not begin to bear interest until +the farmer has failed to make payment at the expected time, that is, +immediately following the harvesting season. The 54 implement and +hardware dealers reported an average of 10.26 per cent. interest per +year on these notes. + +It is more difficult to secure uniform information from dealers on the +subject of book credits, especially with reference to the interest rates +charged on such accounts. The practice varies. Usually an interest rate +is added to the credit price depending on the duration of the account. +There is no common discount rate for cash purchases, though 7 per cent. +is most common, that is, 7 per cent. of the credit price. This brings +the credit price of a $160 binder down to $150 for cash. As a matter of +fact all dealers quote two prices, the cash and the credit price, the +difference between the two depending upon the reputation of the buyer, +the shrewdness of the seller, and the degree of competition in the +particular locality. + +On this point, replies from farmers do not differ materially from the +replies of the implement dealers. The difference between the cash price +and the credit price of a binder is usually given as $5 to $10, and a +wagon or plough, as $3 to $5. The general discount rate is 7 per cent. +off the credit price. + +The implement dealers and the farmers are all agreed that cash payments +would be preferable if rates on bank loans were reduced. The farmer, +however, is often afraid to approach the banker for a loan. On the other +hand, the farmer does not always see that the book credit is quite as +expensive as bank credit, if not more so. The prevailing high bank +rate, however, from 10 per cent. to 12 per cent. on short-time loans, +does not encourage cash payments. + +Are the foregoing rates too high as compared with rates in other +communities? The _Crop Reporter_ for April, 1913, shows interest rates +on short-time loans in every state in the Union. In 1913, the North +Dakota rate exceeded that of all other States; in 1912, it exceeded all +but Oklahoma. + +Farmers as a rule think that rates are fixed arbitrarily by the bankers +and other money lenders in the community. That fundamental laws of +supply and demand have any controlling influence is apt to be +overlooked. Without attempting to justify the high rates let us state +some of the conditions which help to explain them. The demand for +capital in a growing state is always greater than can be met by the +local supply. In 1890, North Dakota farms were mortgaged for +$11,168,854; in 1910, for $47,841,587; in 1920 it will doubtless reach +$150,000,000. Outside capital is attracted into the state by high rates +of interest. Two life insurance companies, the Union Central of +Cincinnati and the Northwestern Mutual of Milwaukee, loan heavily in the +state. In 1910 the Union Central Life Insurance Company reported a total +investment of $5,489,087.33 in North Dakota real estate. Local banks use +farm mortgages in borrowing money from banks in large cities outside of +the state. Every town and village has its money-lender who acts as agent +for foreign investors in farm mortgages. Banks within the state compete +for capital by offering high rates of interest on time deposits, and pay +all the way from 4-1/2 to 7 per cent. interest on deposits. The rate on +loans must necessarily be higher under these circumstances than where +banks are paying 2-1/2 and 3 per cent. interest. The high interest rate +paid on bank deposits is evidence of the lack of local capital to +satisfy the local demand. + +The inability to attract foreign capital on lower terms is due primarily +to the character of the investment. The newness of the state, the +instability of its population, the character of its agriculture, all +make for uncertainty. Hence the speculative character of the farm +mortgage as security for a loan. In the eastern counties where the land +has long been under cultivation, where the population is more stable, +and where mixed farming has in a large measure supplanted the bonanza +wheat farm, rates are correspondingly lower than in the newer portions +of the state. As the element of risk is eliminated from investments, +interest rates will come down. At least this seems to be the consensus +of opinion among bankers. + +The character of the farming is frequently mentioned as a prominent +factor in the credit situation. A crop failure under a single crop +system, such as is practised in North Dakota, is likely to find the +farmer in bad straits. The payment of interest on the mortgage is +delayed or deferred. The local bank or loan company is obliged either to +carry the farmer along for a year or to foreclose. Since many farm +mortgages are held by outside investors, the annoyance is sufficient to +reflect itself in an increased rate of interest. Because of this fact +many bankers are urging mixed farming as a means of reducing rates. This +aspect of the question is well expressed in a communication from a +banker in Stark County who says: + + It is our belief that the scarcity of money and the high + interest rates are largely due to poor farming. The people + having money to loan know well that our farmers here have a + very uncertain income according to their present methods of + farming, and would expect a much higher rate commensurate + with the risk taken when they can find people where money + can be placed more safely. As conditions are here now, some + people have not paid all their interest, for at least three + or sometimes four years. In the older slates, like Iowa for + example, where people farm well, interest rates are much + lower. As soon as our farmers can show that they are safe + and will take care of their obligations promptly, they can + command the lowest interest rates that may exist. We believe + it more necessary to work on better farming methods, + encouraging them, than on better interest rates, for the + lower interest rates are a natural consequence of better + farming. + +Another factor is the character of the population. One prominent banker +says of North Dakota farmers: "They lack a sense of responsibility. Farm +loans require constant care, hence high rates." Another complaint is: +"Farmers are careless in not making prompt payment or renewals of +obligations." Some bankers think the high rates due to too much +borrowing; that is, too much liberality in the loaning of money. +Injudicious loaning leads to extravagance, and naturally calls for high +rates to offset the risks involved. One banker in analyzing the +situation claims that the legal restrictions placed on the loaning power +of banks is responsible for unduly high rates. In support of this view +it might be stated that while the total farm mortgages in the state in +1910 reached the $50,000,000 mark, the power to loan on real estate by +all banks, state and national, was less than $5,000,000. Banks are +forced to loan on the personal note of the farmer, secured by a +mortgage, instead of taking a direct mortgage on the property. Other +banks turn these mortgage loans over to trust companies, and collect a +commission from the farmer for placing the mortgage. + +Commissions are responsible for at least from one to two per cent. of +the rate when loans are handled by real estate agents and loan +companies. In the case of loans by life insurance companies, the state +agent generally receives one per cent. and the local agent, at interior +points, receives one per cent. Two per cent. could be saved by the +farmer if the money could be borrowed directly from the investor, +without the aid of an agent. + +Allowing, however, for all these local conditions--the great demand for +capital in a new and developing country, the inability to attract +sufficient outside capital because of the risky character of +investments, the irresponsible character of some elements in the +population, the character of farming methods, the commission agent, and +the legal restrictions handicapping banks--allowing for all these +conditions, and because of some of them, it is believed that the farmers +by organizing co-operative credit associations could reduce the rate of +interest on both long- and short-time loans; and, furthermore, that such +co-operative credit facilities would be a means of improving the methods +of farming, would encourage stability in population, and would make the +farmer feel that he is not being discriminated against in the borrowing +and employment of capital. + + +CATTLE LOAN BANKS[226] + +Consumers desiring a reduction in the cost of food supplies will be +interested in a study of the operations of cattle loan companies and in +the development which these may reasonably attain as a result of the +provision in the Federal Reserve Act for the rediscounting of +agricultural paper. + +The cattle loan company, commonly referred to as "cattle bank," is a +middleman between borrowing cattle-owners and lending bank-managers. Its +business methods and forms closely parallel those of real estate +mortgage loan companies except for the fact that cattle loans are of +shorter duration and secured by mortgages of the chattel variety. Cattle +loan companies, incorporated under state charters, have been operating +in such cities as Fort Worth, Denver, East St. Louis, St. Joseph, +Portland, South St. Paul, Omaha (2), and Kansas City (3), some of them +for over twelve years; and one is now being organized in Chicago. These +companies have a paid-in capital stock ranging from $50,000 to $300,000, +and are usually closely affiliated with a national or state bank, as are +trust companies in the larger cities. + +These companies are informed of desired loans through country bankers, +or by receipt of direct applications, the latter usually from the larger +"cattle-growers." In some cases the company on its own initiative urges +cattlemen in whom it has particular confidence to undertake feeding +operations at a time when the beef market offers a favorable opportunity +for such production. In every case a salaried examiner of the company +inspects the plant and herd of the cattle-grower and his personal +capacity and integrity before the granting of a loan. And thereafter the +examiner, on his regular circuit, maintains a continuous inspection and +volunteers advice designed to protect the value of the security given +for the loan. When a loan application has been acted upon favorably, a +promissory note and chattel mortgage are taken. The funds of the company +then advanced to the borrowers may be utilized to buy more cattle, to +pay outstanding debts such as those for feeding expense, or, as is often +the case, to buy the very cattle which are pledged as security for the +loan. In a few cases where the cattle-grower enjoys an exceptional +credit, funds will be advanced for the full purchase price of a herd for +seasonal feeding purposes, or to develop two-year-olds into finished +four-year-old beef cattle. The loans granted are seldom less than 60 per +cent. of the known value of the cattle. + +To secure a buyer for the note and mortgage is the second primary +function of the cattle loan company. If the loan is a small one, usually +$10,000, it may be sold entire, the chattel mortgage assigned and the +note indorsed to the buyer. If the loan is a larger one, of $50,000 to +$100,000, it is necessary to subdivide it in order to provide a ready +sale. The mortgage and note are assigned in parts of $5,000, $20,000, or +other denominations, to suit the convenience of the buyers of the paper. +In this case the assigned parts, since they are indorsed by the loan +company, are equivalent to a "debenture" issue secured by a pledge of +specified assets held by the company for the protection of the +note-holders. The size of mortgage loan most frequently made is $10,000, +while loans of $100,000 are exceptional. + +The business of cattle loan companies approaches closely to the +functions of the commercial paper broker. The cattle loan company has an +advantage over the commercial paper broker in that the favorable +location of the company--always at the receiving cattle-market of the +district in which its loans are exclusively placed--enables it fully to +protect its interest by claiming the proceeds of sales of mortgaged +cattle. This is particularly true in the case of range cattle, which can +be readily identified by the mortgaged brands. + +To cover expenses of administration the cattle loan company secures for +itself a part of the interest paid on the loan. The rate charged the +borrower is usually determined by conditions in the locality where it is +made, sometimes running as high as 10 per cent., and again, influenced +by general rates for capital, falling as low as 7 per cent. From this +gross interest charge a commission has to be given to the local banker +who makes the loan, expenses of examination and management must be met, +and an appropriation made to a contingency reserve fund to cover +occasional losses incurred from the circumstance that the companies +usually become surety, by indorsement, for the final payment of all the +loans which they have placed with lenders. These deductions determine +what may be safely paid to eastern purchasers of the paper, usually 5 or +6 per cent. + +Holders of cattle paper have never suffered in times of financial panic +from failure to pay at maturity. Cattle, like grain, are a cash +commodity purchased by retailers and sold by them, largely for cash, to +satisfy a relatively constant consuming demand. This characteristic is +retained even in time of panic. + +Maturities are usually six months for feeding purposes; and less often +of two and one-half years for developing two-year-olds for market. This +two and one-half year paper is occasionally converted into the six-month +variety by the sale of notes running for six months, based upon the +two-and-one-half year mortgage. These notes are taken up at maturity by +the loan company and reissued or renewed for like succeeding periods +until the original loan is repaid. + +In the past this form of loan has not been so desirable as it will be in +the near future. It has been a relatively long-term investment; and +while perfectly liquid at maturity and enjoying a good rate of return, +it has not possessed a sufficiently wide market to insure salability at +those times when the demands of depositors and local customers for +accommodation press in upon the investing bank. This difficulty will be +fully corrected by the expected operations of the Federal Reserve Act. +Eastern bankers possessing these six-month notes will probably find them +readily rediscountable with the local federal reserve bank at any time +up to maturity. And a considerable amount of two-and-one-half year notes +may be held to advantage, since, if properly selected with successive +maturities, one-fifth of their total amount will be immediately +rediscountable when necessary. + +By rendering this form of agricultural paper liquid before maturity the +Federal Reserve Act will have become a most important influence for +enlarging the amount of capital devoted to this branch of industry. +Already eastern bankers have scouts touring the Western States to study +this form of banking with a view to investing several millions of +dollars each. Interest rates upon these loans will unquestionably be +reduced in time through such increased competition of lenders. The loan +companies will hardly suffer, however. While charging the cattle-grower +less, they will be enjoying a larger turnover and should welcome this +new development. The four or five million dollars placed in such loans +yearly by the average loan company, as at present constituted, is but a +fraction of the loans that may be placed by them within a few years. + +By reducing the interest cost charged to cattle-growers an important +service will have been performed for the consumer. Such a reduction will +increase, in the first instance, the cattle-man's profit and induce him +to increase his holdings. The benefit of increased production at lowered +expense should, in time, be passed on to the final consumer of beef. + +This phase of the operations of the Federal Reserve Act will be of +distinct benefit, and possibly also the least dangerous of all forms of +legislation designed to assist American agriculture. + +FOOTNOTES: + +[197] Adapted from R. B. Van Cortland. _What is Agricultural Credit? +North American Review_, Vol. 199, April, 1914, pp. 585-588. + +[198] E. W. Kemmerer, _Agricultural Credit in the United States, The +American Economic Review_, Vol. 2, No. 4, December, 1912, pp. 852-872. + +[199] New York, Chicago, Philadelphia, St. Louis, Boston, Cleveland, +Baltimore, Pittsburgh, Detroit, San Francisco, Milwaukee, and +Cincinnati. For Buffalo, the tenth city in population, Cincinnati, the +thirteenth city, was substituted, since for Buffalo, which is not a +reserve city, satisfactory banking figures are not available. + +[200] [National banks are now permitted to lend on real estate security +by the Federal Reserve Act passed in 1913.] + +[201] Cf. Testimony before United States Industrial Commission +(_Report._ X, under subjects of "Credit System" and "Crop Lien System," +_passim_.) + +[202] _Report_. X, p. 161. + +[203] In some states farmers themselves own considerable amounts of bank +capital. This is said to be particularly true of Iowa. + +[204] The average value per acre of farm land in the United States rose +from $15.57 in 1900 to $32.40 in 1910, a rise of 108 per cent. +_Thirteenth Census, Bulletin on Farms and Farm Property_, p. 15. + +[205] _Report_, X, p. 938. + +[206] Exclusive of Alaska and Hawaii. + +[207] Values in gold. + +[208] Cf. _Twelfth Census_, V, pp. xxix and xxx. and _Thirteenth Census, +Bulletin on Farm and Farm Property by States_, pp. 13 and 15. + +[209] Every census since 1870 has shown a larger percentage of the +native population living in state or territory of birth. + +[210] On this subject see the writer's article on "Agricultural Credit" +in L. H. Bailey's _Cyclopedia of American Agriculture_, IV, p. 270; and +his _Report to the Treasurer of the Philippine Islands on The +Advisability of Establishing a Government Agricultural Bank in the +Philippine Islands_, pp. 9-11, 151-154. + +[211] Cf. E. W. Kemmerer, _Report to the Secretary of War and to the +Philippine Commission, on The Agricultural Bank of Egypt_. (Manila, P. +I.: 1906. Also published by Bureau of Insular Affairs, Washington, D. +C.) + +[212] Cf. E. W. Kemmerer, _An Agricultural Bank for the Philippines, +Yale Review_, November, 1907, pp. 262-279. + +[213] C. R. Fay, _Co-operation at Home and Abroad_, p. 44. (New York; +Macmillan, 1908.) + +[214] Fay, _Co-operation_, etc., p. 44. + +[215] _An Outline of the European Co-operative Credit Systems_, pp. 12 +and 13. + +[216] Under "other liabilities" are included in addition to other items +the funds which the banks have borrowed from banks and individual +capitalists. + +[217] The capital of the district banks and of the central bank came +largely from the local banks. + +[218] In 1909 the figures for Germany were: Loans on current account, M +425,995,403 and Loans for fixed periods, M 1,082,446,388. The +International Institute of Agriculture, _An Outline_, etc., p. 14. + +[219] _Idem_. + +[220] _Ibid._, p. 17. + +[221] _Idem_. + +[222] "Farmers' economic co-operation in the United States has developed +enormously during the period under review [1896-1908], and it safe to +say that at the present time more than half of the 6,100,000 farms are +represented in economic co-operation; the fraction is much larger if it +is based on the total number of medium and better sorts of farmers to +which the co-operators mostly belong." The most prominent objects are: +Insurance, creameries, cheese factories, co-operative selling +organizations of numerous kinds, co-operative buying organizations, +co-operative warehouses, co-operative telephones, co-operative +irrigation, etc. _Annual Report of the Secretary of Agriculture 1908_, +pp. 183, 184. + +[223] Quoted from a letter from Mr. George K. Holmes, Statistician of +the Department of Agriculture, Washington, D. C. + +[224] For a statement of the more liberal privileges concerning the +making continued: of loans on mortgage security conferred on national +banks by the Federal Reserve Act see p. 750.--EDITOR. + +[225] Adapted from Meyer Jacobstein, _Farm Credit in a Northwestern +State, American Economic Review_, Vol. 3, September, 1913, pp. 598-605. + +[226] J. F. Ebersole. _Cattle Loan Banks, The Journal of Political +Economy_, Vol. 22. No. 6, June, 1914, pp. 577-580. + + + + +CHAPTER XXVIII + +THE CONCENTRATION OF CONTROL OF MONEY AND CREDIT + + +HAVE WE A MONEY TRUST? + +[227]If by a "money trust" is meant-- + + An established and well-defined identity and community of + interest between a few leaders of finance which has been + created and is held together through stock holdings, + interlocking directorates, and other forms of domination + over banks, trust companies, railroads, public-service and + industrial corporations, and which has resulted in a vast + and growing concentration of control of money and credit in + the hands of a comparatively few men-- + +your committee has no hesitation in asserting as the result of its +investigation that this condition, largely developed within the past +five years, exists in this country to-day. + +The parties to this combination or understanding or community of +interest, by whatever name it may be called, may be conveniently +classified, for the purpose of differentiation, into four separate +groups. + +First. The first, which for convenience of statement we will call the +inner group, consists of J. P. Morgan & Co., the recognised leaders, and +George F. Baker and James Stillman in their individual capacities and in +their joint administration and control of the First National Bank, the +National City Bank, the National Bank of Commerce, the Chase National +Bank, the Guaranty Trust Co., and the Bankers Trust Co., with total +known resources, in these corporations alone, in excess of +$1,300,000,000, and of a number of smaller but important financial +institutions. This takes no account of the personal fortunes of these +gentlemen. + +Second. Closely allied with this inner or primary group, and indeed +related to them practically as partners in many of their larger +financial enterprises, are the powerful international banking houses of +Lee, Higginson & Co. and Kidder, Peabody & Co., with three affiliated +banks in Boston--the National Shawmut Bank, the First National Bank, and +the Old Colony Trust Co.--having at least more than half of the total +resources of all the Boston banks; also with interests and +representation in other important New England financial institutions. + +Third. In New York City the international banking house of Messrs. Kuhn, +Loeb & Co., with its large foreign clientele and connections, whilst +only qualifiedly allied with the inner group, and only in isolated +transactions, yet through its close relations with the National City +Bank and the National Bank of Commerce and other financial institutions +with which it has recently allied itself has many interests in common, +conducting large joint-account transactions with them, especially in +recent years, and having what virtually amounts to an understanding not +to compete, which is defended as a principle of "banking ethics." +Together they have with a few exceptions pre-empted the banking business +of the important railways of the country. + +Fourth. In Chicago this inner group associates with and makes issues of +securities in joint account or through underwriting participations +primarily with the First National Bank and the Illinois Trust & Savings +Bank, and has more or less friendly business relations with the +Continental & Commercial National Bank, which participates at times in +the underwriting of security issues by the inner group. These are the +three largest financial institutions in Chicago, with combined resources +(including the two affiliated and controlled state institutions of the +two national banks) of $561,000,000. + +Radiating from these principal groups and closely affiliated with them +are smaller but important banking houses, such as Kissel Kinnicut & Co., +White. Weld & Co., and Harvey Fisk & Sons, who receive large and +lucrative patronage from the dominating groups and are used by the +latter as jobbers or distributors of securities the issuing of which +they control, but which for reasons of their own they prefer not to have +issued or distributed under their own names. Messrs. Lee, Higginson & +Co., besides being partners with the inner group, are also frequently +utilised in this service because of their facilities as distributors of +securities. + +Beyond these inner groups and subgroups are banks and bankers throughout +the country who co-operate with them in underwriting or guaranteeing the +sale of securities offered to the public and who also act as +distributors of such securities. It was impossible to learn the identity +of these corporations, owing to the unwillingness of the members of the +inner group to disclose the names of their underwriters, but sufficient +appears to justify the statement that there are at least hundreds of +them and that they extend into many of the cities throughout this and +foreign countries. + +The patronage thus proceeding from the inner group and its subgroups is +of great value to these banks and bankers, who are thus tied by +self-interest to the great issuing houses and may be regarded as a part +of this vast financial organisation. Such patronage yields no +inconsiderable part of the income of these banks and bankers and without +much risk on account of the facilities of the principal groups for +placing issues of securities through their domination of great banks and +trust companies and their other domestic affiliations and their foreign +connections. The underwriting commissions on issues made by this inner +group are usually easily earned and do not ordinarily involve the +underwriters in the purchase of the underwritten securities. Their +interest in the transaction is generally adjusted, unless they choose to +purchase part of the securities, by the payment to them of a commission. +There are, however, occasions on which this is not the case. The +underwriters are then required to take the securities. Bankers and +brokers are so anxious to be permitted to participate in these +transactions under the lead of the inner group that as a rule they join +when invited to do so, regardless of their approval of the particular +business, lest by refusing they should thereafter cease to be invited. + +It can hardly be expected that the banks, trust companies, and other +institutions that are thus seeking participations from this inner group +would be likely to engage in business of a character that would be +displeasing to the latter or that would interfere with their plans or +prestige. And so the protection that can be offered by the members of +this inner group constitutes the safest refuge of our great industrial +combinations and railroad systems against future competition. The +powerful grip of these gentlemen is upon the throttle that controls the +wheels of credit and upon their signal those wheels will turn or stop. + +In the case of the pending New York subway financing of $170,000,000 of +bonds by Messrs. Morgan & Co. and their associates, Mr. Davison +estimated that there were from 100 to 125 such underwriters who were +apparently glad to agree that Messrs. Morgan & Co., the First National +Bank, and the National City Bank should receive 3 per cent.--equal to +$5,100,000--for forming this syndicate, thus relieving themselves from +all liability, whilst the underwriters assumed the risk of what the +bonds would realise and of being required to take their share of the +unsold portion. This transaction furnishes a fair illustration of the +basis on which this inner group is able to capitalise its financial +power. + +It may be that this recently concentrated money power so far has not +been abused otherwise than in the possible exaction of excessive profits +through absence of competition. Whilst no evidence of abuse has come to +the attention of the committee from impartial sources, neither has there +been adequate proof or opportunity for proof on the subject. Here again +the data have not been available. + +Sufficient has, however, been developed to demonstrate that neither +potentially competing banking institutions nor competing railroad or +industrial corporations should be subject to a common source of private +control. + +Your committee is convinced that however well founded may be the +assurances of good intentions by those now holding the places of power +which have been thus created, the situation is fraught with too great +peril to our institutions to be tolerated. + + +THE BORROWER AND THE MONEY TRUST + +[228]Some trusts are denounced because of their attitude toward their +employés. Many trusts are efficient or inefficient because of the way +their millions of labourers work. But let us be fair to Big Business. +Why not examine its one branch where labour is almost absent, where +there is no brawn and all brain? + + +BANKING THE MOST LOGICAL OF TRUSTS + +A bank in New York City gave its employés a Christmas present equal to +half their annual salary. The bank had assets of $100,000,000. A fine +example, you say, to other great business concerns! But the bank had +only fifty employés. In the entire country there are probably not more +than 100,000 persons engaged in banking, either directly or indirectly. + +The banker has, relatively speaking, no human factor to consider. And +that factor with a concern like the United States Steel Corporation or +the Pennsylvania Railroad is mammoth, almost baffling. The banker deals +not in the production or distribution of wealth itself (in both of which +much labor is needed), but solely in the paper representatives of +wealth, money, and credit. Thus he can apply far more directly than the +manufacturer or railroad manager the economies and efficiencies of Big +Business. + +Banking--the business of dealing in money and credit--is the most +logical of trusts. And in practice it has justified the theory. Where +banks have become larger they have become stronger, where co-operation +and concentration have gone far, there safety and effectiveness have +reached a high pitch.... Banking is the one central business of all--it +is the business of businesses. So if it has become more efficient as the +trust idea, or at least the principle of concentration, has gained sway, +how can we have too much concentration and who is there to complain?... + +If the bankers have, faithfully and well, handled the trust of +extending credit to the limit of their ability, yet when the president +of the second bank in size in the country acknowledges himself to be one +of about a dozen men in whose hands the power of extending credit is, in +the last analysis, concentrated--then it is high time, seriously and +fearlessly, to consider the subject.... + +Three main factors are in the main responsible for the concentration of +the control of credit and they are the growth of big banks, the growth +of big industries, and the financial laws of the country.... + + +NO LACK OF BANKING FACILITIES + +However great the concentration of money power in this country, it +cannot truthfully be said that banking facilities are not also +increasing. Figures taken from the reports of the National Monetary +Commission and other official sources show that the number of banks is +mounting up faster than either wealth or population.... + + +WHERE THE MONEY HAS GONE + +When one first realises the extent of this country's banking resources +he is properly astonished. But how evenly are these resources +distributed? It is commonly known that banking facilities in the +Southern and Western sections of the country are small indeed as +compared with the New England, Eastern, Central, and Pacific Coast +sections, where large cities abound. To illustrate, in 1909, when the +total banking power was close to twenty-one billions, more than half was +represented by forty-seven cities, and close to one-quarter was held by +the two hundred banks in New York and Chicago. In other words about 1 +per cent. of the country's banks held close to one-quarter of the +country's banking power. + +Now it is a well-known fact that an individual or corporation with large +resources and large business exerts an influence in his particular field +far in excess of his actual mathematical percentage of the total +resources or business. Thus the dominating position of the big banks is +even greater than mere figures indicate. But there is still another fact +which centralises and cements their power. The only banks which are +really large are in a few cities, and the larger they are, the more they +tend to the very greatest centres of population. Thus toward the end of +1911, there were 183 banking institutions with deposits of $10,000,000 +or more, of which sixty-two were in New York City. There were thirty-six +institutions with deposits of $25,000,000 or more. Sixteen of these were +in New York City and four in Chicago. There were ten with deposits of +$75,000,000 or more, and of these, seven were in New York and two in +Chicago. Of the ten largest trust companies six were in New York, three +in Chicago, and one in Boston. + +These great banks and trust companies are of very recent growth. Twenty +years ago the deposits of our largest bank were one-twentieth of what +they are to-day. At the first inauguration of President McKinley, which +was really not so far back as the Dark Ages, there was no bank in New +York with more than $30,000,000 of deposits. Now there are six banks +each with more than $100,000,000 of deposits. A trust company in New +York City, which had deposits of $20,000,000 five years ago, now has +deposits of $166,000,000 and its twenty-eight directors sit [1912] in +boards of other banking institutions with resources of $1,250,000,000. +When it comes to actual cash we find the position of the New York and +Chicago banks even more dominant.... + + +CONSOLIDATION--A STEADY PROCESS + +Despite the disproportionate size of New York and Chicago banks their +number is steadily decreasing. This is because the process of +consolidation proceeds just as steadily. In 1853 there were fifty-three +banks in the New York Clearing House Association, and in 1911 there were +fifty, although in the meantime the amount of business had increased +twenty times. There are now less than 130 banks in New York, or ten less +than ten years ago, although in that time cash holdings have doubled and +deposits have increased a third. In ten years no less than 103 banks +have gone out of existence, generally through absorption into larger +institutions.... In Chicago the same process of consolidation has gone +on. One Chicago trust company has absorbed six others in eight years. + +New York and Chicago are by no means the only cities in which the +obvious tendency is to have fewer but larger banks. Look about at +random. Akron, Ohio, where the rubber industry has recently become of +more than local importance, has felt the necessity of banks large enough +to carry on its trade, and consolidation has resulted. In Detroit, where +the automobile trade has set in motion a great industrial development, +the Old Detroit National has absorbed the American Exchange National. In +Seattle, Nashville, Wilmington, Portland, Philadelphia, Baltimore, San +Francisco, and Louisville there have been many recent mergers and +absorptions. In Cincinnati one of the largest institutions in the Ohio +Valley has been formed by the absorption of the Merchants' National by +the First National. As for Boston the desire of her capitalists to make +New England more powerful in the business life of the country has led to +the recent absorption of the City Trust Company by the Old Colony and +the steady growth of three financial institutions, the Shawmut National +Bank, the First National Bank, and the Old Colony Trust Company, these +three far exceeding all others in size.... + + +HOW THE LAW HAS FOSTERED AFFILIATION + +... One great cause of the concentration of banking and financial power +into a few hands has been the consolidation of banking resources into a +few great units and the friendly affiliations of these units. But these +units have not grown big merely because their managers or owners willed +it so. The banking and currency laws of the country have forced money +into a few centres. The banks of New York City employ--mainly in +financial or stock market loans--about $600,000,000 which belongs to +banks in other parts of the country. Naturally this concentration of +money in a few banks "places these banks in a position to control the +issuing or granting of credit"--to use the exact words of the president +of one of them--"thereby placing the money power in the hands of a +comparatively small number of men." + +But this gravitation of money to New York is because the money is idle +and is hunting a job, and not because of any process of usurpation, +manipulation, or combination. It naturally arises under and by virtue +of the reserve requirements of our National Banking Act.... The bulk of +idle country bank cash which finds employment in New York comes here +because of the existing reserve system, and there are several great +banks in both New York and Chicago which have few customers other than +the thousands of country banks whose "correspondents" they are. + + +THE CORPORATION AND THE BANK + +Thus banking and financial power is concentrated in a few hands not only +by the growth of great banks and by the laws of the country, but also by +the legitimate business practices which have grown up under these laws. +But the massing of this power in a few vast, centralised units has been +a development of the last ten or fifteen years only. That is, it has +been coincident with the development of trusts and combinations. Big +Business and Big Banking have gone hand in hand. Each has made the other +possible. By law a bank cannot loan more than one-tenth of its capital +and surplus to any one customer. But the customers have grown into +behemoths. How then could the banks fail to grow? + +Before trusts existed and before small railroads were united into large +systems the few banking houses of magnitude which existed in Wall Street +had engaged in merchant banking, for the industries and railroads had +not been large enough to attract their attention. These small industries +and railroads were controlled by their owners, and their capital +requirements were supplied largely in the localities in which they were +situated. But as railroads and industries were consolidated it was found +necessary to apply to the larger New York banking firms to supply the +funds. These bankers had European connections as well as close +affiliations with the big national banks and life insurance companies, +and were able not only to furnish the needed capital but also undertook +to market the securities of the newly formed combinations. + +Thus a few banking houses, of which J. P. Morgan & Co. is the chief +example, became in a way responsible for these new creations and +naturally assumed charge not only of their finances, but to some extent +of their other affairs. Thus the headquarters of the trusts and +railroads gradually moved to New York. In the treasuries of these +companies were vast sums of money to be banked, and it was inevitable +that most of it should be placed in New York banks. The average daily +balance of the United States Steel Corporation is about $75,000,000 and +the American Tobacco Company has perhaps $20,000,000. There is also the +Standard Oil Company, whose balance is perhaps as large. + +These few financial groups, J. P. Morgan & Co., Kuhn, Loeb & Co., and +the capitalists identified with the National City Bank and the First +National Bank, along with a few others, are primarily in the business of +selling securities and loaning money upon them. In fact they may be +described as the great security issuing houses. Such influence as their +members or directors may exert over railroad and other corporations is +largely due to their ability to dispose of securities and to give these +securities the stamp of soundness and conservatism. Here it may be added +that men like J. P. Morgan would not be directors in so many +corporations if their advice and assistance were not eagerly sought. + +In the small village a small group of men own the bank, the coal yard, +the ice-plant, the trolley line, the gas plant, and the little +factories. Every day of the year these men, in their different +capacities, have to trade with themselves in the purchase of supplies, +etc., for their different companies, one from another. No one thinks of +accusing them of double dealing, and yet the situation differs not a +whit from the vast system of interlocking bank and corporate directors +in New York except in degree and in fact, which, however, is vital, that +the New York system affects the whole commonwealth whereas the business +convolutions of Deacon Jones of Jones' Corners do not. + +Now it must not be supposed that bankers such as Mr. Morgan and his +partners are usually large owners in the companies they influence or +even control. Often they do not own 15 per cent. of the stock of the +banks they dominate. Often they become directors with but a few shares +of qualifying stock. Still more often their influence is exerted merely +as financial advisers. Often they nominate the president of a railroad +or manufacturing company as Morgan & Co. nominated the president of the +Atlas Portland Cement Company. Often the bankers take no part in the +direction of companies until these companies have shown incapacity or +have had for any reason, business or governmental, to be reorganised, +either in form or management. Recent cases which come under one or the +other of these heads are the Wabash Railroad, the United States Motors +Co., the Westinghouse Electric & Manufacturing Company, the +International Paper Company, the American Tobacco Company and the +American Sugar Refining Company. + + +HARMONY THE WATCHWORD + +There is little evidence to show any actual agreement or even +arrangement among the great financial groups. Through interlocking +directors and the wide following of smaller firms which each of the big +groups has, the whole big banking situation in New York is closely knit +together. There is a carefully fostered community of interest even among +hostile groups, each group having a director or two, like a financial +ambassador, in the other banks.[229] In the past there has been keen +rivalry. Historically the Morgan and First National Bank groups have +long been close, and two members of the Morgan firm were taken from the +First National Bank. At one time these two groups bitterly fought the +other two powerful groups--the Kuhn, Loeb-National City Bank interests. +But in recent years harmony has prevailed.... + +It must be remembered that the four banking groups are now managed for +the most part by young men. These young men are more accustomed to the +ways of conciliation than were the late E. H. Harriman, and John D. +Rockefeller and J. P. Morgan. The younger men trouble themselves little +with the former conflicts of Morgan, Hill, Rockefeller, Schiff, +Stillman, Harriman, and Ryan. They have forgotten even the accusations +and charges which the life insurance scandals made public. Their aim is +more impersonal--it is to "develop business," and the surest way to do +that is by working harmoniously together. + + +MONEY POWER NOT DISTINCTLY AMERICAN + +Striking as the concentration of banking, money, and financial power +seems, it is no greater here than abroad, perhaps not so great. In +London there are banks with fifty millions of capital, or twice as much +as our one largest bank, and deposits of nearly four hundred millions of +dollars, or twice as much as our largest bank. Even Canada, with a +population less than one-tenth of ours, has a bank as great as our +greatest. Relatively its big banks are bigger than ours. Concentration +in Canada has gone much farther than here. Six banks in the Dominion +hold half its entire banking resources. The autocratic power wielded by +the score of great Canadian banks would start a revolution in this +country. Germany and France long ago went through the process of bank +consolidation. + + +WHY, THEN, DO WE HEAR FEW COMPLAINTS FROM ABROAD? + +Here is a problem to be faced with intellectual honesty. Money power may +be a bad thing, but let us not be so dishonest as to declare it a new +thing. The New York Clearing House Association may wield power too +autocratic, but let it not be overlooked that a similar organisation in +London, with only one-third as many members, has long exercised as great +power without raising any hue and cry of a Money Trust. Also consider +Germany. If you have the time and courage to undertake such a task, go +through the ponderous volume issued by the National Monetary Commission +telling of the actual results of the great bank system in that country. +It is a weary task reading the long-winded testimony of Herr Professor +Doctor Governor this and that, but it is worth the labour. + +We are told that great banks are more amenable to public opinion than +smaller scattered institutions, that the Government is more ably +assisted in its financial operations, that fewer reckless loans are +made. Quicker prognostication of crises, whether on the Bourse or in +commerce and industry, quicker adoption of preventive measures thereby +lessening the effects of crises, are other services rendered by +concentrated banking in Germany.... + +In 1907, when there was far less both of co-operation and concentration +among the banks of this country than there is to-day, each bank standing +weakly isolated and alone, frantically grasped all the cash it could +muster. When the panic storm broke banks struggled to call in loans and +line their vaults with cash. Business was crippled; industry was +squeezed dry of its lifeblood. Last year when Germany was threatened +with both war and panic, trouble was averted by the German "Money +Trust," which loaned more than $200,000,000. It takes no expert +knowledge of finance or banking to perceive that a few great, strong +banks, or many smaller ones (provided they are welded closely together) +can meet a storm more calmly than scattered, unconnected institutions. + + +WHERE IS THE VITAL DIFFERENCE? + +If concentration is a good thing, how can there be too much of it? Here +is the answer. Concentrated power without responsibility may be the +worst possible thing. The other great financial nations have money +trusts ... too, but each is capped by a vast central bank, more or less +a government institution, and from the necessity of the case operated +not only with a view to the general welfare but more or less openly and +publicly.... The American "Money Trust" is strictly private, responsible +to no one. It may act philanthropically if it chooses, but it is +governed by nothing but choice. The money kings can, if they wish, exact +any price. + +R. H. Thomas, former president of the New York Stock Exchange, told the +Pujo committee how Wall Street had finally to turn to one man, J. P. +Morgan, in the panic of 1907, to save it from complete disaster. He did +not know where the relief came from, in what form, nor with what +conditions. It just came. Since at that time the entire country was +dependent upon Wall Street because its surplus money was there, there is +no escaping the fact that the whole financial situation of the country +was at the mercy of one man. A 200 per cent. rate for loans would be +inconceivable in one of the European financial centres because the +central banks of Europe are the guarantors of the stability of the +money market. The central banks of Europe depend upon no man, selfish or +altruistic. They are the public financial regulators of the whole +nation. + +Has the Money Power been used to crush and squeeze?... Suppose that it +has not been so used. Nevertheless, its control is in the hands of a few +men. Even if their action be honest and intended for the public +interest, they are necessarily most interested in the great undertakings +in which we have seen them to be engaged. By reason of these limitations +they must check and limit, if they do not destroy, genuine economic +freedom and competition.... A handful of men, responsible to no one but +themselves and God, have become masters of the lifeblood of commerce and +industry. That this power has been more rapidly concentrated into their +hands than the people have supposed is the unavoidable conclusion of +this article. + +From private persons, acting in private, and dominated in the main by +private motives there cannot be expected the wisest and broadest +direction of the flow of money--the lifeblood of business. These men +have not asked for this power. They know it is too great for them. On +the whole they have behaved with singular restraint. But only a fool +would suppose that the best system for financing the small farmer in +Florida or the small tin can manufacturer in Oregon is to turn over the +entire money power of the nation to J. P. Morgan and a few other private +persons. How under such a system could the great trusts fail to thrive +at the expense of the small man? + + +THE BANKS AND RAILWAY FINANCE + +[230]Close relationships of railways with banks or other credit +institutions have grown up naturally through the need for new capital +constantly imposed upon an expanding railway system. Some railways have +been fortunate enough to possess a relatively stable body of +stockholders whose confidence in the management is so complete that new +funds can be raised by direct appeal of the management to the +stockholders without the intervention of outside financial interests. +But these cases have thus far been rare in American railway finance. +When the policy calls for the raising of funds by the issuance of bonds +rather than stock, the appeal is to a wider and to an anonymous public +rather than to a corporation's own stockholders. Frequently the appeal +must be to a class of investors situated in another section of the +country or even in a foreign country. Most railways have not the +technical organization nor the established market necessary to handle +their issues easily, and usually it is found that in spite of the often +exorbitantly high commissions which the bankers exact for their +services, the net result is more satisfactory than that secured through +the railway's own efforts. To the extent that this is the case, the +bankers are performing a service of genuine economic value, and it must +be concluded that under present conditions such service cannot readily +be dispensed with. + +Assuming this service as a necessity, the next step is for the banker to +seek representation upon the railway board. His house has made itself +responsible for a large issue of securities. It appeals to the investing +public, not technically guaranteeing the issue, but practically doing so +because of solicitude that its reputation for the handling of high-grade +securities shall not be impaired. It seeks therefore to protect its own +standing, and at the same time to make the securities more attractive to +its customers, by demanding a place on the board of directors from which +it can follow in detail the employment of the funds secured through its +assistance. Large investors like life insurance companies, savings +banks, fire insurance companies, guaranty companies, trust companies, +demand as a prerequisite to purchase of securities that the underwriting +house shall be represented on the board. The railway's credit--its +ability to sell its issues--is dependent frequently upon the presence on +its directorate of this representative. However, the banker is not in +the position solely of a spectator or a detective. His expert advice is +sought and usually followed. Often he is in a position where he can +stipulate conditions under which alone he will undertake to provide the +funds required, and such stipulations are frequently of immense +influence in furthering efficient railway management. A recent example +is found in the furnishing of money to the Chesapeake and Ohio Railway +Company by Kuhn, Loeb & Co. under a stipulation that the road must put +back into its property each year a certain amount of its earnings. +Instances might be multiplied in which railway corporations have been +saved from disaster and set upon their feet through the aid of those who +have furnished the funds, and who have stipulated in connection +therewith that in order to insure their knowledge of all transactions, +and to give them a position from which they might bring their influence +to bear, they should be granted representation on the railway board. + +Of course it must be admitted that the power of the banker may be +misused to his own private advantage. The power is there--the power to +refuse funds--the power that comes from command of enormous sources of +capital, the prestige gained by years of successful experience. Men who +have attained such a position have the personal qualities that give them +naturally a commanding place in any council of business men. When such +men dominate the policy of a railway and the results are disastrous, it +is exceedingly difficult fairly to fix the responsibility and assess the +blame. The line between good faith and good judgment or between personal +ambition that amounts to breach of trust, and a misplaced optimism +concerning the outcome of a specific policy, is a very difficult line to +draw. Although praise and blame cannot be assigned with any precision +between Mr. Morgan and Mr. Mellen in the unfortunate New Haven +situation, it is the prevailing opinion of the New England public that +it has not been benefited greatly by the presence on the New Haven board +of the distinguished banker member. Generally speaking, however, the +powerful banking interests have thrown their influence in the direction +of railway efficiency and the public advantage. If our judgment as to +the desirability of the relationship of railways and credit institutions +is to be determined solely by results, we must conclude that the balance +swings heavily in favor of the continuance of the present policy. + +However, opposition to the close association of financial houses and +railways has not sprung from any such favorable relationships as we +have here described. It grows rather out of the concentration and +monopolization of credit. A powerful banking house which has identified +its interests with that of one railway system is in position, because of +its direct influence on the railway and its close affiliation with all +other sources of credit, seriously to hamper if not altogether to +prevent the securing of credit by a rival interest. This power over +credit is not confined to one city or to one section of the country, but +it reaches every section and even extends beyond national boundaries +into the foreign sources of investment funds. Local or small enterprises +requiring only moderate underwriting are frequently financed +independently, but it is an acknowledged fact testified to by the large +bankers themselves that with rare exceptions issues of securities in +large amounts, except when taken up by the stockholders, must receive at +least the tacit approval of the big financial group. Participation by +the smaller banking houses in future underwritings depends upon loyalty +to the syndicate in whatever enterprises are now being offered. The +little fellows are inclined to respect a suggestion not to assist an +enterprise of a character likely to interfere with undertakings already +financed by the large interests. This informal but none the less +effective network of alliances tends to destroy the competitive market +for capital, and to restrict the railways to one source of credit. There +does not appear to be any serious competition among the large bankers, +but rather an understanding in the nature of a division of the field. A +railway obtains the services of a single banking house which acts as its +fiscal agent, underwrites its securities, receives its deposits, and has +a representative on the railway's board of directors. When the railway +becomes involved in financial difficulties, the same banking house +organizes protective committees, devises reorganization schemes, and +creates voting trusts. As Mr. Brandeis has put it, it adds to its duty +as midwife also that of undertaker. + +Is this relationship potentially dangerous for the railways and the +public? The late Mr. Morgan, in his illuminating testimony in the money +trust investigation, took the position that the situation might be +dangerous in the hands of the wrong men, but he clearly implied that +there had been no bad results thus far and there were not likely to be +in the future with a continuance of the present leadership. His argument +reminds one of the young lady who "when she was good was very, very +good, and when she was bad she was horrid." Yet this view is that of +most of the financial leaders who appeared before the Pujo committee.... + +Mr. Davison and Mr. Schiff both opposed the policy of concentration +through interlocking at the point where the representative of the two +interests might wield a dominating influence, but they found it +difficult to fix that point. + +Mr. Baker, who took the position that safety lies in the personnel of +the men, that in good hands interlocking could not do any harm, but in +bad hands would be very bad, concluded nevertheless that the movement of +concentration had gone about far enough. And Mr. George M. Reynolds, of +Chicago, thus frankly expressed himself: "I am inclined to think that +the concentration, having gone to the extent it has, does constitute a +menace." And again, "I think a more wide distribution of the power of +credit ... would really be better in the long run." When asked the +direct question, "Do you approve of the identity of directors or +interlocking directorates in potentially competing institutions?" he +replied, "Personally I do not believe that is the best policy." + +It should be kept in mind that there is no evidence on record that this +power has been used oppressively otherwise than in the rate of +commission charged. Many of the bankers insist that the monopolization +of credit is a physical impossibility.... There is, nevertheless, a +concentration of credit in comparatively few hands. + +If the conclusions thus far established are sound, it becomes clear that +the real evil resulting from the interlocking of railways and credit +houses, if any evil exists, arises primarily out of the relation of +credit institutions to each other, rather than out of their relation to +the railways through representation on railway boards. Were this +interlocking of railways and banks to be wholly prohibited without any +alteration in the organization of the credit market, I am unable to see +how the situation would be changed materially. The tendency on the part +of the bankers would still be to follow the law of "banking ethics" and +divide the field; a railway would still employ a single banking house as +its fiscal agent, and this banking house would still exercise a powerful +influence in determining the policy of the railway. At the same time the +railway would be deprived of the presence on its board of a financial +expert whose experience might be drawn upon in the detail of management +day by day. + +As Mr. Reynolds has admitted, the menace is in the concentration of +credit. Such power may not thus far have been misused. But as the Pujo +committee has said, "whenever the incentive is at hand, the machinery is +ready." Those who have the public welfare at heart have no right to +assume that such power will never be used to the personal interest of +the bankers themselves and to the injury of the public. While I have no +great enthusiasm for the popular pastime of rushing to Washington for a +statute whenever the economic machinery fails to run smoothly, I am in +sympathy with those who are studying the problem of the restoration of +an open competitive market for capital. + +However, this is a problem of extraordinary difficulty, and I do not +myself see the way at present to its solution. I am aware that Congress +has enacted legislation with the purpose of destroying this +concentration of credit, and that many look upon the Clayton Act, so far +as it touches our problem, as a distinct step in advance. Personally I +am sceptical as to its efficacy in its present form. The opportunities +for evasion are too numerous. However, it can be laid down as a general +rule that all statutory enactment which really endures is a product of +successive increments of legislation--the result of experimental tests +and the knowledge that is gained by experience. It is no argument +against the interlocking provisions of the Clayton Act that they do not +solve the problem and that they can be evaded readily. Such an attitude +of timidity and pessimism assumed twenty-five years ago would never have +given us our present air-tight Interstate Commerce Act. It may well be, +however, that no relief can be found short of the radical step of +employing government credit in aid of public-service industries. So +vital is the necessity of the service to the people that the time may +come when government loans to transportation corporations will appear to +be a logical and natural step. But this is a digression. + +Once this free market for capital is assured, the question again arises, +Shall the railway board of directors contain banker members? Obviously +the only purpose that the railway could then have in admitting bankers +to its directorate would be the opportunity to utilize their experience +in the direct management of the property. Quite as obviously the +principal motive of the banker in accepting membership on a railway +board would be to represent the underwriters and to act as fiscal agent. +But with the capital market competitive, I can find no serious objection +to such relationship. Even under present conditions the banker in the +majority of cases respects his trust, refuses to vote on questions +involving his personal interest, and performs loyally his service to the +railway; but his mere presence on the board as the embodiment of the +railway's only source of credit may be sufficient to control the +situation in his behoof. However, with a free credit market, the +dominating position of the banker largely disappears and he becomes what +he ought to be, an expert adviser on financial matters. It may be asked +why, if the banker is now to confine his activities to what Mr. Loree +has called the "necessarily intimate relation between the banker and the +seeker for accommodation," this cannot be accomplished in the same +manner as in unincorporated businesses without putting the banker on the +directorate. In reply attention may be called to the fact that even in +the case of unincorporated businesses, the credit departments of the +large banks are virtually in the position of directors, so intimate and +comprehensive is their influence and advice. But more than this the +business of a railroad is so complex and extensive, its activities are +so multifarious, that an intimacy with its affairs sufficient to make +the banker's counsel of value would be impossible except by actual +presence on the directorate. + +Under these changed conditions of credit, I can see greater opportunity +for the utilization of the service of expert bankers in railway +management. Directorships which have been monopolized in the hands of a +few banker specialists in railway securities should then be more widely +distributed. It is quite impossible to believe that expert banking +talent available for this service is as rare as the present situation +would suggest, in which the abilities of a relatively few men are made +to do duty in dozens of corporations. This absurd situation springs not +from a scarcity of talent but from the narrow market for credit. A +liberation of that market would bring latent ability from its +hiding-places, and by the infusion of new blood would stimulate the +management of our railway enterprises. It would open this field of +activity to men "who have been obliged to serve when their abilities +entitled them to direct." + +FOOTNOTES: + +[227] Adapted from the _Report of the Committee Appointed to Investigate +the Concentration of Control of Money and Credit_, 62d Congress, 3d +Session, pp. 130-33. + +[228] Adapted from Albert W. Atwood, _The Borrower and the Money Trust, +Review of Reviews_, Vol. 46, August. 1912, pp. 207-218. + +[229] [Interlocking directorates among the more important banks were +prohibited by the Clayton Act, passed in 1914. See p. 624.] + +[230] Frank Haigh Dixon, _The Economic Significance of Interlocking +Directorates in Railway Finance, The Journal of Political Economy_, Vol. +23, No. 2, February, 1915, pp. 938-946. + + + + +CHAPTER XXIX + +CRISES + + +THE NATURE OF AN ECONOMIC CRISIS + +[231]A definition of an economic "crisis" is, like most other +definitions, very difficult to construct. By way of introduction we +shall quote a few chosen somewhat at random. Adolph Wagner, the German +economist, expresses his idea by saying: "Crises imply ... the +overwhelming and simultaneous occurrence of inability on the part of +independent _entrepreneurs_ to pay their debts." This is similar to the +statement of John Stuart Mill: "There is said to be a commercial crisis +when a great number of merchants and traders at once either have, or +apprehend that they shall have, a difficulty in meeting their +engagements." Professor E. D. Jones says: "A crisis is the sudden +application of a critical conservatism to business transactions, leading +to such a demand for liquidation as to cause a widespread inability +among business men to meet their obligations." Senator Theodore E. +Burton states: "The word crisis, if employed with entire accuracy, +describes a period of acute disturbance in the business world, the +prevailing features of which are the breakdown of credit and prices and +the destruction of confidence. It has especially to do with the +relations of debtor and creditor." + +None of these definitions gives so clear an idea as does a brief +description. Probably no one has ever pictured the crisis and the +associated events more effectively than did Frederick Engels in his +little volume, _Socialism: Utopian and Scientific_: + + As a matter of fact, since 1825, when the first general + crisis broke out, the whole industrial and commercial world, + production and exchange among all civilized peoples and + their more or less barbaric hangers-on, are thrown out of + joint about once every ten years. Commerce is at a + standstill, the markets are glutted, products accumulate, as + multitudinous as they are unsaleable, hard cash disappears, + credit vanishes, factories are closed, the mass of the + workers are in want of the means of subsistence; bankruptcy + follows upon bankruptcy, execution upon execution. The + stagnation lasts for years; productive forces and products + are wasted and destroyed wholesale, until the accumulated + mass of commodities finally filter off, more or less + depreciated in value, until production and exchange + gradually begin to move again. Little by little the pace + quickens. It becomes a trot. The industrial trot breaks into + a canter, the canter in turn grows into the headlong gallop + of a perfect steeplechase of industry, commercial credit, + and speculation, which finally, after breakneck leaps, ends + where it began--in the ditch of a crisis. And so over and + over again. + +Perhaps even this vivid word picture will be less impressive to some +than a few facts as to the serious effects of the crisis and the +depression that follows it. Professor Wesley C. Mitchell in his recent +volume entitled _Business Cycles_ has recorded the significant features +of the crisis of 1907 in England and the United States and the following +points have been taken from his account. By the middle of the summer +evidences of difficulty had begun to appear in England. British railway +stocks had fallen off in price; the shipbuilding yards had few new +contracts; costs of production had become so great that many +manufacturers were refusing to take new business at the ruling +quotations; the building trades were dull; the ratio of net to gross +railway receipts declined; commodity prices began to drop; bank +clearings fell off; imports gained less rapidly; and the percentage of +trade union members unemployed rose from 2.8 per cent. at the end of +April to 3.6 per cent. by the close of August. These difficulties came +to a climax in the latter half of the year, being intensified by the +crash in the United States. The bank rate of the Bank of England rose +from 4-1/2 to 7 per cent., where it remained for nearly two months. +During this period the market rate averaged from 5-1/2 to 6-1/2 per +cent. Imports and exports showed smaller and smaller increases over the +preceding year and in the early months of 1908 began to decline; +clearings fell off sharply and trade union unemployment increased to +nearly 10 per cent. during the latter months of 1908. + +In the United States, where the crisis degenerated into a panic, +conditions were much worse. In advance of the actual outbreak of the +panic there was for months evidence of a tension in the investment +market. Copper especially fell in price and was followed by copper +stocks. This precipitated difficulty among a group of banks that were +more or less closely identified with the copper interests. Runs were +started and a number of banks were forced to suspend payments. A +scramble for cash followed, spreading from New York throughout the +United States and accompanied by very serious consequences. Among the +worst of the effects were a premium on currency which rose at one time +as high as 4 per cent.; the necessity of introducing numerous +substitutes for cash; a demoralization of the domestic and foreign +exchange markets that caused heavy losses both to bankers and to +business men, while the amount and the prices of securities dealt in on +the stock exchanges seriously declined. During November and December +currency was at a premium of from 1/8 to 4 per cent. Call loan rates +were erratic, going as high as 125 per cent. in the latter part of +October and fluctuating between 5 and 25 per cent. as late as during the +latter half of December. During November there was a decline in the +amount of time loans and the quoted rates ranged from 6 to 7 per cent. +in October, 12 to 16 per cent. in November, and 8 to 12 per cent. in +December. Worse still was the stoppage of business by those enterprises +that could not pay the high rates and could make no special arrangements +to secure lower ones. Business failures in the United States which had +been as low as 161 in the last week of 1906, were 300 for the week +ending December 19, 1907, and 435 for the week ending January 9, 1908. +In the second quarter of 1907 there were 2,471 and for the first quarter +of 1908 there were 4,909. + +These derangements of business would seem to be of interest primarily to +the bankers and brokers or to the large borrowers--to the capitalist +class. The counterpart of the picture is to be found in the effect of +the crisis upon the man of small means and upon the poor. Inability to +borrow may mean considerable inconvenience or even financial ruin for +the man of large affairs but it does not usually mean actual suffering. +Nevertheless his failure to secure funds and the necessity of selling +his securities or commodities at a low price may force him to close his +factory, to delay extensions, or at least to curtail operations. He +receives fewer orders for goods and as a result buys smaller amounts of +raw materials and lessens his own output. + +This means reductions of wages and discharge of workmen. Some writers +have urged that the workingman receives a fixed wage and does not assume +industrial risks, which are borne by the capitalist or entrepreneur. +Such a statement is fallacious. The employee participates in the risks +of modern industry and suffers from a business derangement far more +severely than his employer. The capitalist secures less profits but with +his accumulated savings ordinarily endures no real privation, while +large numbers of the workers with little or no savings face actual +hunger or starvation. Demands upon charitable organizations increase, +bread lines grow longer, and suffering becomes widespread and intense +until the crisis and the ensuing depression are over.... + + +THE CRISIS OF 1907 IN THE LIGHT OF HISTORY + +[232]... From one point of view ... every economic crisis is a financial +crisis. For since values are expressed in terms of money, and since the +modern business superstructure is erected on the basis of credit, every +economic revulsion expresses itself through the medium of a change in +prices; and since the bank is the center of credit operations, every +crisis inevitably involves a revolution in the conditions of credit. +From this point of view, all crises may be declared to be financial +crises. + +From another standpoint, however, a distinction may be drawn between +financial crises proper and commercial or industrial crises in the +larger sense. There may be a financial panic or crisis due primarily to +temporary and sudden oscillations in the condition of the money market +or in the price of securities. Such oscillations, sharp and sudden +though they be, may have but little relation, whether of effect or of +cause, to the general commercial and industrial interests. Of this +character, for instance, were the original Black Friday in England, in +1745, its namesake, the famous Black Friday in 1869 in New York, as well +as many spasmodic fluctuations due either to political rumors like that +which followed the Venezuelan Message of 1895, or to temporary +speculative manipulations, like the Northern Pacific "squeeze" of 1901. +Of a distinctly different nature are those wider disturbances which are +traceable to more general economic causes and which, even though they +culminate in acute financial trouble, are followed by an industrial and +commercial depression of more or less magnitude. + +Into which category is to be put the crisis of 1907; and if in the +latter, what were its causes? + +At the outset it must be remembered that crises are essentially modern +phenomena. We have had financial transactions, and that, too, on a large +scale, for many centuries and in many civilizations. But crises, in +contradistinction to temporary panics, have existed in England only +since the middle of the eighteenth, and in other countries only since +the beginning of the nineteenth, century. The first crisis in England, +barring the financial flurry connected with the South Sea Scheme in +1720, was that of 1763, followed by the minor disturbances of 1772 and +1783, and the more widespread convulsions of 1793, 1810, and 1825. The +first crisis in the United States was that of 1817; and it was not until +1837 that we find the first international crisis, spreading from the +United States to England and then to France. In Germany the period of +important crises was ushered in even later. + +Crises, in other words, are products of modern economic life. Modern +economic life, however, has as its basal characteristic industrial +capitalism, with the factory system and the newer methods of production +for a wide market. This transition to modern industrial capitalism began +in England in the latter half of the eighteenth century, was initiated +in America in the first two decades of the nineteenth century, and took +place on the continent at a later date, last of all in Germany. The +explanation of crises must therefore be sought in some feature of our +modern capitalistic life. + +The current explanations may be divided into two categories. Of these +the first includes what might be termed the superficial theories. Thus +it is commonly stated that the outbreak of a crisis is due to lack of +confidence--as if the lack of confidence was not in itself the very +thing which needs to be explained. Of still slighter value is the +attempt to associate a crisis with some particular governmental policy, +or with some action of a country's executive. Such puerile +interpretations have commonly been confined to countries like the United +States, where the political passions of a democracy have had the fullest +sway. Thus the crisis of 1893 was ascribed by the Republicans to the +impending Democratic tariff of 1894; and the crisis of 1907 has by some +been termed the "Roosevelt panic," utterly oblivious of the fact that +from the time of President Jackson, who was held responsible for the +troubles of 1837, every successive crisis has had its presidential +scapegoat, and has been followed by a political revulsion. The crisis of +1857 helped to weaken the Democrats; the crisis of 1873 resulted in a +popular majority for Tilden; the crisis of 1884 put Cleveland into the +presidential chair; and the crisis of 1893, with the ensuing depression, +brought the Republicans back to power. + +Opposed to these popular, but wholly unfounded, interpretations is the +second class of explanations, which seek to burrow beneath the surface +and to discover the more occult and fundamental causes of the +periodicity of crises. Here we find an interesting and progressive +series of attempts to grapple with the difficulties of the problem. For +a long time economists and business men advanced the theory of +overproduction, forgetful of the fact that there really cannot be any +such phenomenon as too much actual production of wealth. + +With the disappearance of this doctrine there came into prominence its +variant, which put the emphasis on relative, rather than absolute, or +universal overproduction, that is, the overproduction of some things and +the underproduction of others. This theory also failed to command +general assent, for the reason that no one could show in what respects +there was any underproduction of wealth, or any lack of particular +products during the years preceding a crisis. Others again, have sought +the causal fact in underconsumption, alleging that the larger +consumption of wealth will in itself take up all the slack of +production, and thus obviate a crisis. This explanation also is +inadequate, because it overlooks the fact that the real falling off in +consumption comes after the crisis has developed and not before; in +fact, the period of prosperity which precedes a crisis is generally +marked by a prodigious increase in consumption. + +The socialists, again, seek to explain crises by the existence of +private property in the means of production, and contend that if we were +to cease the exploitation of the laborer by the modern capitalistic +method, crises would disappear. While, however, agreeing in this general +conclusion, they differ in their detailed analyses. Thus Rodbertus +maintains that the secret of crises is to be found in the fact that the +progress of industry causes a continually greater output of product, +while the exclusion of the laboring classes from any participation in +this increased productivity involves a relative diminution in demand, +and thus ultimately a fall in price, culminating in a crisis. Marx, on +the other hand, puts the emphasis on the fact that the necessary fall in +the rate of profits (which, according to him, is a result of the surplus +value, or exploitation theory) is incompatible with the greatly +increased productivity of fixed capital inherent in the present system, +and that the clashing of these two incongruous tendencies of modern +industrial life brings about a relative overproduction of capital, and +gives rise to periodical explosions. This view, finally, is sharply +criticised by the latest and ablest of the socialist theorists, +Tugan-Baranowsky, who in turn maintains that crises are due primarily to +the fact that under the modern system it is impossible to invest the +fresh accumulations of capital proportionally in all branches of +industry, and that it is this relative disproportion of accumulated +capital to the particular demand that causes the anarchy of the market +and the recurrent convulsions of industry. + +While the socialist scholars have undoubtedly made valuable +contributions to the discussion of the problem, they, like the earlier +economists, have erred in laying stress on the question of technical +production rather than, as is done by the more recent economic thinkers, +on that of business enterprise and capitalization. This is manifestly +not the place to elaborate a general theory of crises. If we attempt, +however, to give the bare outline of the modern explanation. It would be +approximately as follows: + +The problem of crises or industrial depressions is one of relative +capitalization. Under the present system of enterprise, production is +carried on in mass for a prospective market, rather than as formerly in +small quantities to fill a definite order. Even if it be contended that +certain factories nowadays are busy with producing to order, it is none +the less true that numerous plants are continually being erected in the +expectation that orders will be received in the future. The good times, +or periods of rising prices, may be due to many causes--either in +general to an augmented gold output, or in particular to the increase in +the demand for some special product, whether in the iron industry +through a new navy program, or in the clothing industry through the +outbreak of a war, or in any other industry through a change of fashion +or what not. Prices first rise in the particular enterprise, production +augments, the movement spreads to other lines of business, and the new +enterprises are financed by loans from the banks or trust companies, or +by the sale of securities on a capitalization proportionate to the +anticipated earnings. In times of buoyancy we are continually +capitalizing anticipated earnings and future hopes, and we do this +through the utilization of credit on a large scale. We build railways, +put millions into steel plants, "boom" land sites, and form combinations +of all kinds, employing the credit facilities granted by the banks, or +throwing the securities on the stock market. We "water" the stock or, if +that be forbidden by law, we drive the market quotations to a high +point, because we think that this is warranted by prospective earnings. +Sometimes we say that we capitalize the good will or, in the case of +quasi-public enterprises, the franchise; but in all cases we capitalize +the future because we believe that we shall earn an income which will +justify this capitalization. + +The peculiarity, however, of an up-grade movement which rests on modern +credit facilities is that we wear magnifying glasses or look at the +future in too roseate a light. It is a natural tendency of human nature +to capitalize one's hopes and expectations too liberally. If this is +done on a continually larger scale, the capitalization becomes so great +that actual earnings do not come up to our anticipations or the fear of +a discrepancy between actual and estimated earnings begins to obsess us. +It becomes necessary to reduce the capitalization to its true +dimensions, _i. e._, to a sum proportioned to actual earnings. This +process of readjustment of overcapitalized values obviously involves +loss; but readjustment there must be. If the realization of its +necessity is sudden, we have a crisis or panic. + +In the height of the period of exaltation or prosperity, something +happens to disturb confidence. A chance occurrence, a mere rumor, may +suffice. Some bank considers its credit too heavily engaged, or suspects +the adequacy of the collateral. Just at the flood of the tide, when new +demands are constantly being made, it finds itself unable or unwilling +to respond. Its refusal starts or intensifies the feeling of insecurity, +and with the inability of some important concern to meet its +obligations, a failure occurs and the crisis is precipitated. If, on the +other hand, the situation is well handled, and if the readjustment of +the overcapitalized values to actual earning capacity can be brought +about more gradually, we have, in lieu of a crisis, a liquidation and a +period of depression which lasts until the up-grade movement again sets +in. + +Crises, therefore, are not necessarily the result of increased technical +production. The important point is not production, but capitalization. +There may be overcapitalization, without overproduction. Overproduction +of particular things may indeed accompany overcapitalization, but the +stress must be laid, not on the relation between production and +consumption, as the old writers assumed, but on the discrepancy between +the investment and its returns. + +While the general features of a crisis are thus everywhere the same, the +details differ in each case. Sometimes it is the banks that fail first, +sometimes the general business enterprises. Sometimes it is the railway +securities that first feel the strain, at other times "the industrials," +and at still other times the raw materials. Sometimes the bolt comes out +of the clear sky with prices at a maximum, sometimes it is only the last +stage of a period of liquidation with progressively lower prices. But +however unpredictable and seemingly inscrutable the actual course of +events, the fundamental explanation is always the necessary readjustment +of capitalization to actual earning capacity. + +That this is true of all our crises can be seen from a hasty review. The +crisis of 1817 was the result of the first utilization of modern +capitalist methods in America. The period of the War of 1812 was marked +by three facts: first, the industrial revolution in New England and the +introduction of the factory system in the textile industry; second, the +great development of internal improvements through canal and turnpike +companies; third, the sudden multiplication of banks to finance the new +enterprises. The consequence was the so-called "Golden Age," which +lasted for several years, until checked by the immense imports from +England after the war, and destroyed by the collapse of the +overcapitalized undertakings. It was well into the twenties before the +country recovered from the industrial depression, and then came the +second up-grade movement, which culminated in 1837. This was primarily a +land and transportation, rather than a purely industrial, phenomenon. +The canals and turnpikes in the East were now being replaced by +railways, and the spread of slavery caused a rush of cotton planters, +not only to the black belt, but to the pine barrens and hill country of +the South. It was primarily land values that were being overcapitalized, +and the process went on to such an extent that the annual land revenues +of the Government now exceeded the total governmental receipts from all +sources of a few years before. Finally, to finance this land movement +there were called into being hundreds of the "coon-box" banks, that +found a champion in President Jackson in his war against the Bank of the +United States. As the period of exaltation had been unexampled, so the +collapse was proportionally great. The crisis of 1837, followed as it +was by those of 1839 and 1841, was still more serious than that of 1817. + +It was again well-nigh a decade before the readjustment of values had +been completed. The following decade was in turn marked by five striking +facts: first, the gold discoveries of California and Australia, which +soon initiated a general rise of prices; second, the consummation of the +revolution in the media of transportation by land and water, and the +settlement of the entire Mississippi Valley, the most fertile portion of +the continent; third, the abolition of the corn laws in England and the +opening up of a market for our incipient surplus of wheat; fourth, the +era of industrial invention which resulted in the application of +capitalistic methods to new classes of enterprise besides the old +textile industries; and fifth, the development of free banking with the +"wild-cat" institutions to provide the credit facilities for this +prodigious overcapitalization. The crisis of 1857, which was the +inevitable result, was perhaps still more acute than its predecessors. +The continuance of its depressing influence on industry, however, was +checked by the economic effects of the Civil War, which gave an +artificial stimulus to many forms of enterprise. + +In the period immediately succeeding the war, great changes again +occurred. The transcontinental roads were completed and the Eastern +trunk lines consolidated; the great wheat fields of the country were +opened up under the new homestead laws, and the period of large exports +began; the Bessemer process revolutionized the iron industry, and the +factory system was now applied to boots, sewing-machines, and +agricultural implements; the great copper and silver deposits were +developed, and the petroleum output grew apace; while the greenbacks and +the greenback movement fomented the process of inflation. The +discrepancy between the capitalization and the actual earning capacity +of the country's business enterprises again became so overwhelming that +the necessary readjustment took the form of the convulsion of 1873--a +convulsion the depressing effects of which were felt with almost +increasing severity for six years. + +The crises of 1884 and 1893 were both less intensive and more +short-lived than their predecessors, for reasons which it is now not +difficult to explain. The resumption of specie payment in 1879 was +rendered possible, and was followed by a series of abundant crops which +revivified enterprise, and which were aided by the use of agricultural +machinery on a large scale. The energy and the capital of the nation, +however, were devoted in increasing measure to the transportation +industry. This resulted in a perfect orgy of new railroad construction, +the entire mileage of the country increasing in five years by 50 per +cent. As the overcapitalization was primarily a railway +overcapitalization, the resulting reaction of 1884 was essentially a +railway crisis, leading to but indirect and temporary disturbances in +industry at large. Within a year or two recovery was general, and the +prosperous years from 1886 onward were reflected in the existence of a +huge surplus of governmental revenues. The live-stock and meat-packing +business attained its high-water mark; the textile industries made great +progress in the finer grades, and the ready-made clothing industry +assumed vast dimensions; the iron and steel industry was revolutionized +anew by the invention of the open-hearth process and the utilization of +cheap ore from the Lake Superior region; the South was being quickly +developed by the Northern capital that poured into the cotton mills and +the coal and iron mines; electricity was applied to industry on an +increasing scale, and the country took rapid strides in its evolution +from an agricultural to an industrial community. + +The movement of overcapitalization, however, was somewhat checked by two +important facts: the downward tilt of world prices in general, which had +been falling since 1873 and which were fast reaching their lowest point; +and the relative shrinkage, not only in the amount of the wheat crop, +but also in the value of both the wheat and the cotton crops. The +resulting reaction of 1893, which was itself partly due to the ill-timed +experiments with silver legislation, was as a consequence neither so +profound nor so long-continued, since the discrepancy between +anticipated and actual values turned out not to be so excessive. + +When we come particularly to the crisis of 1907, we find that the +general causes were very much the same. The last decade has been +characterized by the most unexampled prosperity in our history. The most +striking initial cause is the prodigious increase in the gold supply. +Whereas the annual average value of the output of gold was under one +hundred millions in the first half of the eighties, and only a hundred +and twelve millions in the second half, it has grown with such enormous +strides that during the past two years it has reached an annual value of +about four hundred millions. The result has been a constant rise of +prices from the minimum level of 1896. The rapid accumulation of gold, +much of which went into the bank reserves, enabled the financial +institutions to expand their credit facilities many fold, and as a +consequence enterprise flourished in every direction. During the last +decade the record crops of cereals and cotton, the extension of dry +farming, the effects of irrigation on fruit culture, the development of +truck farms, and the unparalleled increase of immigration led to a +remarkable enhancement of land values throughout the length and breadth +of the land; the output of coal doubled, that of petroleum more than +doubled, and that of pig iron, as well as of steel, actually trebled; +the huge combinations of capital, now spreading to every form of +enterprise, effected prodigious economies and revolutionized business +methods; and the transition from the agricultural to the industrial +phase of economic development proceeded with unlooked-for celerity. +Values were pushed up on all sides and the hopes of a prosperous +community were capitalized with a recklessness born of unbounded faith. +The pace was too rapid; the reaction was bound to ensue. In the late +autumn of 1907 the revulsion was precipitated, with all the familiar +accompaniments of an acute panic such as the collapse of several +financial institutions, the sudden curtailment of loans, leading to the +failures of some prominent business concerns, the hoarding of money, the +appearance of a premium on currency, going to over 3 per cent., and the +frantic efforts of the financiers to relieve the situation by the +importation of gold, the issue of clearing-house certificates and the +interference of Government through the dubious expedients of the placing +of a new bond issue and the emission of Treasury loan certificates. + +The crisis of 1907, however, is on the whole not comparable either to +that of 1857 or to that of 1873, for reasons which have thus far perhaps +not been adequately discussed. These reasons may be classed under five +heads. + +In the first place, the very magnitude of the country's resources has +been a favorable factor. The unparalleled prosperity of the past decade +has made possible the accumulation of a vast reserve in the case, not +only of the great corporations, but also of the average business man. +This reserve has acted as a buffer to the shock of reaction, and has +softened the impact through a speedy restoration of confidence in the +excellence of the country's assets and in the real solvency of business. + +Secondly, the crops, while not those of a bumper year, have been large +and valuable. It is significant that almost each of our great crises in +the past has been preceded either by the failure of the harvest at home +or by the existence of such a bountiful output abroad as greatly to +reduce prices. It must be remembered that, notwithstanding all recent +developments, this country is still primarily agricultural, and that +upon the varying extent of our great staple crops depends in large +measure the effective demand which sets and keeps in motion the wheels +of business activity. By a fortunate coincidence, the crisis was +attended by a phenomenon which in ordinary times would have spelled +prosperity, and which in this extraordinary conjuncture helped to bring +back normal conditions. + +In the third place, the overcapitalization of values was somewhat less +conspicuous than hitherto in our greatest industry--that of +transportation. Some of our former crises have, as we know, been brought +on primarily by the speculative building of railroads. But whereas in +the early eighties the annual increase of construction reached ten and +eleven thousand miles, during the past five years, with a railway system +three times as large, the annual increment of new construction was only +four or five thousand miles. The consequence has been that with the +rapid upbuilding of the country the railways have grown up to their +capitalization, until it is now reasonably certain that there has been +for some little time scarcely any actual overcapitalization. A striking +proof of the absence of any real discrepancy between normal values and +the capitalization of actual earning capacity is afforded by the +congestion of traffic of a year or two ago; and even with only normal +business activity it is computed that, in order to prevent this +congestion in future and to maintain the railways at a reasonable +standard of efficiency, there will be required an annual investment of +over a billion dollars. + +Fourthly, the crisis of 1907 was preceded by a period of gradual +liquidation. General prices of commodities, with a few notable +exceptions like that of copper, were indeed high until well-nigh the +outbreak of the panic. But the prices of securities had for some time +undergone a marked shrinkage. Some, quite mistakenly, attribute this +shrinkage to lack of confidence engendered by the governmental policy +toward industry; others, with equal readiness and no less extravagance, +ascribe it to the distress caused by the exposure of the methods of +"high finance" in positions of trusteeship. In reality, however, the +depreciation in securities was caused chiefly by the rise in the rate of +interest. In fact the one phenomenon is really the other; for where +earnings remain unchanged, the capitalization of the earnings depends on +the rate of interest. If it be objected that the price of stocks fell +because of the apprehended decrease of future earnings, due to lack of +confidence, the retort is obvious that this would not suffice to explain +the equal or still greater fall in the capital value of bonds, private +or public, with a fixed rate of interest. The depreciation was not +national, but international, in character; and it applied not only to +our railway and industrial securities, but to the English "Consols" as +well. + +The rise in the interest rate, which explains the fall in the capital +value of securities, was due to several causes. First and foremost is +the increase in the gold output. For, as is now well established by +economic theory and reinforced by the observations of practical men, +while any increase in the supply of loanable funds on the call-money +market temporarily reduces the "money rate," an increase in the general +supply of standard money in the community, on the contrary, raises not +only the price level of all commodities, but the price for the use of +capital, which we call the general rate of interest. The increase of +money as the standard of value inevitably tends to increase the general +rate of interest. Again, since the rate of interest is always adjusted +to the earnings of the fund of capital at the margin of its employment, +the rate of interest has risen because there has been relatively less +capital available for employment. The fund of free capital has been +rapidly diminishing during the past few years. Hundreds of millions were +destroyed in the Boer and Japanese wars; hundreds of millions more +disappeared through the destruction of San Francisco and Valparaiso; and +countless millions in addition have been utilized to finance the more or +less dubious schemes which have sprung up in all countries during the +years of prosperity. Even though there was no great overcapitalization +of railroads and even though many of the industrial enterprises were +really legitimate, the discounting of the future was not quite ample, +and the capital was invested more rapidly than the immediate returns +would warrant. The replacement fund, in other words, was neither quite +large enough nor quite active enough; and with the gradual exhaustion of +the available free capital, interest rates necessarily rose and security +values as a consequence fell. + +The period of liquidation was thus a fortunate event. By checking the +movement of exaltation and preventing the level of prices from being so +extreme, it kept the reaction from being so great. Where the crest of +the wave is lower, the shock of its break is less. Had the ascent of +prices and values gone on unhindered, the convulsion of 1907 would have +been far more severe. From this point of view, even those who mistakenly +persist in ascribing the lack of confidence to the President ought in +reality to be grateful to him; for to the extent that he may be said to +have superinduced the liquidation of the spring and summer, he assuredly +contributed to mitigate the shock of the inevitable reaction in the +autumn. + +The fifth and final cause of the lesser magnitude of the crisis is the +development of trusts. Until we attain the right perspective, it is +always difficult to get a correct view of the far-reaching changes which +are taking place under our very eyes. Especially true is this of such a +veritable revolution as is typified by the modern concentration and +integration of industry into the vast combinations known as trusts. +There are indeed many disquieting and untoward symptoms in the +development of which this is not the place to speak. But as against the +undoubted perils of what we are all now coming to recognize as an +inevitable process, we sometimes forget to put at least one +countervailing advantage which is of especial importance in this +connection. The modern trust, as typified in its most developed form by +the United States Steel Corporation, is apt to exert an undeniably +steadying influence on prices. Precisely because of the immense +interests at stake, and the danger of a reaction, the trust with its +consummately able management tends toward conservatism. As compared with +the action of a horde of small competitors under similar conditions, it +is apt during a period of prosperity to refrain from marking up prices +to the top notch, and is likely to make a more adequate provision for +the contingencies of the market. With this greater moderation is apt to +be associated a more accurate prevision, which succeeds in a more +correct adjustment of present investment to future needs. The drift of +business enterprise in its newer form is thus toward a relative checking +of the discrepancy between estimated and actual earnings, or, in other +words, toward a retardation in the process of overcapitalization. The +history of trusts is still too recent, and in not all of them are we yet +able to discern the working out of what ultimately will come to be +recognized as the real laws of their evolution. To those, however, who +comprehend what this revolution in business enterprise really implies, +it can scarcely be doubted that the fruit of this steadying influence +and of the better adaptation of the present to the future is already +perceptible. Notwithstanding the quite unexampled prosperity of the last +decade, the tempo of overcapitalization has been relatively less rapid +and the process of readjustment throughout the world of enterprise has +therefore been less extreme. Industry has slackened rather than +collapsed, and the disturbance itself has been comparatively +short-lived, with the prospects of an early rebound. The influence of +trusts in moderating crises and in minimizing depressions will doubtless +become more apparent with each ensuing decade in the history of modern +industry. + +While the general causes which are responsible for the crisis of 1907 +have been recounted above, there still remains one point of fundamental +importance. If we compare our economic history with that of Europe, we +observe that acute financial crises have there almost passed away. +England has had no severe convulsion since 1866, and in France and +Germany also the disturbances are more and more assuming the form of +periodic industrial depressions rather than of acute financial crises. +The responsibility for the continuance in this country of a phenomenon +which is in large measure vanishing elsewhere rests beyond all +peradventure of doubt on the inadequacy of our currency system. + + +CURRENT THEORIES OF CRISES + + +TWO POINTS OF AGREEMENT + +[233]Wide divergences of opinion continue to exist among competent +writers upon crises; but in recent years substantial agreement has been +reached upon two points of fundamental importance. + +Crises are no longer treated as sudden catastrophes which interrupt the +"normal" course of business, as episodes which can be understood without +investigation of the intervening years. On the contrary, the crisis is +regarded as but the most dramatic and the briefest of the three phases +of a business cycle--prosperity, crisis, and depression.[234] Modern +discussions endeavor to show why a crisis is followed by depression, +and depression by prosperity, quite as much as to show why prosperity is +followed by a crisis. In a word, the theory of crises has grown into the +theory of business cycles.[235] + +This wider grasp of the problem has discredited the view that crises are +due to abnormal conditions which tempt industry and trade to forsake +their beaten paths and temporarily befog the judgment of business men +and investors, or to misguided legislation, unsound business practices, +imperfect banking organization, and the like.[236] As business cycles +have continued to run their round decade after decade in all nations of +highly developed business organization, the idea that each crisis may be +accounted for by some special cause has become less tenable. On the +contrary, the explanations in favor to-day ascribe the recurrence of +crises after periods of prosperity to some inherent characteristic of +economic organization or activity. The complex processes which make up +business life are analyzed to discover why they inevitably work out a +change from good times to bad and from bad times to good. The influence +of special conditions is admitted, of course, but rather as a factor +which complicates the process than as the leading cause of crises. + + +BEVERIDGE'S "COMPETITION THEORY" + +Among these theories which seek to account not for crises but for the +cyclical fluctuations of economic activity, the "competition theory" +tentatively advanced by Beveridge is one of the simplest. + +In most instances, he begins, production is carried on by several or +many establishments, each acting independently, and each seeking to do +as large a share of the business as possible. Whenever the demand for +their wares increases, each competitor tries to engross a larger portion +of the market. "Inevitably, therefore, all the producers together tend +to overshoot the demand and to glut the market for a time. This is a +result not of wild speculation nor of miscalculation of the total +demand; it must be a normal incident wherever competition has a place at +all." Such activity among producers constitutes the period of +prosperity. But sooner or later the glutting of the market becomes +apparent, and then the crisis comes, because the goods cannot all be +sold at a profit. Prices fall, production is checked, and a period of +depression ensues. Gradually, however, the slackened rate of production +allows the accumulated stocks to be cleared, perhaps below cost price, +perhaps by waiting until demand grows up to supply. When this excess of +demand over supply has once again become patent, business recovers. +Depression yields to prosperity, competitors again vie with each other +to increase their shares in the output, after a few years the market is +glutted again, and a new crisis comes, to be followed once more by +depression. Thus business cycles are due in the last resort to "the +simple and well nigh universal fact of industrial competition."[237] + + +MAY'S THEORY OF THE DISCREPANCY BETWEEN WAGES AND PRODUCTIVITY + +Like Beveridge, May conceives crises to result immediately from the +glutting of markets for industrial products. But May offers a quite +different analysis of the cause of gluts. The continually growing +productivity of industry makes necessary a corresponding growth of the +market, if disaster is to be avoided. But to enable producers to sell +their growing output promptly prices must be reduced and wages must be +raised in proportion as the supply of goods increases. For it is only by +combining an increase in the money income of the mass of the population +with a decrease in the cost of commodities that a country's home markets +can be kept expanding with the progress of industrial methods. Periods +of prosperity attended by rising prices necessarily violate this +condition of business hygiene and inevitably end by glutting markets. +Then come crises, which restore the body politic to health by forcing +down prices to the point where consumers can purchase the supplies which +are offered. The germ of the trouble, then, is the tendency of prices to +rise during periods of increasing productivity. Accordingly, May urges +as remedy a legal limitation of the rate of profits, in order that +producers may be forced to reduce prices as they increase output.[238] + + +HOBSON'S THEORY OF OVER-SAVING + +A third explanation of how markets come to be glutted periodically is +offered by Hobson's theory of over-saving. Hobson holds that at any +given time "there is an exact proportion of the current income which, in +accordance with existing arts of production and existing foresight, is +required to set up new capital so as to make provision for the maximum +consumption throughout the near future." Now, if in a period of +prosperity the rate of consumption should rise _pari passu_ with the +rate of production, there is no inherent reason why the prosperity might +not continue indefinitely. But in modern societies, a considerable +portion of the wealth produced belongs to a small class. In active times +their incomes rise more rapidly than their consumption and the surplus +income is perforce saved. There results for the community as a whole a +slight deficiency of spending and a corresponding excess of saving. The +wealthy class seeks to invest its new savings in productive +enterprises--thereby increasing the supply of goods and also increasing +the incomes from which further savings will be made. This process runs +cumulatively during the years of prosperity until finally the markets +become congested with goods which cannot be sold at a profit. Then +prices fall, liquidation ensues, capital is written down, and the +incomes of the wealthy class are so reduced that savings fall below the +proper proportion to spending. During this period of depression the glut +of goods weighing upon the market is gradually worked off, and the +prospect of profitable investment slowly returns. Saving rises again to +the right proportion to spending and good times prevail for a season. +But after a while the chronic impulse towards over-saving becomes fully +operative once more, and soon or late begets another congestion of the +markets and this congestion begets another depression. Proximately, +then, the cause of alternating prosperity and depression is the +tendency toward over-saving; ultimately it is the existence of the +surplus incomes which lead to over-saving.[239] + + +HULL'S THEORY OF THE CHANGING COSTS OF CONSTRUCTION + +An American business man, George H. Hull, has recently drawn from his +experience of practical affairs conclusions which resemble those drawn +by [a German] Professor Spiethoff, from his theoretical analysis of +economic records. High prices of construction, runs his thesis, is the +hitherto "unknown cause of the mysterious depressions" from which the +industrial nations suffer. + +In demonstrating the thesis, Hull contends that agriculture, commerce, +and finance fluctuate within relatively narrow limits. Agriculture +provides the necessities of life, commerce distributes them, and finance +adjusts the bills. The volume of all this business is fairly constant, +because the demand for necessities is incapable of sudden expansion or +contraction. Industry, on the contrary, may expand or contract +indefinitely--especially that part of industry devoted to construction +work. For the sources of "booms" and depressions, therefore, we must +look to the enterprises which build and equip houses, stores, factories, +railways, docks, and the like. + +Of the huge total of construction, which Hull believes to make over +three-quarters of all industrial operations, at least two-thirds, even +in the busiest of years, consists of repairs, replacements, and such +extensions as are required by the growth of population. This portion of +construction is necessary and must be executed every year. But the +remaining portion is "optional construction," and is undertaken or not +according as investors see a liberal or a meagre profit in providing new +equipment. + +Now, when the costs of construction fall low enough to arouse "the +bargain-counter instinct," many of "the far-seeing ones who hold the +purse-strings of the country" let heavy contracts, and their example is +followed by the less shrewd. The addition of the resulting new business +to the regular volume of "necessity construction" plus the provision of +ordinary consumers' goods creates a "boom." But, after a year or two, +contractors discover that their order books call for more work than they +can get labor and materials to finish on contract time. When this +oversold condition of the contracting trades is realized, the prices of +labor and of raw materials rise rapidly. The estimated cost of +construction on new contracts then becomes excessive. Shrewd investors +therefore begin to defer the execution of their plans for extending +permanent equipment, and the letting of fresh contracts declines apace. +As they gradually complete work on their old contracts, all the +enterprises making iron, steel, lumber, cement, brick, stone, etc., then +face a serious shrinkage of business. Just as the execution of the large +contracts for "optional construction," let in the low-priced period, +brought on prosperity, so the smallness of such contracts, let in the +high-price period, now brings on depression. Then the prices of +construction fall until they arouse "the bargain-counter instinct" of +investors once more, and the cycle begins afresh. + +While Hull grants that panics are often caused by strictly financial +disorders, he holds that all industrial depressions are caused by high +prices of construction, and foreshadowed by high prices of iron. +Consequently he believes that depressions could be prevented from +occurring if the Government would collect and publish monthly "all +pertinent information in relation to the existing volume of construction +under contract for future months, and all pertinent information in +relation to the capacity of the country to produce construction +materials to meet the demand thus indicated."[240] + + +SOMBART'S THEORY OF THE UNEVEN EXPANSION IN THE PRODUCTION OF ORGANIC +AND INORGANIC GOODS + +Sombart, like many of the recent German writers, finds ill-proportioned +production the chief cause of crises; but he thinks it inaccurate to say +that the overproduction is in industrial equipment. For during the +German "boom" which collapsed in 1900-01, overproduction was quite as +marked in industries making equipment for electric lighting systems, +telephone plants, street railways, dwellings, bicycles, etc., as in +industries making machines. The real lack of proportion he sees in the +unlike degree of expansion in industries using organic and inorganic +materials. The inorganic industries, typified by steel, can expand to an +enormous extent within a brief period without being seriously hampered +by scarcity of raw materials. The organic industries, typified by +cotton-spinning, on the contrary, are always in precarious dependence +upon the year's harvests. In the organic industries, one may say, the +condition of business is determined by the harvests; in the inorganic +industries the condition of business determines the production of raw +materials. The modern crisis, then, following upon a period of +prosperity, is substantially the result of the different rhythm of +production in the organic and inorganic realms. The organic industries +dependent upon harvests cannot keep pace with the inorganic when the +latter are being rapidly extended by heavy investments of capital.[241] + + +CARVER'S THEORY OF THE DISSIMILAR PRICE FLUCTUATIONS OF PRODUCERS' AND +CONSUMERS' GOODS + +Carver has suggested a way of accounting for business cycles by applying +the laws of value which govern producers' goods. He points out that a +comparatively small change in a factory's selling prices will cause a +much greater change in its profits, if volume of output and expenses +remain the same. Since the value of the factory as a going concern is +the capitalized value of its prospective profits, a large increase of +profits will cause a large increase of the factory's value, provided the +high profits are expected to continue long. Hence the law that "the +value of producers' goods tends to fluctuate more violently than the +value of consumers' goods." It follows that: + + "A slight rise in the price of consumers' goods will so + increase the value of the producers' goods which enter into + their production as to lead to larger investments in + producers' goods. The resulting larger market for producers' + goods again stimulates the production of such goods, and + withdraws productive energy from the creation of consumers' + goods. This for the time tends to raise the price of + consumers' goods still higher, and this again to stimulate + still further the creation of producers' goods. There is no + check to this tendency until the new stock of producers' + goods begin to pour upon the market an increased flow of + consumers' goods. This tends to produce a fall in their + value, which in turn produces a still greater fall in the + value of producers' goods, and so the process goes." + +Thus, once more, prosperity breeds crisis and depression; but this time +the reason is found in the dissimilar fluctuations which the laws of +value establish for the goods which people use and the equipment with +which they are made.[242] + + +FISHER'S THEORY OF THE LAGGING ADJUSTMENT OF INTEREST + +Another interesting suggestion comes from Irving Fisher. By statistics +he has shown that when for any reason prices begin to rise, interest +rates advance, but not fast enough to offset the decline in the +purchasing power of the principal caused by the rise of prices. During +such periods, accordingly, borrowers on the whole get the better of +lenders and make high profits. Since the borrowers consist largely of +active business men, precisely the class of greatest foresight, they +grasp the situation more quickly than lenders. As a result of their +desire to profit by their opportunity, loans are rapidly extended. This +extension is effected largely by the lending of bank credits, that is, +by the increasing of deposit currency. The greater volume of the +currency combines with more rapid circulation of money and checks to +increase prices again, and so to start the whole process anew on a +higher level. "There is thus set up a vicious circle, which will +continue just as long as the rate of interest fails to make a proper +adjustment to put on the brakes and prevent over-borrowing." + +"But the rise in interest, though belated, is progressive, and, as soon +as it overtakes the rate of rise in prices, the whole situation is +changed." Borrowers can no longer hope to make great profits, and the +demand for loans ceases to expand. Further, the higher rate of interest +reduces the price of many of the securities used as collateral for +loans. Business men "who have counted on renewing their loans at the +former rates and for the former amounts are unable to do so. It follows +that some of them are destined to fail." There follow suspicions +regarding the solvency of the banks, runs for cash, forced curtailment +of loans, and exceedingly high rates of interest--in short, the +phenomena of crisis. + +The contraction of loans is accompanied by a reduction of deposit +currency and a slower circulation both of money and of checks. Hence +prices decline. Again the rate of interest follows; but just as it was +slow to rise so now it is slow to fall. Then the business men who borrow +find that the sluggish adjustment of interest reduces their profits. +Therefore loans, and the deposits based on loans, contract again. But +the shrinking volume of deposit currency causes a further fall of +prices, and once more interest lags behind and renews the process. Thus +the phase of depressions runs cumulatively until at last the progressive +reduction of interest has overtaken the fall of prices. At this point +business men find their profits rising to the normal level. Borrowing +becomes freer, the volume of deposit currency swells, prices start +upward, and the cycle begins afresh.[243] + + * * * * * + +Beveridge ascribes crises to industrial competition, May to the +disproportion between the increase in wages and in productivity, Hobson +to over-saving,... Hull to high costs of construction, Lescure to +declining prospects of profits,... [Seligman] to a discrepancy between +anticipated profits and current capitalization, Sombart to the unlike +rhythm of production in the organic and inorganic realms, Carver to the +dissimilar price fluctuations of producers' and consumers' goods, Fisher +to the slowness with which interest rates are adjusted to changes in the +price level. + +One seeking to understand the recurrent ebb and flow of economic +activity characteristic of the present day finds these numerous +explanations both suggestive and perplexing. All are plausible, but +which is valid? None necessarily excludes all the others, but which is +the most important? Each may account for certain phenomena; does any one +account for all the phenomena? Or can these rival explanations be +combined in such a fashion as to make a consistent theory which is +wholly adequate? + + +MITCHELL'S THEORY OF BUSINESS CYCLES + +[244]Only by putting any theory to the practical test of accounting for +actual business experience can its value be determined. The case for the +present theory, therefore, and also the case against it, is to be found +not in the easy summary which follows, but in the difficult chapters +which precede,[245] or better still in an independent effort to use it +in interpreting the ceaseless ebb and flow of economic activity. + + +1. THE CUMULATION OF PROSPERITY + +With whatever phase of the business cycle analysis begins, it must take +for granted the conditions brought about by the preceding phase, +postponing explanation of these assumptions until it has worked around +the cycle and come again to its starting point. + +A revival of activity, then, starts with this legacy from depression: a +level of prices low in comparison with the prices of prosperity, drastic +reductions in the costs of doing business, narrow margins of profit, +liberal bank reserves, a conservative policy in capitalizing business +enterprises and in granting credits, moderate stocks of goods, and +cautious buying. + +For reasons which will appear in the sequel, such conditions are +accompanied by an expansion in the physical volume of trade. Though slow +at first, this expansion is cumulative. Now it is only a question of +time when an increase in the amount of business transacted which grows +more rapid as it proceeds will turn dullness into activity. Left to +itself, this transformation is effected by slow degrees; but it is often +hastened by some propitious event arising from other than domestic +business sources, such as exceptionally profitable harvests, heavy +purchases of supplies by Government, or a marked increase in the export +demand for the products of home industry. + +Even when a revival of activity is confined at first within a narrow +range of industries or within some single section of the country, it +soon spreads to other parts of the business field. For the active +enterprises must buy more materials, wares, and current supplies from +other enterprises, the latter from still others, and so on without +assignable limits. Meanwhile all enterprises which become busier employ +more labor, use more borrowed money, and make higher profits. There +results an increase in family incomes and an expansion of consumers' +demand, which likewise spreads out in ever widening circles. Shopkeepers +pass on larger orders for consumers' goods to wholesale merchants, +manufacturers, importers, and producers of raw materials. All these +enterprises require more supplies of various kinds for handling their +growing trade, and increase the sums which they pay out to employés, +lenders, and proprietors--thus stimulating afresh the demand for both +producers' and consumers' goods. Soon or late this expansion of orders +reaches back to the enterprises from which the impetus to greater +activity was first received, and then this whole complicated series of +reactions begins afresh at a higher pitch of intensity. All this while, +the revival of activity is instilling a feeling of optimism among +business men, and this feeling both justifies itself and heightens the +forces which engendered it by making every one readier to buy with +freedom. + +While the price level is often sagging slowly when a revival begins, the +cumulative expansion in the physical volume of trade presently stops the +fall and starts a rise. For, when enterprises have in sight as much +business as they can handle with their existing facilities of standard +efficiency, they stand out for higher prices on additional orders. This +policy prevails even in the most keenly competitive trades, because +additional orders can be executed only by breaking in new hands, +starting old machinery, buying new equipment, or making some other +change which involves increased expense. The expectation of its coming +hastens the advance. Buyers are anxious to secure or to contract for +large supplies while the low level of quotations continues, and the +first definite signs of an upward trend of quotations brings out a +sudden rush of orders. + +Like the increase in the physical volume of business, the rise of prices +spreads rapidly; for every advance of quotations puts pressure upon some +one to recoup himself by making a compensatory advance in the prices of +what he has to sell. The resulting changes in prices are far from even, +not only as between different commodities, but also as between different +parts of the system of prices. Retail prices lag behind wholesale, the +prices of staple consumers' behind the prices of staple producers' +goods, and the prices of finished products behind the prices of their +raw materials. Among raw materials, the prices of mineral products +reflect the changed business conditions more regularly than do the +prices of raw animal, farm, or forest products. Wages rise often more +promptly, but always in less degree than wholesale prices; discount +rates rise sometimes more slowly than commodities and sometimes more +rapidly; interest rates on long loans always more sluggishly in the +early stages of revival, while the prices of stocks--particularly of +common stocks--both precede and exceed commodity prices on the rise. The +causes of these differences in the promptness and the energy with which +various classes of prices respond to the stimulus of business activity +are found partly in differences of organization between the markets for +commodities, labor, loans, and securities; partly in the technical +circumstances affecting the relative demand for and supply of these +several classes of goods; and partly in the adjusting of selling prices +to changes in the aggregate of buying prices which a business enterprise +pays, rather than to changes in the prices of the particular goods +bought for resale. + +In the great majority of enterprises, larger profits result from these +divergent price fluctuations coupled with the greater physical volume of +sales. For, while the prices of raw materials and of wares bought for +resale usually, and the prices of bank loans often, rise faster than +selling prices, the prices of labor lag far behind, and the prices which +make up supplementary costs, _i. e._, interest, rent, depreciation, +insurance, salaries for general officials and the like, are mainly +stereotyped for a time by old agreements regarding salaries, leases, and +bonds. + +This increase of profits, combined with the prevalence of business +optimism, leads to a marked expansion of investments. Of course the +heavy orders for machinery, the large contracts for new construction, +etc., which result, swell still further the physical volume of business, +and render yet stronger the forces which are driving prices upward. + +Indeed, the salient characteristic of this phase of the business cycle +is the cumulative working of the various processes which are converting +a revival of trade into intense prosperity. Not only does every increase +in the physical volume of trade cause other increases, every convert to +optimism makes new converts, and every advance of prices furnishes an +incentive for fresh advances; but the growth of trade also helps to +spread optimism and to raise prices, while optimism and rising prices +both support each other and stimulate the growth of trade. Finally, as +has just been said, the changes going forward in these three factors +swell profits and encourage investments, while high profits and heavy +investments react by augmenting trade, justifying optimism, and raising +prices. + + +2. HOW PROSPERITY BREEDS A CRISIS + +While the processes just sketched work cumulatively for a time to +enhance prosperity, they also cause a slow accumulation of stresses +within the balanced system of business--stresses which ultimately +undermine the conditions upon which prosperity rests. + +Among these stresses is the gradual increase in the costs of doing +business. The decline in supplementary costs per unit of output ceases +when enterprises have once secured all the business they can handle +with their standard equipment, and a slow increase of these costs begins +when the expiration of old contracts makes necessary renewals at the +high rates of interest, rent, and salaries which prevail in prosperity. +Meanwhile prime costs, wages and raw materials, rise at a relatively +rapid rate. Equipment which is antiquated and plants which are ill +located or otherwise work at some disadvantage are brought again into +operation. The price of labor rises, not only because standard rates of +wages go up, but also because of the prevalence of higher pay for +overtime. More serious still is the fact that the efficiency of labor +declines, because overtime brings weariness, because of the employment +of "undesirables," and because crews cannot be driven at top speed when +jobs are more numerous than men to fill them. The prices of raw +materials continue to rise faster on the average than the selling prices +of products. Finally, the numerous small wastes, incident to the conduct +of business enterprises, creep up when managers are hurried by a press +of orders demanding prompt delivery. + +A second stress is the accumulating tension of the investment and money +markets. The supply of funds available at the old rates of interest for +the purchase of bonds, for lending on mortgages, and the like, fails to +keep pace with the rapidly swelling demand. It becomes difficult to +negotiate new issues of securities except on onerous terms, and men of +affairs complain of the "scarcity of capital." Nor does the supply of +bank loans grow fast enough to keep up with the demand. For the supply +is limited by the reserves which bankers hold against their expanding +demand liabilities. Full employment and active retail trade cause such a +large amount of money to remain suspended in active circulation that the +cash left in the banks increases rather slowly, even when the gold +output is rising most rapidly. On the other hand, the demand for bank +loans grows not only with the physical volume of trade, but also with +the rise of prices, and with the desire of men of affairs to use their +own funds for controlling as many business ventures as possible. +Moreover, this demand is relatively inelastic, since many borrowers +think they can pay high rates of discount for a few months and still +make profits on their turnover, and since the corporations which are +unwilling to sell long-time bonds at the hard terms which have come to +prevail try to raise part of the funds they require by discounting one- +or two-year notes. + +Tension in the bond and money markets is unfavorable to the continuance +of prosperity, not only because high rates of interest reduce the +prospective margins of profit, but also because they check the expansion +in the volume of trade out of which prosperity developed. Many projected +ventures are relinquished or postponed, either because borrowers +conclude that the interest would absorb too much of their profits, or +because lenders refuse to extend their commitments farther. + +There is one important group of enterprises which suffers an especially +severe check from this cause in conjunction with high prices--the group +which depends primarily upon the demand for industrial equipment. In the +earlier stages of prosperity, this group usually enjoys a season of +exceptionally intense activity. But when the market for bonds becomes +stringent, and--what is often more important--when the cost of +construction has become high, business enterprises and individual +capitalists alike defer the execution of many plans for extending old +and erecting new plants. As a result, contracts for this kind of work +become less numerous as the climax of prosperity approaches. Then the +steel mills, foundries, machine factories, copper smelters, quarries, +lumber mills, cement plants, construction companies, general +contractors, and the like find their orders for future delivery falling +off. While for the present they may be working at high pressure to +complete old contracts within the stipulated time, they face a serious +restriction of trade in the near future. + +The imposing fabric of prosperity is built with a liberal factor of +safety: but the larger grows the structure the more severe become these +internal stresses. The only effective means of preventing disaster while +continuing to build is to raise selling prices time after time high +enough to offset the encroachments of costs upon profits, to cancel the +advancing rates of interest, and to keep investors willing to contract +for fresh industrial equipment. + +But it is impossible to keep selling prices rising for an indefinite +time. In default of other checks, the inadequacy of cash reserves would +ultimately compel the banks to refuse a further expansion of loans upon +any terms. But before this stage has been reached, the rise of prices is +stopped by the consequences of its own inevitable inequalities. These +inequalities become more glaring the higher the general level is forced; +after a time they threaten serious reduction of profits to certain +business enterprises, and the troubles of these victims dissolve that +confidence in the security of credits with which the whole towering +structure of prosperity has been cemented. + +What, then, are the lines of business in which selling prices cannot be +raised sufficiently to prevent a reduction of profits? There are certain +lines in which selling prices are stereotyped by law, by public +commissions, by contracts of long term, by custom, or by business +policy, and in which no advance, or but meagre advances can be made. +There are other lines in which prices are always subject to the +incalculable chances of the harvests, and in which the market value of +all accumulated stocks of materials and finished goods wavers with the +crop reports. There are always some lines in which the recent +construction of new equipment has increased the capacity for production +faster than the demand for their wares has expanded under the repressing +influence of the high prices which must be charged to prevent a +reduction of profits. The unwillingness of investors to let fresh +contracts threatens loss not only to contracting firms of all sorts, but +also to all the enterprises from whom they buy materials and supplies. +The high rates of interest not only check the current demand for wares +of various kinds, but also clog the effort to maintain prices by keeping +large stocks of goods off the market until they can be sold to better +advantage. Finally, the very success of other enterprises in raising +selling prices fast enough to defend their profits aggravates the +difficulties of the men who are in trouble. For to the latter every +further rise of prices for products which they buy means a further +strain upon their already stretched resources. + +As prosperity approaches its height, then, a sharp contrast develops +between the business prospects of different enterprises. Many, probably +the majority, are making more money than at any previous stage of the +business cycle. But an important minority, at least, face the prospect +of declining profits. The more intense prosperity becomes, the larger +grows this threatened group. It is only a question of time when these +conditions, bred by prosperity, will force some radical readjustment. + +Now such a decline of profits threatens worse consequences than the +failure to realize expected dividends. For it arouses doubt concerning +the security of outstanding credits. Business credit is based primarily +upon the capitalized value of present and prospective profits, and the +volume of credits outstanding at the zenith of prosperity is adjusted to +the great expectations which prevail when the volume of trade is +enormous, when prices are high, and when men of affairs are optimistic. +The rise of interest rates has already narrowed the margins of security +behind credits by reducing the capitalized value of given profits. When +profits themselves begin to waver the case becomes worse. Cautious +creditors fear lest the shrinkage in the market rating of the business +enterprises which owe them money will leave no adequate security for +repayment. Hence they begin to refuse renewals of old loans to the +enterprises which cannot stave off a decline of profits, and to press +for a settlement of outstanding accounts. + +Thus prosperity ultimately brings on conditions which start a +liquidation of the huge credits which it has piled up. And in the course +of this liquidation prosperity merges into crisis. + + +3. CRISES AND PANICS + +Once begun, the process of liquidation extends rapidly, partly because +most enterprises which are called upon to settle their maturing +obligations in turn put similar pressure upon their own debtors, and +partly because, despite all efforts to keep secret what is going +forward, news presently leaks out and other creditors take alarm. + +While this financial readjustment is under way, the problem of making +profits on current transactions is subordinated to the more vital +problem of maintaining solvency. Business managers concentrate their +energies upon providing for their outstanding liabilities and upon +nursing their financial resources, instead of upon pushing their sales. +In consequence, the volume of new orders falls off rapidly. That is, the +factors which were already dimming the prospects of profits in certain +lines of business are reinforced and extended. Even when the +overwhelming majority of enterprises meet the demand for payment with +success, the tenor of business developments therefore undergoes a +change. Expansion gives place to contraction, though without a violent +wrench. Discount rates rise higher than usual, securities and +commodities fall in price, and as old orders are completed working +forces are reduced; but there is no epidemic of bankruptcies, no run +upon banks, and no spasmodic interruption of the ordinary business +processes. + +At the opposite extreme from crises of this mild order stand the crises +which degenerate into panics. When the process of liquidation reaches a +weak link in the chain of interlocking credits and the bankruptcy of +some conspicuous enterprise spreads unreasoning alarm among the business +public, then the banks are suddenly forced to meet a double strain--a +sharp increase in the demand for loans, and a sharp increase in the +demand for repayment of deposits. If the banks prove able to honor both +demands without flinching, the alarm quickly subsides. But if, as has +happened twice in America since 1890, many solvent business men are +refused accommodation at any price, and if depositors are refused +payment in full, the alarm turns into panic. A restriction of payments +by the banks gives rise to a premium upon currency, to hoarding of cash, +and to the use of various unlawful substitutes for money. A refusal by +the banks to expand their loans, still more a policy of contraction, +sends interest rates up to three or four times their usual figures, and +causes forced suspensions and bankruptcies. There follow appeals to the +Government for extraordinary aid, frantic efforts to import gold, the +issue of clearing-house loan certificates, and an increase of bank-note +circulation as rapid as the existing system permits. Collections fall +into arrears, domestic-exchange rates are dislocated, workmen are +discharged because employers cannot get money for pay-rolls or fear lest +they cannot get pay for goods when delivered, stocks fall to extremely +low levels, even the best bonds decline somewhat in price, commodity +markets are disorganized by sacrifice sales, and the volume of business +is violently contracted. + +That crises still degenerate on occasion into panics in America, but not +in England, France, or Germany, arises primarily from differences in +banking organization and practice. In each of the three European +countries, the banking system as a whole is so organized by the +prevalence of branch banking and the existence of a central bank that +reserves which bear a small proportion to the aggregate demand +liabilities of all the offices can be applied when and where they are +most needed. The central bank not only carries a reserve which is far in +excess of immediate requirements in ordinary times, but also uses this +reserve boldly in times of stress, presenting in both these respects a +marked contrast to the policy of American banks. As a result, European +business men need not fear either a refusal to lend or a restriction of +payments by the banks on which they depend. And panic has small chance +to develop where the depositor can get his money at need and the solvent +business man can borrow. [Written before the establishment of the +Federal Reserve system.] + + +4. DEPRESSION + +The close of a panic is usually followed by the reopening of numerous +enterprises which had been shut during the weeks of severest pressure. +But this prompt revival of activity is partial and short-lived. It is +based chiefly upon the finishing of orders received but not completely +executed in the preceding period of prosperity, or upon the effort to +work up and market large stocks of materials already on hand or +contracted for. It comes to an end as this work is gradually finished, +because new orders are not forthcoming in sufficient volume to keep the +mills and factories busy. + +There follows a period during which depression spreads over the whole +field of business and grows more severe. Consumers' demand declines in +consequence of wholesale discharges of wage-earners, the gradual +exhaustion of past savings, and the reduction of other classes of family +incomes. With consumers' demand falls the business demand for raw +materials, current supplies, and equipment used in making consumers' +goods. Still more severe is the shrinkage of investors' demand for +construction work of all kinds, since few individuals or enterprises +care to sink money in new business ventures so long as trade remains +depressed and the price level is declining. The contraction in the +physical volume of business which results from these several shrinkages +in demand is cumulative, since every reduction of employment causes a +reduction of consumers' demand, and every decline in consumers' demand +depresses current business demand and discourages investment, thereby +causing further discharges of employés and reducing consumers' demand +once more. + +With the contraction in the physical volume of trade goes a fall of +prices. For, when current orders are insufficient to employ the existing +equipment for production, competition for what business is to be had +becomes keener. This decline spreads through the regular commercial +channels which connect one enterprise with another, and is cumulative, +since every reduction in price facilitates, if it does not force, +reductions in other prices, and the latter reductions react in their +turn to cause fresh reductions at the starting point. + +As the rise of prices which accompanied revival, so the fall which +accompanies depression is characterized by certain regularly recurring +differences in degree. Wholesale prices fall faster than retail, the +prices of producers' goods faster than those of consumers' goods, and +the prices of raw materials faster than those of manufactured products. +The prices of raw mineral products follow a more regular course than +those of raw forest, farm, or animal products. As compared with general +index numbers of commodity prices at wholesale, index numbers of wages +and interest on long-time loans decline in less degree, while index +numbers of discount rates and of stocks decline in greater degree. The +only important group of prices to rise in the face of depression is +that of high-grade bonds. + +Of course the contraction in the physical volume of trade and the fall +of prices reduce the margin of present and prospective profits, spread +discouragement among business men, and check enterprise. But they also +set in motion certain processes of readjustment by which depression is +gradually overcome. + +The prime costs of doing business are reduced by the rapid fall in the +prices of raw materials and of bank loans, by the marked increase in the +efficiency of labor which comes when employment is scarce and men are +anxious to hold their jobs, and by close economy on the part of +managers. Supplementary costs also are reduced by reorganizing +enterprises which have actually become or which threaten to become +insolvent, by the sale of other enterprises at low figures, by reduction +of rentals and refunding of loans, by charging off bad debts and writing +down depreciated properties, and by admitting that a recapitalization of +business enterprises--corresponding to the lower prices of stocks--has +been effected on the basis of lower profits. + +While these reductions in costs are still being made, the demand for +goods ceases to shrink and then begins slowly to expand--a change which +usually comes in the second or third year of depression. Accumulated +stocks left over from prosperity are gradually exhausted, and current +consumption requires current production. Clothing, furniture, machinery +and other moderately durable articles which have been used as long as +possible are finally discarded and replaced. Population continues to +increase at a fairly uniform rate: the new mouths must be fed and the +new backs clothed. New tastes appear among consumers and new methods +among producers, giving rise to demand for novel products. Most +important of all, the investment demand for industrial equipment +revives; for though saving may slacken it does not cease, with the +cessation of foreclosure sales and corporate reorganizations the +opportunities to buy into old enterprises at bargain prices become +fewer, capitalists become less timid as the crisis recedes into the +past, the low rates of interest on long-term bonds encourage borrowing, +the accumulated technical improvements of several years may be utilized, +and contracts can be let on most favorable conditions as to cost and +prompt execution. + +Once these various forces have set the physical volume of trade to +expanding again, the increase proves cumulative, though for a time the +pace of growth is kept slow by the continued sagging of prices. But +while the latter maintains the pressure upon business men and prevents +the increased volume of orders from producing a rapid rise of profits, +still business prospects become gradually brighter. Old debts have been +paid, accumulated stocks of commodities have been absorbed, weak +enterprises have been reorganized, the banks are strong-all the clouds +upon the financial horizon have disappeared. Everything is ready for a +revival of activity, which will begin whenever some fortunate +circumstance gives a sudden fillip to demand, or, in the absence of such +an event, when the slow growth of the volume of business has filled +order books and paved the way for a new rise of prices. Such is the +stage of the business cycle with which the analysis began, and, having +accounted for its own beginning, the analysis ends. + + +MOORE'S "RAINFALL" THEORY + +[246]To Professor Moore the fundamental problem of economic dynamics is +to formulate the law governing the "ebb and flow of economic life" which +is "the most general and characteristic phenomenon of a changing +society." The motto of the department of agriculture of the United +States--"Agriculture is the foundation of manufacture and commerce"--is +significant and that the farmer is at the mercy of the weather is +proverbial. There may be such a close connection between the weather, +the crops, and crises that we shall be able to find in weather changes +the cause of crises. + +An examination of all the numerous factors involved in the problem would +be a stupendous task and Professor Moore limits himself to a +consideration of a selected few. "The variation in the quantity of the +rainfall is one of the weather changes known to have a marked effect +upon the yield of the crops." Hence the inquiry is directed to an +examination of the "appropriate data with reference to three things: (1) +the periodicity of rainfall; (2) the effect of rainfall on the crops; +(3) the relation of the yield of the crops to economic cycles." The +study is a statistical one conducted with the greatest of care to avoid +error and the conclusions are deserving of the most careful +consideration. All generalizations are made carefully and used +cautiously with a full realization that a limited area--the upper +Mississippi Valley--has been used and a period of only seventy-two years +surveyed. Of the numerous climatic factors only rainfall has been +examined. + +Remembering that these limitations are fully realized we may state the +conclusions in Professor Moore's own words: "The fundamental, persistent +cause of the cycles in the yield of the crops is the cyclical movement +in the weather conditions represented by the rhythmically changing +amount of rainfall; the cyclical movement in the yield of the crops is +the fundamental, persistent cause of economic cycles." This should be +supplemented with a statement of the law that has been sought and which +may be formulated thus: + + The weather conditions represented by the rainfall in the + central part of the United States, and probably in other + continental areas, pass through cycles of approximately + thirty-three years and eight years in duration, causing like + cycles in the yield per acre of the crops; these cycles of + crops constitute the natural, material current which drags + upon its surface the lagging, rhythmically changing values + and prices with which the economist is more immediately + concerned.... + +In conclusion we may merely observe that many theories are obviously +presented to defend some of the other views of their advocates. The +connection of the socialist theory with the socialistic idea of value is +an obvious one. It may also be true that interest in some particular +phase of study may cause the investigator to overlook the importance of +other elements in the problem. Thus to Professor Moore climatic +conditions seem of great importance, while Professor Mitchell relegates +them to a very minor position. As time passes it will doubtless be +possible to estimate the significance of each factor with more accuracy. +When this is done a more satisfactory theory can be formulated and +methods of prevention and alleviation employed to better advantage. + + +STRINGENT MONEY AND FINANCIAL PANICS[247] + +Is there any tendency for financial panics to occur more frequently in +the seasons of the year when the money market is normally stringent? It +has been found that the two periods of the year in which the money +market is most likely to be strained are the periods of the spring trade +revival (about March and April) and that of the crop-moving demand in +the fall; and that the two periods of the easiest money market are the +"readjustment period," extending from about the middle of January to +about the first of March, and the period of the summer depression, +extending through the summer months. Of the eight panics which have +occurred since 1873, four occurred in the fall or early winter (_i. e._, +those of 1873, 1890, 1899, and 1907); and one (_i. e._, that of 1903) +extended from March until well along in November. Out of a total of +twenty-one minor panics or "panicky periods" occurring between 1876 and +1908, inclusive, nine occurred during the fall and early winter, eight +during the spring, one began in May and extended into June, three +occurred during the summer months, and one occurred in February. The +evidence accordingly points to a tendency for the panics to occur during +the seasons normally characterized by a stringent money market. + + +HOW BANKS SHOULD HANDLE PANICS + +[248]Whatever persons--one bank or many banks--in any country hold the +banking reserve of that country, ought at the very beginning of an +unfavourable foreign exchange at once to raise the rate of interest, so +as to prevent their reserve from being diminished farther, and so as to +replenish it by imports of bullion.... + +A domestic drain is very different. Such a drain arises from a +disturbance of credit within the country, and the difficulty of dealing +with it is the greater, because it is often caused, or at least often +enhanced, by a foreign drain. Times without number the public have been +alarmed mainly because they saw that the banking reserve was already +low, and that it was daily getting lower. The two maladies--an external +drain and an internal--often attack the money market at once. What then +ought to be done? + +In opposition to what might be at first sight supposed, the best way for +the bank or banks who have the custody of the bank reserve to deal with +a drain arising from internal discredit, is to lend freely. The first +instinct of every one is the contrary. There being a large demand on a +fund which you want to preserve, the most obvious way to preserve it is +to hoard it--to get in as much as you can, and to let nothing go out +which you can help. But every banker knows that this is not the way to +diminish discredit. This discredit means, "an opinion that you have not +got any money," and to dissipate that opinion, you must, if possible, +show that you have money: you must employ it for the public benefit in +order that the public may know that you have it. The time for economy +and for accumulation is before. A good banker will have accumulated in +ordinary times the reserve he is to make use of in extraordinary times. + +Ordinarily discredit does not at first settle on any particular bank, +still less does it at first concentrate itself on the bank or banks +holding the principal cash reserve. These banks are almost sure to be +those in best credit, or they would not be in that position, and, having +the reserve, they are likely to look stronger and seem stronger than any +others. At first, incipient panic amounts to a kind of vague +conversation: Is A B as good as he used to be? Has not C D lost money? +and a thousand such questions. A hundred people are talked about, and a +thousand think--"Am I talked about, or am I not?" "Is my credit as good +as it used to be, or is it less?" And every day, as a panic grows, this +floating suspicion becomes both more intense and more diffused; it +attacks more persons, and attacks them all more virulently than at +first. All men of experience, therefore, try to "strengthen themselves," +as it is called, in the early stage of a panic; they borrow money while +they can; they come to their banker and offer bills for discount, which +commonly they would not have offered for days or weeks to come. And if +the merchant be a regular customer, a banker does not like to refuse, +because if he does he will be said, or may be said, to be in want of +money, and so may attract the panic to himself. Not only merchants but +all persons under pecuniary liabilities--present or imminent--feel this +wish to "strengthen themselves," and in proportion to those +liabilities.... + +A panic, in a word, is a species of neuralgia, and according to the +rules of science you must not starve it. The holders of the cash reserve +must be ready not only to keep it for their own liabilities, but to +advance it most freely for the liabilities of others. They must lend to +merchants, to minor bankers, to "this man and that man," whenever the +security is good. In wild periods of alarm, one failure makes many, and +the best way to prevent the derivative failures is to arrest the primary +failure which causes them. The way in which the panic of 1825 was +stopped by advancing money has been described in so broad and graphic a +way that the passage has become classical. "We lent it," said Mr. +Harmon, on behalf of the Bank of England, "by every possible means and +in modes we had never adopted before; we took in stock on security, we +purchased Exchequer bills, we made advances on Exchequer bills, we not +only discounted outright, but we made advances on the deposit of bills +of exchange to an immense amount, in short, by every possible means +consistent with the safety of the bank, and we were not on some +occasions over-nice. Seeing the dreadful state in which the public were, +we rendered every assistance in our power." After a day or two of this +treatment, the entire panic subsided, and the "City" was quite calm. + +The problem of managing a panic must not be thought of as mainly a +"banking" problem. It is primarily a mercantile one. All merchants are +under liabilities; they have bills to meet soon,... are dependent on +borrowing money, and large merchants are dependent on borrowing much +money. At the slightest symptom of panic many merchants want to borrow +more than usual; they think they will supply themselves with the means +of meeting their bills while those means are still forthcoming. If the +bankers gratify the merchants, they must lend largely just when they +like it least; if they do not gratify them, there is a panic. + +On the surface there seems a great inconsistency in all this. First, you +establish in some bank or banks a certain reserve; you make of it or +them a kind of ultimate treasury, where the last shilling of the country +is deposited and kept. And then you go on to say that this final +treasury is also to be the last lending-house; that out of it unbounded, +or at any rate immense, advances are to be made when no one else lends. +This seems like saying--first, that the reserve should be kept, and then +that it should not be kept. But there is no puzzle in the matter. The +ultimate banking reserve of a country (by whomsoever kept) is not kept +out of show, but for certain essential purposes, and one of those +purposes is the meeting of a demand for cash caused by an alarm within +the country. It is not unreasonable that our ultimate treasure in +particular cases should be lent; on the contrary, we keep that treasure +for the very reason that in particular cases it should be lent. + +When reduced to abstract principle, the subject comes to this. An +"alarm" is an opinion that the money of certain persons will not pay +their creditors when those creditors want to be paid. If possible, that +alarm is best met by enabling those persons to pay their creditors to +the very moment. For this purpose only a little money is wanted. If that +alarm is not so met, it aggravates into a panic, which is an opinion +that most people, or very many people, will not pay their creditors; and +this too can only be met by enabling all those persons to pay what they +owe, which takes a great deal of money. No one has enough money, or +anything like enough, but the holders of the bank reserve.... + +... Before 1844, an issue of notes [of the Bank of England], as in +1825, to quell a panic entirely internal did not diminish the bullion +reserve. The notes went out, but they did not return. They were issued +as loans to the public, but the public wanted no more; they never +presented them for payment; they never asked that sovereigns should be +given for them. But the acceptance of a great liability during an +augmenting alarm, though not as bad as an equal advance of cash, [_i. +e._, specie] is the thing next worst. At any moment the cash may be +demanded. Supposing the panic to grow, it will be demanded, and the +reserve will be lessened accordingly.... + +"On extraordinary occasions," says Ricardo, "a general panic may seize +the country, when every one becomes desirous of possessing himself of +the precious metals as the most convenient mode of realizing or +concealing his property--against such panic banks have no security on +any system." The bank or banks which hold the reserve may last a little +longer than the others; but if apprehension pass a certain bound, they +must perish too. The use of credit is, that it enables debtors to use a +certain part of the money their creditors have lent them. If all those +creditors demand all that money at once, they cannot have it, for that +which their debtors have used, is for the time employed, and not to be +obtained. With the advantages of credit we must take the disadvantages, +too; but to lessen them as much as we can; we must keep a great store of +ready money always available, and advance out of it very freely in +periods of panic, and in times of incipient alarm. + +FOOTNOTES: + +[231] E. M. Patterson, _The Theories Advanced in Explanation of Economic +Crises. Annals of American Academy of Political and Social Science_, +Vol. 59, May, 1915, pp. 133-6. + +[232] Address by Edwin R. A. Seligman, _The Crisis of 1907 in the Light +of History_, in _The Currency Problem and the Present Financial +Situation_, A Series of Addresses Delivered at Columbia University, +1907-1908, ix-xxv. The Columbia University Press, 1908. + +[233] Wesley Clair Mitchell, _Business Cycles_, _pp._ 5-19. The +University of California Press. Berkeley, 1913. + +[234] The not infrequent statement that prosperity sometimes merges into +depression without the intervention of a crisis means simply that the +writers understand by crisis a violent disturbance of business +conditions. It is in closer accord with every-day usage to call such +occurrences "panics," and to apply the term "crisis" to the transition +from prosperity to depression even when accomplished quietly. On closer +inspection, a business cycle is often found to be complicated by minor +changes, such as the interruption of depression by a premature +resumption of activity, the occurrence of a pause or even a slight +crisis in the midst of prosperity, and the like. But for the present it +is wise to confine attention to the broadest features of the cycle. + +[235] Compare W. Sombart, _Versuch, einer Systematik der +Wirtschaftskrisen_, Archiv für Sozialwissenschaft, 1904, pp. 1-21. + +[236] The first type of theories mentioned in the preceding section. + +[237] W. H. Beveridge, _Unemployment_, ed. 3 (London, 1912), chapter iv. + +[238] R.E. May, _Das Grundgesetz der Wirtschaftskrisen_ (Berlin, 1902). + +[239] I have followed Mr. Hobson's latest exposition, _The Industrial +System_ (London, 1909), chapters iii and xviii. + +[240] George H. Hull, _Industrial Depressions_ (New York, 1911), p. 218. + +[241] W. Sombart, _Die Störungen im deutschen Wirtschaftsleben_, +Schriften des Vereins für Socialpolitik, vol. 113, pp. 130-133. + +[242] T. N. Carver, "A Suggestion for a Theory of Industrial +Depressions," _Quarterly Journal of Economics_, May, 1903, pp. 497-500. + +[243] Irving Fisher, _The Purchasing Power of Money_ (New York, 1911), +chapter iv, and chapter xi, §§ 15, 16, 17. Compare the same writer's +summary statement of his theory in _Moody's Magazine_, February, 1909, +pp. 110-114, and H. G. Brown's paper "Typical Commercial Crises _versus_ +A Money Panic," _Yale Review_, August, 1910. + +[244] Adapted from Wesley Clair Mitchell, _Business Cycles_, pp. +571-579. The University of California Press. 1913. + +[245] The extract here reproduced is from the concluding chapter of the +work indicated.--EDITOR. + +[246] E. M. Patterson, _The Theories Advanced in Explanation of Economic +Crises_. _Annals of American Academy of Political and Social Science_, +Vol. 59, May, 1915, pp. 140, 141, 147. + +[247] E. W. Kemmerer, _Seasonal Variations in the Relative Demand for +Currency and Capital in the United States_, p. 232. Publications of the +National Monetary Commission, Senate Document No. 588, 61st Congress, 2d +Session. + +[248] Walter Bagehot, _Lombard Street_, pp. 46-56. Charles Scribner's +Sons. New York. 1892. (First Edition, 1873.) + + + + +CHAPTER XXX + +THE WEAKNESSES OF OUR BANKING SYSTEM PRIOR TO THE ESTABLISHMENT OF THE +FEDERAL RESERVE SYSTEM + + +CONFLICTING OPINIONS + +[249]For fifty years the United States has lived rather happily under +the National Bank Act, born in the strife of the Civil War and developed +in the period of the nation's greatest expansion and growth. This act +has, by its record, earned for itself a place as a great piece of +constructive legislation; and the recognition of this fact is +responsible for the preservation of our national banking system almost +intact under the Federal Reserve Act. The National Bank Act removed the +ills of wild-cat banking, which so afflicted the country prior to the +Civil War; gave us an absolutely safe form of money which, although not +legal tender, is taken without question by everyone; and has made +possible an enormous expansion in the banking resources and facilities +of the country. In spite of the denunciation and abuse which have been +heaped upon it, the act has been reasonably satisfactory in operation. +Anyone who reviews the figures of the material growth and prosperity of +the nation and the rise of its financial power will be forced to the +conclusion that no act that was fundamentally unsound could have been an +integral part of the achievement of such a notable record. + +Designed for the purpose of encouraging a system of independent banks, +the act has been responsible, directly and indirectly, for the creation +of some twenty-five thousand banking institutions in this country, +practically all of which are independent of each other. Instead of a +small banking class and an equally small group of banks, all under the +domination of one or a very few interests, we have developed a system of +banking which has sprung from the people, and which is closer to the +people than that of any other country. + +[250]We have grown and prospered in spite of an imperfect, repressing, +and perilous banking and currency system. We have grown as a vine +sometimes forces its way through a crevice in a wall, our very growth +inviting disaster and death, our wonderful vitality hastening +catastrophe.... Over fifty years of growth under the old banking act has +been forced by the generosity of the soil of a new land, by the +unconquerable energy and resiliency of a virile and courageous people; +yet it has been interrupted by periods of business depression and +stagnation; our progress punctuated by panics, discreditable, +appalling--to many ruinous.... The immediate results ... have been +crashing of banks and commercial houses, the wholesale stoppage of +industries, the wiping away or cruel draining of the results of honest +thrift, denial to willing and hungry labor of the opportunity to earn +bread and shelter. + +[251]A physician would probably say that what primarily ails our +currency system and causes panics and desperate stringencies is +something akin to _arteriosclerosis_. The veins and arteries of credit, +which in order to function properly ought to be elastic and contractile +like rubber, are hard and brittle as glass. When subjected to unusual +strain they can yield but little and are very liable to rupture, and +when once stretched they are apt to remain over-enlarged.... + +The temporary act of May 30, 1908, which relaxed the rigor of the law in +moments of critical emergency [as to note issues] by permitting +additions to the currency to be based upon other security by payment of +a heavy and increasing tax, was no real solution of the situation. It +contained no provision to render the currency responsive to ordinary +fluctuations in currency demand, and resort to its provisions in times +of great stress might easily precipitate a panic if one did not already +exist. It was only enacted for six years, and was only regarded by its +sponsors as a temporary palliative pending the preparation of a +permanent cure. _One universally recognized essential ... of a proper +banking and currency plan is provision for a more flexible and +responsive note issue_. + + +INFLEXIBILITY OF LEDGER BALANCES + +When we turn to credit in the form of ledger balances or "deposits" and +enquire as to the causes of their inflexibility, the explanation also +rests in quite familiar facts. There are two peculiar features of our +banking system which are practically without counterpart in other +important countries, and which render ledger balances or deposit credits +in this country less flexible and responsive than such balances or +credits are elsewhere. The _first_ is the rigidity of our reserve laws, +and the _second_ is the lack of any bankers' bank or similar +institution, with ample resources and lending power, from which the +banks can replenish their own reserves when necessary. + + +RIGID RESERVE REQUIREMENTS + +Outside of the United States I know of only one other country in which +the law requires a cash reserve to be held against deposits. That +country is Holland, and the law applies to only one institution, the +Bank of the Netherlands, and that institution does not hold enough +deposits to make it worth mentioning in this connection (less than +$3,000,000). Our national banking law, however, and the banking laws of +most of the states are unreasonably and unsoundly rigorous in this +regard. Not only must stated proportions of all deposits be held by the +banks in reserve, but these reserves, according to the law, can never +under any circumstances be used. It is very much as if the Government, +having established naval and military reserve forces in times of peace, +were to insist that these forces should not be used in time of war, in +order to maintain them intact as reserves. Whenever the cash held by a +bank has fallen to the required minimum, the bank cannot legally +continue to extend accommodation. It cannot issue more notes unless it +has additional government bonds to deposit for their security, and it +cannot enlarge its ledger balances unless it has additional reserves. No +matter what may be the stress of an emergency, or whether it is due to +war, catastrophe, or unreasoning fear, there are no legal means for +relaxing this requirement. And so, in moments of great sensitiveness and +anxiety, legal spokes are apt to be suddenly thrust into the wheels of +credit, and the whole machinery of business brought crunching to a +standstill. _A second essential then of any adequate currency plan is +some provision which will render the reserve requirements pliable and +the reserves of possible use._ + + +NEED OF BANKERS' BANK + +Our banks also have less flexibility in their power to lend ledger +balances than the banks of practically all other countries for another +reason, because of the lack of any permanent institution or institutions +which can perform for them services similar to those which they perform +for their customers. An individual bank makes the money of each and all +of its customers flexible in amount, by rendering it of mutual service, +and available to those who most need it, when they most need it, and, in +order that the money of individual banks may be similarly flexible in +amount, of mutual service to each other and available to those +institutions which most need it, when they most need it, they require in +their turn some agency which will do for them severally and jointly what +they do for the general public.... + +It does not matter what such an agency may be called. It may be a +discount bureau, or a rediscount bureau, a national clearing house, or a +national or regional reserve association. Out of deference to those +great financial experts who write the banking clauses of political +platforms and whose bans and edicts are blessed with sacerdotal +infallibility, when such an institution is proposed for this country, +it must not be called a central bank. Such an institution is perhaps +most plainly designated if it is called a "bankers' bank," but by +whatever name it is referred to, the need of such an institution is the +fact of primary importance in the American banking situation. + +Just as an individual bank economizes and mobilizes and makes flexible +in amount the funds of individual members of a community, so a bankers' +bank mobilizes and economizes and makes flexible in amount the money of +the banks. It collects money from institutions and localities when and +where they do not need it, and lends it to others when and where they +do. In like manner the active deposits of the various banks, as they are +not all wanted simultaneously, furnish the bankers' banks with a large +surplus reserve of lending power, which in turn is an invaluable source +of flexibility to the individual banks. By its means they can, if need +be, rediscount their commercial paper, exchange their unmatured assets +for actual cash, and secure its still better known credit in place of +their own. By its means their reserves can be replenished and their +lending power made responsive to the needs of their communities. A +bankers' bank makes it possible for the money of the individual banks to +do many times the work it would do if left in the separate institutions, +and to do it far more effectively. It is the only ultimate safeguard, +the only scientific deposit guarantee, the only sound basis of +flexibility in any banking system. As some philosopher once said of +God--if such an institution did not already exist, people would +certainly have to invent one, and, as we have no such institution +permanently and legally established in America to-day, _the prime +essential of any sufficient banking plan is the equipment of our system +in some way or other with the facilities of a bankers' bank_. + + +THE PARCELLATION OF RESERVES + +[252]If the absolute certainty of ability to pay all depositors in +money on demand be taken as the _summum bonum_ of banking, an idea which +quite generally prevails among the unthinking, it is interesting to +reckon the cost. A bank has no fairy wand with a wave of which it can +transmute into gold the amounts due it, whether represented by +borrowers' notes or balances due from other banks. Such repayments have +an element of uncertainty which pervades all human affairs. All +uncertainty could be eliminated only by having in money on hand an +amount equal to the total of liabilities to depositors. A deposit with a +bank would then be simply a warehousing transaction. + +If a readjustment to such a condition were accomplished, and if we +consider only the ultimate result, and not the cataclysm of the process, +it would clearly prove such an extinguishing restriction of commerce as +would cost fabulously more than the value of the advantage gained. It +would be like preferring the constitution of a jelly-fish to that of a +human being in order to avoid the hazard of fracturing a bone. + +Only by having banks which employ in loans a part of depositors' capital +lodged with them, can the best interests of the whole people be served, +even if this entails something less than an absolute certainty of power +to liquidate deposits on demand. That banking system must then be best +which combines equally the largest measure of each of two elements: the +use in commerce of funds deposited, and the certainty of paying +depositors in money on demand. + +Turning now to the vast system of banks throughout the country, if the +separate reserves of all the banks were gathered into one mass, +available to meet the demands of depositors for payment in money, +whether made in Maine or Texas, New York or California, the banks of the +whole system would be able to operate with the highest degree of safety +by having a total sum of money equal to only a small percentage of the +aggregate amount owing to depositors, and consequently would be able to +lend for use in the commerce of the country the greater proportion of +the funds deposited. The total of deposits and withdrawals made +throughout the country would very nearly offset one another. Very little +of the reserve money would actually be used. A special requirement of +one section would represent only a small percentage of the total massed +reserves. The country has such vast area, and the requirements in +different parts so vary in season that a deficiency of money in some +sections would find a measurably offsetting surplus in others. + +While theoretically an institution so constituted would be strongest and +most efficient, none such exists, and no one would advocate such a +system. Omniscience and omnipotence would be required for its wise +administration. + +But the conclusion seems clear that only in proportion to the massing of +reserves can efficiency in lending for commerce be combined with +strength to pay depositors. The greater the proportion of the entire +reserves gathered into one mass, the greater the efficiency and strength +rendered possible. This principle is fundamental. + +The fundamental defect of our banking system, then, is the parcellation +of the entire reserves among the separate self-independent banks, +necessitating either a wastefully large proportion of reserve for +assured ability to pay, with correspondingly inefficient service to +commerce, or efficient service with the hazard of unexpected exhaustion +of reserves and consequent inability to make good the contracts to pay +depositors in money on demand. + +[253]If after a prolonged drought a thunderstorm threatens, what would +be the consequence if the wise mayor of a town should attempt to meet +the danger of fire by distributing the available water, giving each +house owner one pailful? When the lightning strikes, the unfortunate +householder will in vain fight the fire with his one pailful of water, +while the other citizens will all frantically hold on to their own +little supply, their only defence in the face of danger. The fire will +spread and resistance will be impossible. If, however, instead of +uselessly dividing the water, it had remained concentrated in one +reservoir with an effective system of pipes to direct it where it was +wanted for short, energetic, and efficient use, the town would have been +safe. + +We have parallel conditions in our currency system, but, ridiculous as +these may appear, our true condition is even more preposterous. For not +only is the water uselessly distributed into 21,000 pails, but we are +permitted to use the water only in small portions at a time, in +proportion as the house burns down. If the structure consists of four +floors, we must keep one-fourth of the contents of our pail for each +floor. We must not try to extinguish the fire by freely using the water +in the beginning. That would not be fair to the other floors. Let the +fire spread and give each part of the house, as it burns, its equal and +inefficient proportion of water. _Pereat mundus, fiat justitia!_ + + +REDEPOSITED OR OVERLAPPING RESERVES + +[254]If we are to understand the radical change which will be worked by +the Federal Reserve Act in the reserve situation in this country it is +necessary to examine at some length the system heretofore prevailing. +Under the National Bank Act these banks were divided into three groups +or classes, referred to as the country banks, the reserve city banks and +the central reserve city banks. + +There are three central reserve cities: New York, Chicago, and St. +Louis. Every national bank in these cities is a central reserve city +bank. The reserve cities are forty-seven in number and include the +larger cities of the country. Every bank not situated in any one of the +three central reserve cities or the forty-seven reserve cities is a +country bank. This last term includes all the national banks of the +smaller cities in the country, of the manufacturing towns and +communities of New England and the Middle States and thousands of +national institutions doing business in the agricultural sections. + +~The Country Banks.~--The country banks, by the terms of the National Bank +Act, are required to keep a cash reserve at all times equal to 15 per +cent. of their deposits. Under the old law the country bank must keep +only 40 per cent. of this required reserve in its own vaults, while it +is allowed to deposit 60 per cent. of the required reserve on call in +such national banks in any of the reserve cities or central reserve +cities as may be approved as "reserve agents" for it by the Comptroller +of the Currency.... + +~The Reserve and Central Reserve Cities.~--The second class of national +banks, known as reserve city banks, includes all national banks located +in forty-seven cities of the country, which from time to time have been +designated as reserve cities. Every national bank in them is required to +keep a reserve at all times equal to at least 25 per cent. of its +deposits. It must be borne in mind that the deposits of a reserve city +bank include not only what the banker refers to as individual +deposits--the deposits of individuals, firms, partnerships, and +corporations--but also deposits which have been made with the reserve +city bank by country banks, for which it is the reserve agent. + +A reserve city bank is permitted by the National Bank Act to keep +one-half of its required reserve on deposit, subject to withdrawal on +demand, in a national bank or banks in a central reserve city, approved +by the Comptroller of the Currency, as its reserve agent.... + +Every national bank within the central reserve cities must keep a +reserve equal in amount to at least 25 per cent. of its deposits, +including not only individual deposits but deposits by bankers for whom +it acts as reserve agent or correspondent. + +~The Reasons for the System.~--This rather complicated system of reserves +was authorized by Congress because it was necessary to allow the banks +of the country districts or smaller cities to keep reserves in other +banks in the larger centres of trade in order to facilitate the +commercial exchanges of the country; and also because it was necessary +to have some means by which banks of the larger cities could finance +payments for their customers in the great centres of the country, +especially in New York, Chicago, and St. Louis.... + +~Its Weaknesses.~--Our system of deposited reserves has failed miserably +in times of stress, although it has worked reasonably well in ordinary +times. It is contended that it has, to a large degree, built up the +great centres, and more especially New York City, at the expense of +country districts. It has been responsible for the seasonal withdrawal +of money which was at one time a most serious embarrassment to business, +especially in New York, Chicago, and other large cities in the fall +months, but which has practically disappeared in New York City since the +panic of 1907.... It was not until the system of deposited reserves +brought about the panic of 1907 that the country at large became +convinced that this feature of the national banking system was vicious, +dangerous, and likely to produce trouble at any time. With this +conviction began the movement which finally ended in the enactment of +the Federal Reserve Act. + +~Much of Our Reserve Fictitious.~--As a matter of fact, the actual +available reserves of the three classes of national banks in the country +are much less than is indicated by the percentage specified in the act +quoted above.... This condition is referred to frequently as the +pyramiding of reserves, which means, in substance, that the national +banks of this country, omitting from consideration the state banks where +the same conditions exist in an even more aggravated form, are doing +business largely upon a paper reserve, which experience has shown is +utterly useless in times of panic. The seven thousand five hundred and +nine national banks held cash and paper reserves on October 21, 1913, as +follows: + + _Cash in vaults._ _Due from banks._ + +Country banks $294,000,000 $534,000,000 +Reserve city banks. 251,000,000 258,000,000 +Central reserve city banks 381,000,000 + ------------ ------------ + $926,000,000 $792,000,000 + +As a matter of fact the national banks of the country held $926,000,000 +in cash as against total deposits subject to reserve requirements of +$7,172,000,000, or about 12.8 per cent. of the liabilities subject to +the requirements. + +~Dangers of the System.~--So conclusive are the lessons to be learned from +the experience of the last half century with the system of redeposited +reserves, that there is a practical unanimity among bankers and +financial experts that the reserves of our banks, with the exception of +the money actually held in the vaults, are, in the words of William +Ingle, vice-president of the Merchants and Mechanics National Bank of +Baltimore, "A great deal of a delusion and a snare." In every panic, the +country banks and the reserve city banks have found that it has been +impossible for them to secure the return of the portion of these +reserves which has been redeposited in New York, Chicago, and St. Louis. +At a time of great stress, when the banks have been subjected to a +drain, they have been suddenly bereft of the support which, in theory, +should have been forthcoming from their reserve agents, and have been +forced to depend upon the 6 per cent. or 12-1/2 per cent. reserve, which +was contained in their own vaults. What is even worse, the outbreak of a +panic in New York City, where every panic of the last half century has +started, was the signal for the suspension of cash payments by every +bank in the country, within a few hours.... Thus a local panic, in many +cases occurring when business conditions were exceedingly prosperous and +healthy, has completely disorganized the exchanges of the country and +brought business to a standstill. + + +THE PERVERSE ELASTICITY OF NATIONAL BANK NOTES + +[255]... It is not quite correct to call our national bank notes +inelastic. They are decidedly elastic. The trouble is that their +elasticity is of a wrong sort; they expand when there is need of +contraction, and contract when the need is for more currency. By calling +the notes inelastic we mean that their volume does not correspond +automatically to the need for currency. This is true, and is one of the +most serious defects of the bond-secured notes.... + +The demand for currency depends upon the volume of business to be +transacted, and is continually in a state of fluctuation. Various causes +have only to be mentioned to explain the unequal demand at different +times. We have thus the payments of salaries, bills, etc., coming +usually, on the first of each month. Then there are the quarterly +payments of dividends, interest, etc., falling generally on the first of +January and at intervals of three months thereafter during the year. +Above all, we have in this country a regularly recurring seasonal change +in the volume of business, due to the harvesting and moving of the crops +every fall and early winter. Besides these normal fluctuations in the +demand for currency there are of course such abnormal circumstances as +business emergencies, panics, depressions, etc., which at irregular +intervals call for expansion or contraction of the currency. To meet all +these varied demands an elastic currency is a necessity. + +The most serious evils of inelasticity in this country are seen in +connection with the annual handling of the crops. It may be safely said +that for this purpose the United States needs every fall at least one +hundred and fifty million dollars of extra currency. Since our monetary +system contains no really elastic element, this extra business of the +fall has to be done with little or no increase of the country's +currency. The crops must be handled by means of a shifting of currency +from one part of the country to another. In the spring and early summer +the agricultural districts are apt to have more money than they need. +Accordingly, the country banks are in the habit of depositing part of +their reserves in banks situated in the reserve cities. A large part of +these sums eventually finds its way into the money markets of New York +and other Eastern cities, where a low rate of interest is paid to +outside banks for such deposits. Now comes the harvest season, and a +demand goes up from the country banks for the return of their deposits. +Every fall the clearing-house banks of New York City alone give up about +fifty millions of "lawful money" to meet this demand.[256] Of course +this means a tight money market. In the spring and summer the funds +obtained from the country banks were loaned out or used as reserves for +deposits. Money was in excess, interest rates were low, and speculation +was encouraged. Now loans must be called in and deposits reduced. This +sudden contraction is a hard blow to all business interests. It is +especially hard on the speculators, and their desperate demands cause +the enormous rates on call loans which are witnessed every fall on the +New York money market.... + +It has ... been suggested that the inelasticity of the national bank +notes does not mean that their volume never changes. As a matter of +fact, the circulation has been marked by enormous fluctuations, and +these fluctuations, having no relation to the demands of business, have +simply aggravated the evils of inelasticity which have been described. +Thus, between June 1, 1880, and June 1, 1891, the total volume of bank +notes outstanding declined from $345,000,000 to $169,000,000, a decrease +of $176,000,000, or 51 per cent. This retirement of half the circulation +came during a decade marked by large growth in population and wealth, +and by remarkable industrial expansion and business activity. The reason +for this decline lies in the fact that the Government was using part of +its large surplus revenue to pay off the debt. In eleven years the +Treasury paid $1,105,000,000, reducing the debt by more than half, +something without parallel in the history of public finance. The +retirement of half the debt caused a scarcity of United States bonds, +and their prices went soaring. Four per cents of 1907 rose from 103-113 +in 1880 to 125-130 in 1888. The inevitable result was the decline of +circulation. The opposite course of events has been seen in recent +years.... + + [The subjoined diagram (suggested by a similar one for + 1902-1906, accompanying the article a part of which is here + reproduced) illustrates the comparative seasonal elasticity + of the notes of our national banks and the circulation of + the chartered banks of Canada for the period 1910-1914. The + marked expansion of national bank notes in 1914 was due to + the crisis brought on by the outbreak of the European war. + The Aldrich-Vreeland notes which were issued in that + emergency were retired in a few months and the volume of + national bank notes assumed normal proportions. + + For the Canadian statistics involved the editor is indebted + to Mr. G. W. Morley, Secretary of the Canadian Bankers' + Association.] + +[Illustration] + + +NATIONAL BANK NOTES UNSOUND AND UNSAFE + +[257]... Any correct system of credit currency must be based on a +foundation of gold. Bank credit is issued in the two forms of deposits +and notes. The former are based on a reserve of gold, the latter are +not. We have here a fundamental weakness of our bank-note system. Under +proper banking methods, deposits cannot expand without a proportional +increase of the gold reserves of the banks. This furnishes the natural +and necessary check to inflation. Our bank notes, however, have no such +connecting link with the business and the monetary stock of the world. +The basis of the American bank-note currency is the government debt, a +very inferior kind of foundation. Such a system carries with it the +possibility of paper money inflation of a peculiarly dangerous kind, +because its real meaning is apt to be concealed. For example, between +January 1, 1900, and January 1, 1908, the volume of national bank notes +outstanding increased from $246,000,000 to $690,000,000, an expansion of +$444,000,000. In other words, the circulation nearly trebled in eight +years. The cause of this great increase was not the need of more +currency but the changes in the National Bank Act made in 1900, changes +which made the establishment of national banks easier and the issue of +notes more profitable.... The future is likely to witness further +expansion, unless some change is made in our system.... It is +undoubtedly the present intention to give ... to future [bond] issues +[the privilege of being used as security for notes]. Indeed, unless this +privilege is given, there will be no market for the 2 per cent. bonds. +We may expect, therefore, to see each issue made the basis of a further +increase in the volume of bank notes. + +All this means inflation, and inflation by means of a circulating medium +having no connection with the gold stock of the world. To make room for +the additional currency, gold must be forced to leave the country, and +our whole monetary system, by no means too strong to-day, will be +weakened at its foundation. This is the fundamental difference between +expansion of credit by means of deposits and expansion by means of +national bank notes. The one is based on gold; the other is based on the +government debt. When deposits expand, the reserves of the banks must +increase proportionately and, if carried far enough, the result must be +to bring in gold rather than to force it out. In like manner, deposits +cannot for any considerable time be in excess of business needs. But +bank notes may be increased indefinitely, if the Government only borrows +enough, and the result will be the expulsion of gold whenever the +currency becomes redundant. That this is an actually present danger is +sufficiently demonstrated by the recent action of the Secretary of the +Treasury, who has seen fit to add to the national debt at a time when +the Treasury had a surplus of over 250 millions, for the sole purpose of +increasing the circulation of the national banks. Our currency system +can never be sound until the bank circulation is entirely divorced from +the government debt. + +The danger of inflating our monetary system with bank notes having no +gold reserve back of them is all the more serious from the fact that the +notes of the national banks are used as reserves by state banks, private +banks, trust companies, etc. They are part of the "cash reserves" on +which these banks base their deposits. Thus we have a system of credit +based on credit, and any weakness in the national bank note is carried +over and multiplied in the deposits of other banks. + +The complete _reductio ad absurdum_ of this multiple credit system came +when at a recent convention of the American Bankers' Association it was +seriously proposed that it be made lawful for national banks to count +their notes as "lawful money" in their own reserves. There is good +reason to believe that this is actually practised to some extent by +national banks to-day, though the practice is, of course, illegal. + +The safety of the national bank notes is seldom questioned. Whenever the +evils of our currency system are pointed out and plans for asset +currency or other reforms are proposed, the reformer is apt to be met by +the reply that, at any rate, our bank notes are perfectly safe, and we +had better put up with their other shortcomings rather than launch out +on new schemes which may possibly sacrifice that safety which we now +enjoy. The foregoing discussion should already have cast some suspicion +on this complacent attitude. It will be further weakened by a closer +analysis of the basis of the national bank circulation. + +National banks may issue their notes up to the amount of their paid-up +capital, and up to 100 per cent. of the par value of United States bonds +deposited with the Treasury, but never in excess of the market value of +the bonds. The notes are engraved by the Government and issued to the +banks. When signed by the proper officers of the bank, they become the +bank's promise to pay upon demand and may be issued for circulation. The +United States Treasury is also required by law to redeem on demand all +notes of national banks presented to it. For this purpose each bank must +keep with the Treasury a reserve fund equal to 5 per cent. of its +circulation. The duty of the Treasury to pay notes on demand, however, +is not limited to the amount of this reserve, but applies to all notes +properly presented. In case of the failure of a national bank, the +Treasury is required by law to immediately redeem all its notes. The +Treasury is secured against loss by the bonds deposited, by the 5 per +cent. cash reserve, by its prior lien on the assets of the banks, and by +the personal liability of the stockholders for an amount equal to their +stock investments. + +It is thus seen that the popular idea that the holder of a national bank +note is secured against loss by the government bonds deposited in +Washington is not strictly correct. What protects the holder of a note +is the absolute responsibility of the Treasury to redeem all notes on +demand. The bonds are to secure the Treasury, not the individual +noteholder, against loss. The noteholder is secured so long as the +Treasury is able to meet its legal obligations. + +Let us examine the character of our government bonds as security to +enable the Treasury to meet its obligations. To understand the +situation, it should be remembered that the leading purpose in the +establishment of the national banking system was not the creation of a +scientific currency system. The National Bank Act was a war measure +enacted largely for the purpose of improving the market for government +bonds during the Civil War. It was for this purpose that the circulation +of state banks was forced out of existence by a 10 per cent. tax and the +right of issue restricted to national banks on condition of the deposit +of government bonds as security. In the accomplishment of this purpose +the act has been eminently successful. United States bonds have been +given a new utility over and above their utility as an investment. From +the very beginning, this has given them an added value and enabled the +Government to borrow at lower rates of interest than it would otherwise +have had to pay. The act of March 14, 1900, made provision for the +ultimate refunding of all the United States debt into 2 per cent. bonds, +and gave an added inducement to the use of these bonds as note security +by lowering the annual tax on circulation from 1 per cent. to one-half +of 1 per cent., provided the notes were secured by the new 2 per cent. +bonds. All bonds issued since 1900 have borne 2 per cent. interest. Yet +the market value of these bonds has always stood above par.... +Obviously, this value is not based on earnings. British consols paying +2-1/2 per cent. are to-day quoted in the neighborhood of 85, which makes +them yield about 3 per cent. on the investment. The French and German 3 +per cent. loans are both considerably below par. United States bonds +have been given an artificial value through their use as security for +bank circulation. The national banks to-day hold for this purpose about +two-thirds of the total funded debt of the United States. Remove this +privilege from the national debt, and we should see the 2 per cent. +bonds (which compose two-thirds of the interest-bearing debt of the +United States) fall to perhaps seventy cents on the dollar, very likely +even lower. + +Here we have a remarkable situation. Our national bank notes are safe +because they are secured by government bonds, and our government bonds +are valuable because they are security for national bank notes. This +looks very much like lifting oneself by one's bootstraps. + +If we are to cling to the bond-secured note system, this matter of the +artificial value of government bonds will become an important practical +problem whenever it becomes necessary for the United States to make any +addition to its debt. Either the rate of interest will have to be raised +to 3 per cent. or higher, or, if that alternative is rejected, means +will have to be found to induce the banks to use the greater part of the +new loans as security for additional note issues.[258] In practical +effect, this is only a thinly disguised resort to the time-honored but +now thoroughly discredited practice of compelling the people to use the +government debt as a circulating medium. + +The bearing of this matter on the safety of the national bank note is +simple. The burden of the ultimate redemption of the bank notes has been +placed on the shoulders of the Treasury, to add to its other burdens of +maintaining the value of the greenbacks and of the silver dollars. If +loss of confidence in the bank notes should ever lead people to demand +their wholesale redemption, the Treasury would have to meet the demand +in gold. But the moment it tried to sell the bonds, it would find there +was no market for them except at a discount of perhaps 30 or 40 per +cent. It is true that the Treasury would still be able to recoup itself +for this loss in the value of the bonds by exercising its prior lien on +the assets of the banks. But this leads us to the important conclusion +that the final security for our bond-secured notes rests on the assets +of the banks after all. A more striking argument for asset currency +could hardly be discovered. + +It must be remembered, however, that the foreclosure by the Government +of its claim on the assets of the national banks would cut into the +wealth on which deposits are based and so have a most disastrous effect +on the deposit system. The pressure upon the Government to refrain from +such a crushing blow to credit would be overwhelming. It is almost +inconceivable that in time of panic or a national crisis the Government +would resort to such a procedure. Almost any alternative would be +preferred. It would not be too difficult a matter for the Government to +persuade itself that the wiser and safer course would be to suspend +specie payments, perhaps even declaring the bank notes a legal tender. A +more plausible case could be made out in favor of such action than was +found sufficient to justify the issue of the greenbacks of the Civil +War. Yet such action would mean the breakdown of our financial system. + +This is, of course, looking into the future and anticipating a state of +disaster which may never come. But a system which bids fair to break +down in time of disaster should be remodelled before disaster comes. And +we should not rest too confidently in the notion that disaster can never +reach us. It is only thirteen years ago [1895] that the burden of +supporting its paper and silver currency brought the United States +within twenty-four hours of suspension.... + + +SPECULATION INVOLVED IN THE ISSUE OF NOTES + +[259]When a banker takes out currency he engages in two distinct +transactions and enters upon two different hazards. In one transaction +he assumes the risk and holds the expectation of greater profit for +taking out circulation. Since buying bonds and taking out circulation +most of the time shows some theoretical profit over loaning direct, +presumably if there were no other consideration, most of the time our +bankers would keep outstanding all the notes they could. In the other +transaction, however, the banker engages in a speculation in government +securities. As a matter of fact, if the price of government bonds +advances, the profit from taking out circulation declines; but our +banker is pretty likely to view with equanimity the declining +circulation profit when he considers the profit he is making in his +speculation in bonds. On the other hand, as the price of government +bonds declines, circulation grows more profitable. The banker is likely +to view this with sour satisfaction when he looks on his loss in his +bond speculation. Profit or loss in the bond speculation is likely to +outbalance loss or profit in the circulation transaction.[260] + +Let us examine the situation more closely. Just what is the profit or +loss from taking out circulation? In the first place the bank gets the +regular current money rates on the loans it makes through issuing notes. +Also it gets the interest on the government bonds it buys. This, of +course, means the real interest, or income on the investment, called +basis, taking into consideration coupon interest, price paid, and date +of maturity. Excepting for the tax of 1/2 per cent. on the circulation +taken out (1 per cent. if taken out on the 3's or 4's) and for the +expenses attendant on taking out circulation, which the government +actuaries compute to average $63 on the $100,000, this interest on the +government bonds looks like clear "velvet." It would be, too, if the +banker did not have to pay more for the bonds than the amount of +circulation he can take out against them. To figure his net profit he +must deduct from the gain items just stated what he would have made if +he had loaned his funds direct instead of investing in bonds. + +Expressed as an algebraic equation the situation becomes much clearer. +Let + + x = current money rate; + y = basis rate at which government bonds are bought; + z = price of government bonds; + b = circulation received ($100,000 used as basis of calculation); + c = taxes, redemption, and other circulation expenses. + +(As already stated, government actuaries have calculated that +circulation expenses average to cost the banks $63 on the $100,000 of +circulation taken out. Taxes depend on whether the 2's, in which case +the tax is 1/2 per cent., or the 3's or 4's, in which case the tax is 1 +per cent., are bought. Taxes, then, amount to either b(.01) or b(.005). +We can take b as a constant in our calculations and base all our +computations on taking out $100,000 of circulation.) + +The equation of profit or loss on taking out circulation then reads: + + yz + bx - xz - c = profit or loss. + +But circulation taken out (b) can never be greater than the amount of +money paid for the bonds (z). + +If government bonds should be at par or at a discount, the nominal +profit would always be just the basis interest on the bonds, less the +tax and the cost of taking out circulation, or a constant advantage in +the case of the 2's of 1.437 per cent. For the purpose of this +discussion we will consider only the 2's of 1930. + +In the regular case, then, the money paid for the bonds (z) is greater +than the amount of circulation received (b). With that statement in mind +we can draw certain very definite conclusions about our circulation +direct from the equation we have formed; z is greater than b. + +Repeating the equation in order to have it directly before us: + + yz + bx - xz - c = profit or loss. + +Then as the current interest rate (x) increases, if all the other +quantities remain constant, the negative influence in the equation grows +greater, or profit from circulation decreases. We can, then, make +definitely: + + +STATEMENT I + +_If all other circumstances remain the same, circulation grows less +profitable as the current money rate advances._ + +As business increases and the demand for both credit and money +increases, as reflected in the rising interest rates, taking out +circulation _cæteris paribus_, with the inexorability of a mathematical +law, becomes _less_ profitable. + +Further, there is an intimate relationship between y and z. If the price +of bonds (z) declines, the basis rate (y) must advance. As a matter of +fact as z declines yz grows greater. If, then, x remains constant and z +declines the influence of the negative quantities of the equation is +growing less. Then follows: + + +STATEMENT II + +_As the price of bonds declines, if the current interest rate remains +constant, the profit from taking out circulation increases._ + +That gives the absolute mathematical basis for such general statements +as that "the price of bonds is too high to make circulation profitable." + +These two facts set out in Statement I and Statement II place the banker +who has taken out circulation between the devil and the deep, blue sea. +If the price of bonds remains the same and the current interest rate +rises, his circulation grows steadily less profitable. A decline in the +price of bonds affords the only offset to an increasing interest rate. +But if the price of bonds declines enough to offset the advance in the +current interest rate, the banks must mark off enough profits to cover +the loss on the capital value of the bonds. + +Speculating in securities properly forms no part of a bank's business. +It is an anomalous situation that in order to fulfil a proper function +of note issue a bank should have to undertake such an improper +speculation. + + +THE LACK OF ADJUSTMENT BETWEEN BANK NOTES AND DEPOSITS + +[261]Under our present currency system the volume of money in +circulation is perfectly flexible. It constantly expands and contracts +in automatic adjustment to the requirements of trade and the convenience +of the people. An increase in the volume of cash transactions brings +promptly an increase in the volume of currency in circulation through +the current withdrawals of money exceeding the current deposits of +money. A lessening in the volume of cash transactions promptly drives +unneeded currency out of circulation through the deposits of money +exceeding the withdrawals. No other system could provide a currency +which would adjust its volume in circulation more exactly to the needs +of trade and the preferences of the people. There is a ceaseless flow of +the money in circulation into bank reserves, and of money in bank +reserves into circulation--ceaseless except in an occasional crisis when +the natural flow of money from bank reserves into circulation is +arbitrarily stopped by banks refusing, for self-protection, to continue +paying out to the point of exhausting reserves. + +While the volume of money in circulation is thus perfectly and +automatically adjusted to trade requirements, it is to be noted that +this flexibility arises from the flow back and forth, between the mass +of money in circulation and the mass in bank reserves. In this lies the +main economic defect of our present currency system. An expansion in the +volume of money in circulation entails a corresponding contraction in +the volume of bank reserves, and necessarily a corresponding contraction +in loans. A period of expanding business would naturally be attended by +both an increased volume of loans and an increased volume of cash +transactions, such as increased pay-rolls, increased retail sales. +Increased cash transactions cause a larger volume of money to flow into +circulation. But this flow is out of bank reserves, thus contracting +them and necessitating a contraction of loans depending upon them, at +the very time when loans would naturally expand. Obviously, if business +becomes very active, the effect upon bank reserves is so adverse, and +the contraction of loans depending upon reserves so important, that +embarrassment is widespread and panic ensues. + +The main defect, then, of our present currency system is that the volume +of currency in circulation has its adjustment in the flow from bank +reserves into money in circulation and from money in circulation into +bank reserves, causing a contraction of bank reserves and the loans +depending on them as business expands. + +A remedy would be the use of bank notes through which the volume of +currency in circulation would have its adjustment in the flow from bank +deposits into bank notes in circulation, and from bank notes in +circulation into bank deposits, thus protecting from disturbance both +bank reserves and the loans based on them. + + +THE COMMERCIAL PAPER SITUATION IN THE UNITED STATES + +[262]... At the present time the commercial paper situation in the +United States is peculiar. "Commercial paper" in the old and strict +sense is little used in this country. "Trade paper," as it is now +called, arises in less than 3 per cent. of the credit transactions in +the United States.[263] In some lines of trade, especially where a local +wholesaler does a large business with small tradesmen, the wholesaler +will extend credit by taking the retailers' notes; but in obtaining +credit for himself the wholesaler will not surrender control of the +bundle of retailers' notes, preferring instead to give simply his own +note on a general understanding with his banker that the personal note +rests on, and is fully covered by, the retailers' notes.[264] The +wholesaler hesitates to surrender to the banker the notes that he +receives because he fears that his competitors might get some inkling of +his trade connections, etc. In general, "trade paper" is used to settle +accounts only when the credit terms are still long, that is, four months +or more.[265] + +What generally passes as "commercial paper" in the United States is +single-name paper. As in the case of the wholesaler referred to above, +the borrower of bank credit in these days offers for discount simply his +own promissory note. Some of this paper, particularly corporation notes, +carries indorsements, but these are largely "accommodation" +indorsements, which may buttress the security of the paper but which +indicate nothing as to its purpose. + +The wide use of single-name paper in this country is largely explained +by the fact that the prevailing terms of payment in business +transactions are net in 30 or 60 days, with a discount for payment in +cash within variously from 10 days to one month. The cash discount +allowed is usually so large that a purchaser can ill afford not to take +advantage of it. Two per cent. discount for cash within 10 days, for +example, with "60 days net" is equivalent to a return of 12 per cent. +per annum on one's capital. In actual practice the allowance is often +even more liberal. Hence where competition is at all keen the business +man is practically forced to adopt the system of cash payments, +depending upon his bank to advance to him, on his own notes, the +necessary funds. Moreover, so broadly has the custom of taking cash +discounts spread that a failure to take advantage of them is generally +regarded as an indication of weakness, and tends to undermine general +confidence in the business man's credit standing. Hence the necessity +for maintaining his credit rating, as well as competition, virtually +forces the business man into making anticipatory cash payments and thus, +more or less as a consequence, into the general practice of discounting +his personal paper.[266] + +Furthermore, as business operations have grown to a larger and larger +scale, especially in the case of large corporate enterprises, the credit +needs of business have in many cases expanded beyond the capacity of the +local banks to supply them. The necessity arose, therefore, to go +elsewhere for accommodation. This was met in some cases by the opening +of bank accounts in other centers, but obvious difficulties and +restrictions attend this method of procedure. More elastic possibilities +and fewer difficulties grew out of the employment of middlemen to market +the paper over the country as a whole on the best available terms. Hence +the note-broker is to-day an important factor in the discount market. As +a result of the note-broker's activities there has come to be +established an extensive open market for commercial (single-name) paper +in this country, and the rates at which such paper is discounted are +regularly reported in the daily newspapers. + +This development of a commercial-paper market reflects, of course, a +considerable development of the demand of the banks for this form of +investment.[267] "Country banks" especially have in the last few years +heavily increased their purchases in the open market, because the +necessity of writing off heavy losses due to the shrinkage of bond +values has tended to make them more timid about investing in securities, +and because they have also learned by experience that paper purchased +through a broker does not have to be renewed, as does most of the purely +local paper.[268] + +This development has, of course, tended to put an increasingly heavy +responsibility on the note-broker and has brought about, at least to +some extent, a readjustment of his business methods. At first +note-brokers simply solicited paper from merchants and charged a +brokerage fee. Latterly, the custom has grown up for the broker to buy +up the paper outright.[269] This forces the broker "to stand between the +maker and the bank," and to the extent that any given piece of paper may +be left on his hands, even though he does not indorse the paper that he +sells, it compels him to be very circumspect about the paper that he +purchases. Moreover, some banks now purchase paper with an option of +return within a specified period, making it a point carefully to +inquire about the maker of the paper before the option expires. In the +last few years banks as well as brokers have established carefully +organized credit departments, the purpose of which is, through careful +inquiry into the character and standing of sellers of paper, to enable +both brokers and bankers to select paper with sounder discrimination. + +This characteristically American discount system differs greatly from +that which prevails in Europe. Abroad, single-name paper is very little +used.[270] The European banker demands more than one signature, not only +as a guaranty of security, but also as an assurance of the validity of +the transaction out of which the paper offered for discount grew. When +the prospective borrower, for some sufficient reason, does not wish to +divulge the names of his clients, as would be necessary if he drew bills +on them, he may arrange with his bank for an overdraft (known as a cash +advance),[271] or by paying a small commission he may get the bank to +"accept" a bill drawn directly on it. With a bank's acceptance a bill, +even though drawn by the humblest shopkeeper, becomes a prime investment +and may be sold openly on the market at the lowest terms that +prevail.[272] On the Continent bank acceptances thus open the market +widely to all who can arrange for them, while the open market for +single-name paper in this country is restricted to large firms of +established reputations. + +In view of the prevailing practice in Europe it is interesting to +inquire why in America there should have been this peculiar development +in the discount field. It has been pointed out that before the Civil War +trade paper, as it is now called, was pretty generally used, but the +exigencies growing out of the war completely changed the situation. The +excessive issue of the greenbacks and the uncertain value of credit +instruments covering any appreciable period of time led sellers to +endeavor to bring business to a cash basis. Credits were shortened to 30 +or even to 10 days, and strong emphasis was placed on immediate +payment. With cash discounts alluringly liberal, merchants could ill +afford to forego them, and cash payments tended to become more and more +common. Big houses offered single-name paper to raise the needed funds, +and little by little the older system of settling by the promissory note +of the debtor was supplanted by the system of selling on open account, +with the choice given to the debtor of a liberal discount for cash or +the payment of the due amount "net" at the expiration of a relatively +short credit period. + +The transition was hastened by the development of the practice of +selling goods by sample instead of by personal selection from an +accumulated stock. Under the old practice the buyer bought under the +rule of _caveat emptor_, but when purchasing by sample he had a right to +demand that the delivered goods attain the standard of the sample, and +there grew up in consequence the doctrine of "implied warranties." These +warranties have in some lines been pushed very far,[273] but in any case +the buyer would hesitate to pay for goods until he had had a chance to +inspect them, and hence he would as a rule demand that they be consigned +to him on open account. The seller, however, cannot afford to wait for +payment until his accounts become due. Too much of his capital would be +tied up. He is forced, therefore, to go to his banker and, on the basis +of his accounts receivable, to offer his own note and thus to obtain +release of the capital otherwise temporarily beyond reach.... +Single-name paper virtually monopolizes the field.... + + +NO SYSTEM OF BANK ACCEPTANCES AND THE ABSENCE OF AN OPEN DISCOUNT MARKET + +[274]The weakness of our banking system as compared with the systems of +Europe may very certainly be attributed in part to the omission of the +bank act to permit bank acceptances. It is a weakness, furthermore, +which involves the country in serious economic loss. Without a national +discount market, the great majority of our merchants and manufacturers +are compelled to confine their borrowings to American capital, either +through the discounting of their paper with their local banks or through +its sale to note brokers. All but the strongest and largest are +practically excluded from the benefits of foreign competition for their +paper. Aside from the great concerns with international ramifications, +which are able to arrange their own credits abroad, our merchants and +manufacturers are not benefited by low foreign discount rates, except in +so far as note brokers, who make it a practice to borrow in Europe with +commercial paper as collateral, are better able to finance their +purchases. What is more, they receive relatively little advantage from +an accumulation of funds in New York banks. Low call loan rates have an +indirect rather than a direct effect on the rate which the mercantile +community has to pay for money. Low call rates, in other words, are an +indication more especially of stagnation in the stock market than of a +lack of demand for accommodation from merchants and manufacturers. Such +rates do not act as a stimulus to trade in general any more than high +call rates act as an immediate check to over-expansion. + +It is not only in our domestic trade that the country suffers through +the want of a discount market. Without bank acceptances we are at a +distinct disadvantage in connection with our foreign trade. Our +importers, unable to open credits with their banks, as is done abroad, +are not in a position to finance their purchases upon as favorable a +basis as the importers in other countries, as English cotton spinners, +for example. The English spinner about to purchase cotton in America +arranges for his bank to accept sixty or ninety days' sight bills drawn +on it by the American shipper. The latter draws his bills on the English +bank and attaches the documents covering the shipment, such as the bills +of lading, insurance certificates, invoices, etc. He then sells them to +a New York bank, thereby receiving immediate payment for his cotton. The +New York bank forwards the bills to its London correspondent, which +presents them for acceptance to the bank upon which they are drawn. Upon +the acceptance of the bills the documents are delivered to the +accepting bank, which then turns them over to the spinner upon whatever +arrangement has previously been made. The accepted bills are discounted +by the New York bank in London and the proceeds placed to its credit +there. The New York bank can afford to pay a high rate for such bills, +as they are drawn on prime bankers, rendering certain their ultimate +payment. The purchase of the bills does not, moreover, necessitate any +outlay of money, as against the credit to be received through the +discount of the bills the New York bank can immediately sell its checks +on London. + +Without such banking facilities--that is, the ability to arrange with +his bank to accept time bills drawn on it by a foreign shipper, the +American importer is compelled to finance his purchases in either one of +two ways. He may pay for the goods at once by remitting funds direct to +the shipper. This, however, ordinarily necessitates the negotiation by +the importer of a loan on his promissory note. If he is not in a +position to secure such an advance he must shift the burden of providing +funds to finance the shipment, from the time it is forwarded until it is +to be paid for, upon the foreign shipper, who is then in a position to +exact terms more favorable to himself through an adjustment of prices. +The practice in connection with this method of making payment for +foreign purchases is for the shipper to draw his draft on the American +importer and turn it over to his banker to forward for collection. Such +drafts, drawn as they are on individual importers and not on banks whose +standing is well known abroad, must be sent for collection since there +is no general market for them. Practically the only way in which a +foreign shipper can realize immediately on bills of this character is to +dispose of them to his own banker or get him to make an advance on them. + +Either of these two methods of financing our imports is expensive even +when the time between the shipment and the receipt of the goods is +short. When the time is much longer, as in the case of imports from +South America and the Far East, the cost is almost prohibitive--that is, +so great that we can not compete on an even basis with foreign buyers. +In fact, we might be practically excluded from these markets if a +makeshift were not possible. Our importer gets around our lack of +banking facilities by having his bank arrange a credit with its London +correspondent. He receives an undertaking, called a commercial letter of +credit, giving the terms of the credit--that is, the name of the London +bank upon which the bills are to be drawn, the amount which may be +drawn, the character of the goods which are to be purchased, the tenor +of the bills, and the documents which must accompany them. On the +strength of such a letter of credit, the shipper in South America, for +example, is able to dispose of his bills on London and thus receive +immediate payment for his goods. The local bank which buys the bills +sends them with the documents to its London correspondent, which +presents the bills to the bank on which they are drawn--that is, the +bank with which the credit was opened. Upon the acceptance of the bills +the documents are delivered. They are then sent by the London accepting +bank to the New York bank which opened the credit and the latter +delivers them to the importer against his trust receipt. Twelve days +prior to the maturity of the bills in London the New York bank presents +a statement to the importer indicating the amount of pounds sterling +which must be remitted to London to provide for their payment at +maturity or rather a bill stated in dollars for the amount of pounds +sterling drawn under the credit. In this purchase of exchange the +importer makes payment for his goods. This method while workable is +obviously cumbersome, yet it is practically the only one which the +American importer can follow in connection with such imports. It is +expensive for the importer, for not only must he pay his bank a +commission for arranging the credit, but there is included in this +commission a charge made by the London bank for its acceptance. Further +than that the importer must take a material risk in exchange. At the +time a credit is opened the cost of remitting, say £10,000 to take up +the bills in London, might be only $48,600, or at the rate of $4.86, +whereas by the time the bills actually mature exchange may have risen +and cost him $4.87, or $48,700. + +As a result of the inability of our banks to finance imports through the +acceptance of time bills, American importers are, then, made dependent +to a large extent upon London, and are required to pay London a +considerable annual tribute in the way of acceptance commissions. This +practice not only adds to the importance of London and militates against +the development of New York as a financial center, but it at the same +time works serious injury to our export trade. Since time bills can not +be drawn on our banks from foreign points against shipments of goods to +the United States, there are consequently in such foreign countries very +few bills which can be purchased for remittance to the United States in +payment for goods which have been bought here. In other words, under our +present banking system our imports do not create a supply of exchange on +New York, for example, which can be sold in foreign countries to those +who have payments to make in New York. This means that our exporters are +also, to their great disadvantage, made dependent upon London. It means +that when they are shipping goods to South America and to the Orient +they can not, when they are subject to competition, advantageously bill +them in United States dollars. They naturally do not care to value their +goods in local currency--that is, in the money of the country to which +the goods are going--so their only alternative is to value them in +francs or marks or sterling, preferably the latter, owing to the +distribution and extent of British trade, creating throughout the world, +as it does under the English banking system, a fairly constant supply of +and demand for exchange on London. When we come to bill our goods in +sterling, however, it is at once seen that our exporters are obliged to +take a risk of exchange, which is a serious handicap when competing with +British exporters. Our exporters who are to receive payment for their +goods in sterling must previously decide on what rate of exchange will +make the transaction profitable. If, in an effort to safeguard +themselves against a loss in exchange, they calculate on too low a rate +for the ultimate conversion of their sterling into dollars, their prices +become unfavorable compared to those made by British exporters and they +lose the business. If they do not calculate on a sufficiently low rate +they get the business but lose money on the transaction through a loss +in exchange. + +The prohibition of bank acceptances not only acts as a hamper upon our +domestic and foreign trade, but is detrimental to our banks as well. It +is the small country bank which is chiefly affected. The business of the +country bank, so far as the employment of its funds is concerned, may be +divided into two classes--that which relates to advances to local +customers and that connected with the investment of its surplus. It is +in respect to the latter that the matter of acceptances is important. +Under the present limitations of the National Bank Act there are three +principal ways in which a country bank may render its surplus funds +productive. It may deposit them with its reserve agent. This means a low +interest return, too low in fact to permit of only a relatively small +amount being thus employed. It may invest in bonds. In this way an +increased interest return can be secured, providing a wise selection of +securities is made, but it partakes of the nature of speculation. The +third way is to buy commercial paper. Such purchases give an ample +interest return and there is no savor of speculation. Even this method +of employing a bank's funds, however, is far from satisfactory. It means +the investment in a security for the strength of which the bank must +depend on the word of note brokers, the rating of the mercantile +agencies, or the opinion of some correspondent bank. It means, +furthermore, the tying up of the bank's funds for a fixed period. If +national banks were permitted to accept time bills the country bank +could then invest its funds in paper bearing the guaranty of some great +bank with whose standing it is perfectly familiar. Risk such as now has +to be taken would be eliminated. What is vital, however, is that with a +national discount market an investment in a bank-accepted bill is one +which could be realized upon immediately. Commercial paper and bank +acceptances are both discountable. The prime difference between them, as +affecting a country bank, is that they are not both readily +rediscountable. Herein probably lies the reason for the strong prejudice +against rediscounts which exists among bankers in the United States. In +this country when a bank discounts a piece of commercial paper it is +discounting something which for its security depends solely on its +maker. Should the bank desire to realize on this paper it could do so +by rediscounting it, but such a rediscount would be practically +equivalent to a loan to the bank on the strength of its own name. In +other words, to rediscount its commercial paper would affect a bank's +credit. To ask for a rediscount is to ask for accommodation. This would +not be the case with bank-accepted bills. If such bills were discounted +by a country bank as a means of investing its surplus and it was desired +to realize on them such a rediscount would be made not on the name of +the country bank, but on the name of the accepting bank. A rediscount in +this instance would not constitute a loan to the country bank and would +have absolutely no effect on its credit. It would merely indicate that +some more profitable business had arisen in which to employ its funds or +that it was desirous of increasing its reserve. + +Since the reserves of interior banks are so largely concentrated with +them and it is essential that they keep their assets in an especially +liquid condition, the prohibition of bank acceptances works injury to +the banks at the country's financial center, New York, in a different +way. It deprives them of what London banks, for example, have--that is, +a mass of the soundest securities against which to loan their money on +call or in which they may invest their funds for very brief +periods--bills of exchange, covering genuine commercial transactions, +bearing the acceptance of prime bankers. Unquestionably such securities +as a basis for loans are preferable to stock and bonds, but without them +New York banks must have recourse to day-to-day loans on the Stock +Exchange. Moreover, when the demand for such loans is limited. New York +banks are forced into the keenest kind of competition, a competition +which, as has been pointed out, is not only of little benefit to trade +but which, through the lowering of the money rate, actually stimulates +speculation. Furthermore, without a steady money rate such as exists in +countries possessing discount markets, New York banks are left with no +reasonable or satisfactory basis upon which to fix a rate of interest to +pay for the deposits of country banks. In London interest on bank +deposits is fixed at a certain percentage below the Bank of England +discount rate, usually 1-1/2 per cent.--that is, a rate which +fluctuates with the value of money and normally leaves a certain margin +of profit to the London bank. The same practice is followed in all the +great financial centers of Europe. With us, country banks receive a +fixed rate of interest for their deposits, usually 2 per cent., the year +around, regardless of fluctuations in the value of money. The +unscientific nature of such a rate is obvious. When the call loan rate +is high country banks do not receive interest in proportion to the value +of their deposits. When it is low the New York banks pay more interest +than the deposits are worth. In the latter instance the New York banks +are forced into injurious competition with one another. They are in much +the same position as competing railroads were earlier in our history, +with results similarly baneful. With the railroads it was worth while to +secure traffic even at a losing rate, as no matter what the return it +helped, if only a little, toward meeting fixed charges. Oftentimes with +the New York banks to-day any rate which they can secure for their money +whether losing or not is acceptable as helping to meet this fixed +interest charge on bank deposits. To pay 2 per cent. for deposits and to +keep a 25 per cent. reserve a bank must loan its money at 2-3/4 per +cent., to come out even, taking into consideration the actual expense of +making and recording the transaction. It is better to loan at 1-3/4 per +cent., however, than to let the money lie idle. It is better to lose 1 +per cent. than to lose the entire 2-3/4 per cent., as would be done in +case no loans at all were made, clerk-hire being just as much a fixed +charge as interest. With the amendment of the National Bank Act, to +permit the acceptance of time bills, such ruinous competition would +cease. The funds of the banks would come to be principally invested in +trade paper and stock-exchange loans would be relegated to a position of +secondary importance, as in London and on the Continent. The field for +the investment of their deposits would be greatly broadened, to the +benefit both of the banks and trade in general. + +To remedy this primary defect in our banking system, to make possible +the financing of our domestic and foreign trade along the lines which +have proved so advantageous in other countries, to provide negotiable +paper of a character suitable to the investment of foreign funds, paper +which can not only be discounted but rediscounted, to give trade the +advantage of bank surpluses accumulated both in the country at large and +in New York, to lessen the evils of speculation, to afford a reasonable +basis for the calculation of interest rates on bank deposits in central +reserve cities, to bring New York into the circle of those financial +centers between which funds move naturally as discount rates rise or +decline, to secure the advantage of the competition of foreign capital +for our trade paper, can be put in the way of accomplishment by the +insertion of a paragraph or two in the National Bank Act. + + * * * * * + +[275]The European financial system is constructed upon discounts as its +foundation; the American system is constructed upon bonds and stocks as +its foundation. Bank notes in Europe are issued mainly against bullion +and discounts; in the United States mainly against bullion and bonds. + +The quick assets held by European banks against their deposits consist +of discounts or call loans, largely secured by discounts. The quick +assets of American banks ... are primarily call loans on stock and bond +collateral. + +In Europe the daily plus and minus of money requirements are adjusted by +the use of the discount market--that is to say, in a final analysis, by +purchase or sale of bills. (Calling in or putting out money on call +where the loans are secured by bills amounts, in effect, to a sale or a +purchase of bills.) In a last analysis this means that in Europe +attempts to liquidate are primarily appeals to the whole nation to +liquidate its temporary commercial investments, the brunt of such +liquidation being borne by the entire community, and the pressure being +constantly subdivided, every member of the community thus contributing +his share. + +As a majority of discounts represent goods in process of production or +on the way to consumption, liquidation with them primarily expresses +itself by a falling off in new production, while the consumer, on the +other hand, can not stop consuming and must therefore continue to pay. +The brunt is thus borne by the whole nation and adjustment follows +without violent convulsions. + +In sharp contrast with such a system the attempts to liquidate in the +United States are directed primarily at the contractors of stock +exchange loans. This means that a comparatively limited number of +debtors are called upon to sell their securities. This they can do only +by finding new investors, who, as a rule, are at such times +comparatively rare, because when acute pressure arises it generally +originates in the inability of the investor to purchase because of lack +of funds or in his unwillingness by reason of his distrust of the +financial situation. The concomitant of this is that those forced to +sell securities at such times must offer them at sufficiently reduced +prices to bring about an entire change in the attitude of the investor. +The difficulty here is that violent reductions of prices in themselves +cause distrust, and low prices caused by distrust not only frighten away +purchasers but, in addition, unsettle the owners of securities and thus +cause them to join the ranks of the sellers. An acute convulsion, +therefore, must inevitably follow before the tide can be turned.... + +Of course, general liquidation in Europe includes a liquidation of +securities, just as liquidation in the United States also includes +liquidation of commercial paper as it matures. But the difference is +that in Europe bills will be the main factor and securities will play a +much more subordinate part, while with us just the reverse is true. + + +THE ESSENTIAL CONDITIONS FOR THE ESTABLISHMENT OF AN INTERNATIONAL +DISCOUNT MARKET + +[276]The essential conditions for the establishment of an international +discount market are: + +1. Every bill offered for discount should be based on a commercial +transaction where value passes. Finance or accommodation bills should +be extremely rare and capable of satisfactory explanation. + +2. It follows that almost invariably the bill will arise out of a sale +of goods and will be in the form of a draft by the seller upon the +buyer, and accepted by the buyer. + +3. It will thus be a two-name bill, and not an individual promissory +note. How far you can change your system in this respect and how far the +powers of your new Federal banks can be used to induce such a change, is +a question which I cannot pretend to answer, but which you will no doubt +be able to answer. + +4. The bill should be drawn for a period neither too long nor too short. +The period should be sufficient to allow of a resale of the goods on +which the bill is based, thus making the bill in a sense +self-liquidating. The usual period is three months. + +5. While there should be a large proportion of trade bills, there should +be a still larger proportion of acceptances by banks and finance houses, +based, of course, on collateral, which usually takes the form of +imported produce. In Germany, however, I understand that banks accept a +good many drafts arising out of internal transactions. + +6. If the market is not to be merely a home market, but international: +that is, attractive to foreign bill buyers, an important and desirable +step would be the opening of American banks or branches of American +banks in foreign exchange centres, such as London, Paris, Berlin, +Amsterdam, Buenos Aires, Shanghai, and so on, and these banks should +always be prepared to encourage American bills by buying, at reasonable +rates of exchange, bills on New York, Chicago, and other American +centres, payable in dollars. + +7. Your usury laws would have to be modified so as to allow discount +rates to move freely upwards if required. + +8. Your Federal reserve banks which are intended to be the equivalent of +the Central banks of other countries, such as the Bank of England, Bank +of France, and the Reichsbank, should be prepared to rediscount approved +bills at all times and to any extent. + +The advantages to you of such a market would be the same advantages +that we possess, namely, liquid employment for short money; power to +meet demands for money without disorganizing stock exchange prices; +power to check overtrading at home, and finally, power to check a +foreign drain of gold. + + +CASH STOCK EXCHANGE DEALINGS + +[277]In England, France, and Germany there exist monthly or half-monthly +settlements of stock exchange transactions, and as stock exchange loans +run from one settlement to the next the amount of money employed on the +stock exchange between settlements remains stationary. If, at the +settlement, it develops that commitments on the stock exchange have +increased and that a larger amount of money is needed there, so much +additional money will under normal circumstances be withdrawn from the +bill market and go into the stock exchange. If less money is wanted on +the stock exchange, so much more will go into the bill market. + +Without entering upon a discussion of the question of cash stock +exchange dealings versus stock exchange dealings per settlement (for +which, be it said in passing, a suitable method of weekly stock exchange +settlements can probably be devised for this country, combined with +provisions for proper margining in order to prevent over-stimulation to +gambling), we are, for the purposes of this article, interested only in +the effect of this method of cash dealings on the whole financial +system. An exclusive system of cash dealings brings about the +pre-ponderance of the call loan on stock exchange collateral. But for +the existence of the seducing call loan, which is one of the gravest +dangers and curses of our system, we should have been forced to develop +our bill market as a regulator of our daily money requirements. In that +case, instead of seeing the idle money of the whole nation poured into +stock exchange loans when trade is inactive--thus unduly stimulating +speculation when it should be discouraged--and again withdrawing money +from the stock exchanges in order to provide for the business of the +whole nation when trade becomes active--thus bringing about anxiety and +convulsions on the stock exchange in the face of prosperity--we should +have a system based on bills; that is to say, based on the broad +foundations consisting of the commerce and trade of the whole nation, +and we should then enjoy an almost uniform rate of interest all over the +country, gently rising and falling within moderate bounds, instead of +the violent fluctuations and unbearable conditions to which we are now +subjected. + +The aggregate amount invested by a nation in trade and commerce should +be and is many times the amount invested in stock exchange loans, which +latter represent undigested securities and securities carried for +speculative investors. Our way of doing business may be illustrated by +two adjoining reservoirs, one small and one very large. The small one +represents the stock exchange and contains the call loans; the large one +represents the general business of the country, as expressed by commerce +and industry. In Europe the small reservoir is regulated by pumping +water into it from the large one or by withdrawing water from it into +the large one. In this way the outflow and inflow of the large reservoir +are scarcely perceptible, and yet there is no difficulty in regulating +the small one. With us, the reverse is done. If there is a shortage of +water in the large reservoir we draw on the small one and, in order to +increase the water in the large reservoir by perhaps an inch, we empty +the small one altogether, or else in order to decrease the amount of +water in the large reservoir by an inch, we fill the small one to +overflowing. + + +NO POWER TO LEND ON REAL ESTATE[278] + +Most of the restrictions in the national banking law have to do with +loans, reserves, or the issue of notes. Of these the restrictions upon +loans are by far the most serious impediment in competing for business +with state banks and trust companies. For the banks outside the large +cities this is particularly true of the provision which forbids loans +upon real estate as security. + +This restriction is based upon a sound banking principle, learned after +much bitter experience. But the experience which led to a complete +prohibition of real estate loans was gained amid the economic conditions +of the first half of the last century, and the principle itself is one +which is applicable only to a particular form of banking organization. +While the country was in process of settlement, with an abundance of +unoccupied fertile land, real estate was a security of most uncertain +value. Moreover, the wildest of the speculative movements which preceded +all our early crises were invariably in land. At present, land values +are far more stable, and real estate is everywhere included among the +most conservative of investments, proper for all with the one exception +of commercial banks. + +For banks, all of whose obligations are payable upon demand, the real +estate loan, quite regardless of its safety, is wisely considered +unsuitable. Such loans are commonly wanted by borrowers for a +considerable period of time and, therefore, they can not readily be +reduced in amount even by an individual bank. In other words, they are +not liquid. But the importance of this quality in all its assets +disappears when a bank begins to acquire time or savings deposits, as +well as those payable on demand.... The example of the trust companies +shows that a great variety of financial business can be carried on +safely and profitably under a single management. Failures among them +have been comparatively few in number, and it would be difficult to find +a single instance of disaster which could be attributed to the variety +of business carried on. + +Some of the advantages which the banks would derive if they were able to +lend on real estate are so evident that they require little more than +mere mention. It would give them more of the most profitable kind of +business, that which has its origin in the neighborhood of the bank. The +immediate return is generally greater than can be secured from the +employment of funds in the money centers or in the purchase of paper +from note brokers. Moreover, in fostering the growth of wealth and +population in its locality a bank is laying a solid foundation for the +future expansion of its own business. Finally, the ability to lend on +real estate will often enable a bank to secure valuable customers who +would otherwise go elsewhere. It has been the unpleasant experience of +many a national banker to be obliged to refuse a loan to a would-be +borrower who has nothing but real estate to offer as security and to see +him enter a neighboring state bank or trust company where there was no +legal obstacle to the transaction. Relations once established are pretty +certain to continue even after the borrower has security which falls +within the provisions of the national law. + +There are then at least three distinct advantages which may be expected +to follow if the national banks are permitted to lend on real estate. It +would be profitable for the banks; it would be of advantage to the +localities served by the banks; and, finally, it would enable the banks +to compete with state institutions upon a more equal footing,[279] thus +checking to some extent the relative decline of banking under the +national law. + + +THE INDEPENDENT TREASURY AS A SOURCE OF WEAKNESS IN OUR BANKING +SYSTEM[280] + +For many years the banks of this country have conducted a persistent +agitation for the abolition of the Independent Treasury system. It has +been their contention that the Independent Treasury was an archaic and +inefficient system of administering the finances of the nation; that it +worked serious hardship upon the banks and the business of the country, +and that any system of reform should include its abolition. + +The treasury is, in reality, a central bank of deposit with branches, +run by the Government, in which the Government is the only depositor, +and from which there are no borrowers. The central office of the +Treasury is situated in Washington, while there are ten subtreasuries or +branches scattered among the various large cities of the country. The +most important subtreasury, from the standpoint of the volume of +business handled, is located in New York City.... + +The United States is the only large nation in the world which has a +treasury system of this sort, and this fact has been made much of in the +agitation for its abolition. + + +DIFFICULTIES ARISING FROM THE TREASURY SYSTEM + +There is no room for dispute that many features of the Independent +Treasury have, in the past, been the source of serious difficulties. +However, we must recognize that within the last decade, and particularly +within the last two or three years, most of the glaring defects have +been eliminated through a liberalization in methods, involving, in +brief, a deposit of a very considerable amount of the Government's money +in national banks rather than carrying it locked up in the vaults of the +Treasury, through more liberal administrative regulations by which +payments to the Treasury could be made with certified checks, and +through facilitating in other ways the transactions of business men with +the Treasury Department. + + +CORRESPONDENCE OF TREASURY RECEIPTS AND DISBURSEMENTS + +... The real criticism against the Treasury is that it causes the tying +up of money, not over a series of years, but during the months in which +the banking system of the country most needs it. This condition is the +result of the lack of correspondence between government receipts and +disbursements. + +During the first four months of the year the receipts are less than in +any other period. During the month of May, the receipts sharply +increase, reaching their maximum about the first of June, and continuing +at a very high rate over that month. In July the income falls off, +reaching by the end of the month a point a little above that which +prevailed in April, after which it gradually increases during August and +September. About October first the tide turns and the receipts fall off +sharply during that month, while during December the revenue again +increases. As contrasted with this the government expenditures change +only in a general way.... + + +EXAGGERATION OF TREASURY EVILS + +It should be stated that whatever embarrassment exists because of this +condition, and which as a matter of fact has been grossly exaggerated, +is found almost entirely in New York City. + +However, in order to reduce as much as possible the objections raised by +the bankers and to prevent money being taken out of circulation and +buried in the Treasury, where it would be of no service to the country, +the Secretary of the Treasury, on January 9, 1913, issued the following +order, which inaugurated a radical change in the manner of handling and +disbursing the public funds. The objects to be accomplished were +announced in the order as follows: + +"For the purpose of bringing the ordinary fiscal transactions of the +Federal Government more nearly into harmony with present business +practices, it has been determined that the daily receipts of the +Government shall be placed with the national bank depositaries to the +credit of the Treasurer of the United States. Disbursements will be made +by warrant or check drawn on the Treasurer, but payable by national bank +depositaries, as well as by the Treasury and subtreasuries." + +Secretary McAdoo, in his report for the fiscal year ending June 30, +1913, in speaking of this, stated that while it had caused some +embarrassment "the difficulties at first encountered are disappearing, +and the system appears to respond to the public requirements, and to be +accomplishing the purposes for which it was devised." + + +LACK OF CENTRAL CONTROL + +[281]There is no country in the world where the volume of currency in +circulation and the demand for bank credits fluctuate more widely than +in the United States. This is due to the great expanse of our territory, +to the annual harvest requirements of the agricultural sections, to the +prevailing business activity and enterprise, and to the rapid and +unequal increase of population and wealth in different sections. +Furthermore, there is no country in the world where intelligent control +over bank credits and bank reserves is needed more than in the United +States. There are in the United States nearly seven thousand national +banks, besides twice as many state banks and trust companies. Each of +these institutions acts for its individual interest alone, independently +of the others, and the prevailing tendency of each at all times is to +expand its credits to the limit permitted by law. The country banks lend +their surplus resources in the form of deposits at interest to the banks +in the larger cities, and the banks in the principal money centres +commonly expand their credits as much as practicable by lending on call +such sums as they deem it unsafe to lend on time or by discount of +commercial paper. Each bank with a deposit in another bank assumes that, +in case of need, it can strengthen its reserve by drawing upon this +deposit; but it fails to consider that, when thus it strengthens its own +reserve, it must to the same extent weaken the reserve of the other +bank, and that the deposits of banks with other banks add no strength to +the general credit situation. Each bank that has loaned money on call +assumes that, in case of need, it can strengthen its reserve by calling +such loans; but it fails to consider that, generally, when a loan is +called the borrower is obliged to borrow the same sum from some other +bank, although a high rate of interest may be exacted, and, therefore, +that call loans affect the security of the entire bank situation +practically to the same extent as time loans. + +In the United States there is no way of regulating the supply of bank +credits and of holding part of the potential supply in reserve for +periods of financial stringency. Consequently, nearly always there is +either an over-abundance of money (meaning credit which the banks are +ready to lend) or a money famine. It has been argued that the volume of +credits granted by the banks depends upon business activity and upon the +consequent demand for credit and not upon the power of the banks to +grant credits, and, therefore, that low interest rates have little +effect in causing an expansion of bank credits. Experience, however, +shows that the contrary is the case, at least in the United States. It +is true that, when there is loss of confidence and when business is +depressed, interest rates are low, because there is less currency in +circulation and more in the bank reserves, while at the same time the +demand for bank credits is diminished. It is true, also, that low +interest rates will not stimulate speculation and enterprise unless +people have confidence and are ready to speculate and to embark in new +enterprises. But we know by experience that when people are in a mood +for speculation and for business expansion low interest rates operate as +a powerful stimulus to speculation and business expansion. A leading +banker has said: "In the long run commerce suffers more from the periods +of over-abundance (of money) than from those of scarcity. The origin of +each recurring period of tight money can be traced to preceding periods +of easy money. Whenever money becomes so over-abundant that bankers, in +order to keep it earning something, have to force it out at abnormally +low rates of interest, the foundations are laid for a period of +stringency in the not far distant future, for then speculation is +encouraged, prices are inflated, and all sorts of securities are floated +until the money market is glutted with them."[282] [The need of +intelligent control over discount rates and bank credits is (was) +imperative.] + + +ABSENCE OF REGULATION OF RATIO OF DEPOSITS TO CAPITAL AND SURPLUS + +[283]The reports of condition of the national banks, according to the +statements of September 12, 1914, to the Comptroller of the Currency, +show that, on an average, the total deposits of all national banks +amount to about four and six-tenths times their total capital and +surplus. This means that the average capital and surplus of these banks +is equal to approximately 21 per cent. of the total amount of deposits. +There are, however, national banks whose deposits amount to ten or more +times their capital and surplus, and in these cases the margin of +protection to depositors is only 10 per cent. or less of the sum total +of deposits. Usually the amount of money which a bank has invested in +loans approximates the amount of its deposits. In the case of a bank +whose loans equal its deposits, and whose deposits are approximately ten +times its capital and surplus, it is obvious that the loss of over 10 +per cent. in loans would wipe out both capital and surplus and destroy +the solvency of the bank, rendering it unable to pay its depositors. + +The view is held by many practical bankers and experienced economists +that it is not sound banking for an active commercial bank to be allowed +to receive deposits in excess of ten times its capital and surplus. I am +firmly impressed with the correctness of this view, and respectfully +recommend to the Congress that the national-bank act be amended so as to +provide that no national bank shall be permitted to hold deposits in +excess of ten times its unimpaired capital and surplus. Perhaps it might +be wiser to make this limitation eight times the capital and surplus. + +Such a limitation need not interfere with the growth and development of +the bank. When its deposits approach an amount equal to ten times its +capital and surplus, or whatever other limitation may be fixed, +arrangements may be made to increase its capital. A bank whose deposits +amount to ten times the capital and surplus, if efficiently managed, +should be so profitable that there would be no difficulty in providing +for an increase of capital by the sale of additional stock, and when the +proposed increase shall have been authorized by two-thirds of its +stockholders and approved by the Comptroller of the Currency, it can be +made promptly effective. A commercial bank whose capital and surplus +amount to less than one-tenth of its deposits is, except possibly under +very exceptional conditions, doing business on too small a capital and +upon too narrow a margin for safety, and does not furnish its creditors +the protection to which they are entitled against unexpected losses and +contingencies which are liable to, and do, so frequently arise.... + + +BANKING ABUSES + +[284]... Among the many abuses and violations of law and regulations +with which the department has to contend are excessive loans; +overdrafts; loose and unbusinesslike methods of accounting; excessive +borrowings by the banks; investment of the bank's funds in securities +not authorized by law; charging of usurious rates of interest; unlawful +loans on real estate; excessive loans to officers, clerks, and employés +of the bank employing them; loans to a bank's officers or employés and +others through "dummies"; loaning money, directly or indirectly, upon +the bank's own stock; transaction of a brokerage or commission business +by the bank's executive officers, the commissions thus collected being +sometimes appropriated personally by the officers and sometimes going +directly or indirectly to the bank; false statements of directors as to +ownership of stock; false statements made by bank officers, such as +including as cash or cash items memoranda of moneys due from one source +or another which do not represent actual cash and can not be immediately +converted into cash; and failure or refusal when so directed to charge +off bad debts and other ascertained losses; delay on the part of +directors in taking the oath of office. + +For many of the offences indicated the only penalty which can be +enforced by the Comptroller's office is the forfeiture of the bank's +charter by suit in the United States Court. This in many cases would +prove a great hardship to innocent stockholders and depositors, and can +only be resorted to with much reluctance by this office.... + + +USURIOUS INTEREST RATES + +[285]All the national banks of the country have been required in each +report of condition made to the Comptroller's office since January 1 +last to state under oath the highest rate of interest they have charged +since the preceding report and the average rate of interest charged by +them on all loans since the preceding report. + +The reports received at the Comptroller's office show indisputably that +in some States and sections borrowers, especially small borrowers, have +been and are being subjected to extortions and exactions which the +average man would consider impossible in this enlightened age. + +One thousand and twenty banks in different sections of the country, out +of the total of 7,615 banks, admitted that they were receiving an +average of 10 per cent. or more--some an average of 18 per cent.--on all +their loans. + +Those receiving an average of 10 per cent. and upwards included 2 banks +in Illinois, 6 in Minnesota, 2 in Missouri, 23 in Georgia, 6 in Florida, +21 in Alabama, 2 in Louisiana, 315 in Texas, 17 in Arkansas, 3 in +Tennessee, 90 in North Dakota, 25 in South Dakota, 18 in Nebraska, 5 in +Kansas, 38 in Montana, 14 in Wyoming, 37 in Colorado, 25 in New Mexico, +300 in Oklahoma, 12 in Washington, 10 in Oregon, 13 in California, 2 in +Utah, 1 in Nevada, and 33 banks in Idaho. + +Let me illustrate the methods of some of these bankers by giving you the +facts and figures as taken from the sworn statements submitted to the +Comptroller's office by the national banks in two particular States in +the Southwest. + +In one of these States there were 131 banks which reported that they +charged a maximum rate of interest ranging from 15 per cent. to 24 per +cent. per annum, 67 banks whose maximum rate ranged between 25 per cent. +and 60 per cent. per annum, 22 banks which charged between 60 per cent. +per annum and 100 per cent. per annum, 18 banks whose maximum rate was +from 100 per cent. to 200 per cent. per annum, and 8 banks which owned +up to having charged maximum rates ranging between 200 per cent. and +2,000 per cent. Most of these disgraceful and unprecedented rates were +for comparatively small loans.... + +These figures are not results of the rule, applied by many banks, not to +pass a loan on their books for less than a dollar.... When we find loans +made by national banks for $25, $50, $100, $200, $500, and $2,000 or +more, at 40, 50, 100, or 1,000 per cent., it is merely a hideous gamble +on how long the borrower can keep starvation from his door and live and +work. Yet I am told on good authority that in one State, largely +agricultural, reports from nearly 200 banks--lending chiefly or largely +to farmers--show losses of only a fraction of 1 per cent. on farmers' +loans, while the average interest rate in these particular banks is 12 +per cent. to 15 per cent.--and the maximum rate 30 per cent. or 40 per +cent., the banks paying large dividends. + +We read much of the infernos of the slums of the great cities, of +degradation and misery and squalor, of the grinding callousness of +tenement landlords and sweatshop operators. Here in the country we find +bankers, men in business that should be the most respectable, as it is +the most responsible, of all secular avocations, literally crushing the +faces of their neighbors, deliberately fastening their fangs in the very +heart of poverty.... + +A well thought out, carefully constructed, conservative system of rural +credits for the development of agriculture and the increase of our +wealth and resources by offering encouragement and opportunity to the +ambitious farmer will come presently. When it comes all of us will share +the splendid results.... + + +BANKERS' VIEW OF USURIOUS INTEREST RATES + +[286]On February 25 the following statement was "given out" from the +office of the Comptroller of the Currency: + + The Comptroller of the Currency received to-day from the + Farmers' Grain Dealers' Association of Iowa notification of + the adoption at the convention of that association in Des + Moines, Iowa, on the 17th instant, of the following + resolution: + + _Be It Resolved_, By the Farmers' Grain Dealers' Association + of Iowa, representing 40,000 members, as follows: + + That we are as much opposed to bank discrimination in + interest rates as to railroad discrimination in freight + rates. + + We oppose private control of the public currency. + + That we strongly commend the Comptroller of the Currency for + his courageous exposure of bank usury; and we unalterably + oppose the efforts of the guilty parties to abolish his + office. + +There has been no better statement of the Comptroller's position than is +here given--credit standing and variations of it must have no influence +on interest rates and anyone who wishes his office abolished is guilty +of usury; or, conversely, only those guilty of usury wish the office +abolished. + +The statement is inadequate only in the failure to define what is meant +by "private control of the public currency." + +FOOTNOTES: + +[249] Conway and Patterson, _The Operation of the New Bank Act_, pp. 1, +2. J. B. Lippincott Company, Philadelphia, 1914. + +[250] John Skelton Williams, Comptroller of the Currency, _Democracy in +Banking_, Address delivered before the annual convention of the North +Carolina Bankers' Association, Raleigh, May 13, 1914. Printed in +_Congressional Record_, 63d Congress, 2d Session, Vol. 51, pp. 10150-53. + +[251] A. Piatt Andrew, _The Essential and the Unessential in Currency +Legislation_, in Questions of Public Policy, Addresses delivered in the +Page Lecture Series, 1913, before the Senior Class of the Sheffield +Scientific School, Yale University, pp. 62-70. Yale University Press, +New Haven, Connecticut, 1913. + +[252] Adapted from John Perrin, _What is Wrong with Our Banking and +Currency System?, The Journal of Political Economy_, Vol. 19, No. 10, +December, 1911, pp. 856-865. + +[253] Paul M. Warburg. _The Discount System in Europe_, Publications of +the National Monetary Commission, Senate Document, No. 402, 61st +Congress, 2nd Session, pp. 33, 34. + +[254] Conway and Patterson, _The Operation of the New Bank Act_, pp. +203-207. J. B. Lippincott Company. Philadelphia. 1914. + +[255] Fred Rogers Fairchild, _Bond-Secured Bank Notes and Elasticity_, +_The Outlook_, Vol. 88, No. 11, March 14, 1908, pp. 590-93. + +[256] [As was pointed out in an earlier chapter, the autumnal demand for +currency in the agricultural sections of the country has fallen off +appreciably since 1907.] + +[257] Fred Rogers Fairchild. _Fundamental Defects of the Bond-Secured +Bank Notes_, _Bankers Magazine_, Vol. LXXVI, No. 4, April, 1908, pp. +487-90. + +[258] We are not considering the third alternative of issuing bonds at a +heavy discount. + +[259] Adapted from W. H. Lyon, _A Gamble in Governments_, _Moody's +Magazine_, Vol. XI, No. 1, January, 1911, pp. 181-186. + +[260] [In this extract the explanation of the so-called perverse +elasticity of our national bank notes is given incidentally but very +clearly.] + +[261] Adapted from John Perrin, _What is Wrong with Our Banking and +Currency System?_, _The Journal of Political Economy_, Vol. 19, No. 10 +December, 1911, pp. 856-865. + +[262] Eugene E. Agger. _The Commercial Paper Debate. The Journal of +Political Economy_, Vol. 22, No. 7, July, 1914, pp. 663-667. + +[263] _Annalist_, March 9, 1914, p. 293. + +[264] _Annalist_, March 9, 1914, p. 294. + +[265] J. J. Klein, _Annalist_, March 23, 1914, p. 361. + +[266] _Ibid._ + +[267] During 1912 over $1,700,000,000 in notes were sold by reputable +brokers, and they represented in these transactions from 2,500 to 3,000 +concerns. In one large eastern state over two-thirds of the state banks +and trust companies regularly invest a portion of their funds in this +class of paper (J. A. Broderick, _Finance_, October 4, 1913, p. 328). On +August 9, 1913, according to the report of the Comptroller of the +Currency, the national banks held over six billions of dollars of +commercial paper, most of which was single-name. + +[268] _Financier_, June 22, 1912. + +[269] J. G. Cannon, _Financial Age_, October 19, 1908. + +[270] P. M. Warburg, _The Discount System in Europe_, in Report of the +National Monetary Commission. + +[271] _Ibid._: see also William Jacobs, _Bank Acceptances_, in Report of +the National Monetary Commission. + +[272] Warburg, _loc. cit._ + +[273] E. D. Page, _Annalist_, March 16, 1914, p. 324. + +[274] Lawrence Merton Jacobs, _Bank Acceptances_, Publications of the +National Monetary Commission, Senate Document No. 569, 61st Congress, 2d +Session, pp. 9-19. + +[275] Paul M. Warburg, _The Discount System in Europe_, Publications of +the National Monetary Commission, Senate Document, No. 402, 61st +Congress, 2nd Session, pp. 23-25. + +[276] Adapted from James H. Simpson, General Manager, Bank of Liverpool, +Ltd., _Some Leading Features of the London Money and Discount Markets_, +an address delivered at the annual banquet of the bankers of the city of +New York, January 19, 1914. + +[277] Paul M. Warburg, op. cit., pp. 28-30. + +[278] O. W. M. Sprague, _Banking Reform in the United States_, pp. +72-75, Harvard University, 1911. + +[279] The importance of real estate to the state banking institutions is +shown in the Special Report from the Banks of the United States on April +28, 1909, recently published by the National Monetary Commission. For +state banks real estate loans and mortgages amounted to $414,000,000 or +12-1/2 per cent. of total resources and for the trust companies to +$377,000,000, more than 9 per cent. of their resources. + +[280] Conway and Patterson, _The Operation of the New Bank Act_, pp. +184-192. J. B. Lippincott Company. Philadelphia, 1914. + +[281] Victor Morawetz, _The Banking and Currency Problem in the United +States_, pp. 47-50. North American Review Publishing Company. 1909. + +[282] From an address by Mr. James B. Forgan to the Texas Bankers' +Association. + +[283] Report of the Comptroller of the Currency, 1914, pp. 20, 21. + +[284] _Ibid._, pp. 16, 17. + +[285] John Skelton Williams, Address before the Kentucky Bankers' +Association, October 6, 1915. _The Commercial and Financial Chronicle_, +Vol. 101, No. 2624, October 9, 1915, pp. 1137, 1138. + +[286] _Journal of the American Bankers' Association_, Vol. VIII, No. 9, +March, 1916, pp. 755-6. + + + + +CHAPTER XXXI + +THE FEDERAL RESERVE SYSTEM + + +THE FEDERAL RESERVE ACT[287] + + +THE SPIRIT AND OBJECTS OF THE ACT + +The primary purpose of the Federal Reserve Act of December 23, 1913, is +to make certain that there will always be an available supply of money +and credit in this country with which to meet unusual banking +requirements. Banks of a new class, to be known as Federal Reserve +Banks, are to be established, and upon these banks is to rest the heavy +responsibility of supporting the structure of credit in periods of +financial strain. The new banks are expected to keep themselves in a +condition of such strength in ordinary times that the other banks may +safely rely upon them for all needed cash and credit in emergencies. In +the past, the banks in this country, when subjected to financial +pressure, have relied mainly upon loan contraction and the selling of +securities. In future it is expected that they will resort to the +Federal Reserve Banks, securing additional funds from these by +rediscounting commercial loans. If the new arrangements work well, loans +in future will not be reduced merely for the purpose of strengthening +the banks. Loan contraction will take place only when there is evidence +of an over-extended condition of business; and even then contraction +will be carried through gradually, so as to conserve all interests so +far as may be possible. Under the new system a most important influence, +if not the most important single influence determining the character of +banking operations, will be just the reverse of what it has been in the +past. + +To meet the heavy responsibilities placed upon the Federal Reserve +Banks, two things are absolutely essential--good management, and ample +powers and resources. Good management cannot be secured with certainty +by means of legislative provisions, however carefully designed with that +end in view. In the particular instance of the Federal Reserve Act, an +ingenious combination of government and banking influence in selecting +the management is provided. Purely banking operations are very largely +to be handled by boards of directors, a majority of the membership of +which is to be chosen by banks. General supervision, and for some +purposes control, is placed with the Federal Reserve Board, which is to +be appointed by the President of the United States, by and with the +advice and consent of the Senate. Experience alone can determine the +wisdom of these arrangements for securing effective management. + +The Federal Reserve Banks are to exercise wide powers, and would seem +likely to have ample resources. The country is to be divided into not +less than eight, nor more than twelve districts, in each of which a +federal reserve bank is to be established.[288] All national banks are +required, and qualified state banking institutions are invited, to +subscribe to the capital of the reserve bank in their district. +Subscribing banks, to be known as member banks, are required to keep a +part of their reserve with their Federal Reserve Bank. These banks will +presumably receive most if not all of the general funds of the United +States Government. They will provide an elastic currency, issuing notes +secured by their commercial assets. They are also empowered to undertake +the business of collecting, and clearing checks throughout the entire +country, thus providing an organization for making settlements between +banks in different places, the lack of which has been one of the most +serious defects in our banking system. + +Each Federal Reserve Bank will be a central bank for the section of the +country which it is to serve. It will have all the responsibilities and +most of the powers of central banks in the various European countries; +but largely because the system is to be superimposed upon a fully +developed banking system, some important provisions of the Federal +Reserve Act are unlike anything to be found in European legislation. The +Federal Reserve Banks are to receive deposits from the Government and +from member banks only. Ordinarily they will lend to member banks only. +All European central banks, though the bulk of their business is with +banks and bankers, may deal with the general public and do so. The most +striking divergence from European example, however, is the really novel +plan of a system of regional banks in place of a single central bank. +But the extent of this divergence is generally exaggerated. Political +boundaries are indeed in large measure economic and financial boundaries +as well; but central banks in the European countries do act and react +upon each other, often working in harmony, and yet at times very much at +cross purposes. If all Europe were brought under a single government, +very likely the various existing central banks would be merged into a +single institution. In some respects this would be advantageous, but it +would not be absolutely necessary. Certainly European arrangements are +not so fundamentally unlike those of a system of regional banks in a +single country of great size, as to afford ground for the opinion that +in setting up this system foreign experience has been altogether +disregarded. + +The various considerations which led to the adoption of the plan for +regional banks, rather than a single central institution, deserve +careful attention, since they indicate the spirit and purpose of the +Federal Reserve Act. A single central bank was the solution of the +banking problem reached without a dissenting voice by the members of the +National Monetary Commission. The bill which the commission prepared was +a notable achievement. Pioneer work though much of it necessarily was, +very few defects on the technical banking side were disclosed in the +discussion which followed the statement of the proposed measure. Its +provisions regarding banking operations, including relations with other +banks, are embodied with few changes of an essential character in the +Federal Reserve Act. Most of the important differences between the bill +and the Federal Reserve Act reflect differences in spirit and purpose +rather than in methods. A central bank and also the system of regional +banks necessarily involve placing somewhere very extensive power to +influence and control credit. In the present temper of public opinion, +the possession of great economic power is not tolerated in the absence +of a large measure of government supervision and control. But +unfortunately, in framing its measure the monetary commission failed to +realize the fundamental importance of this consideration as a factor in +securing general public approval. In devising a form of organization, +competent management and approval in banking circles were evidently the +controlling factors. An organization was proposed under which out of +forty-five directors, but three were to represent the Government, the +remainder being selected in various ways by bankers. Support from some +who were the most bitter opponents of the measure might have been +secured if the bill had provided for a larger measure of government +control; but an equal or even greater number of adherents would probably +have been lost. Under the plan of the commission and indeed under any +central bank plan, government supervision and control cannot be made +effective without at the same time placing the details of operation in +charge of government officials. Few of the most ardent advocates of a +central bank were prepared to take this extreme step. + +Under the plan of organization of regional banks, the difficulty of +combining government control and private management vanished. Purely +banking matters, such as the granting of loans, could be placed with +boards entirely or mainly composed of persons selected by the bankers +whose funds were to provide most of the necessary resources. On the +other hand, supervision and whatever measure of control might be deemed +advisable, could be placed with a board mainly or entirely appointed by +the President of the United States. Differences of opinion may be +entertained regarding the particular arrangements in the Federal Reserve +Act for selecting the various administrative bodies, and regarding the +division of power between the directorates of the federal reserve banks +and the Federal Reserve Board. If experience should disclose defects in +this form of organization, it is flexible enough to permit at any time +an extension of government or of banking influence. + +Another important advantage of the regional system is to be noted. The +operation of a central bank would be far more likely to give rise to +sectional antagonism. This danger was apparently fully realized by the +members of the National Monetary Commission, and elaborate arrangements +for selecting the management were devised in order to make certain that +each section of the country should be properly represented. But +obviously regional banks, managed by local people, are very much more +certain to meet this requirement. Apparently it was an endeavor to +remove still further the danger of sectional dissatisfaction that led +the Monetary Commission to make its one serious departure from sound +banking principle in framing its bill. A provision was inserted +requiring rediscounts to be made at a uniform rate throughout the entire +country, regardless of the wide differences in the demand and supply of +capital, which occasion the existing wide differences in lending rates. +Under the regional plan no such indefensible provision was found +necessary. This important feature of the Federal Reserve Act outweighs +such advantages in economy of resources and effectiveness in management +as were sacrificed in substituting for a central bank the regional +banks. + +The Monetary Commission in framing its bill seems to have been guided by +two principles generally wise in legislation--the scope of the measure +was limited to the single purpose of removing purely banking defects in +our banking system, and no greater departure from existing arrangements +was proposed than was essential for the purpose in hand. The Federal +Reserve Act certainly runs counter to the first of these principles. Its +primary purpose is similar to that of the bill of the monetary +commission; but a secondary purpose evidently exercised a potent +influence. This purpose was to decentralize credits by lessening the +concentration of banking funds in a few large banks in the chief +financial centers, and especially in New York. The regional system +itself gained much support because it was believed by many that it would +lessen the financial predominance of New York City. No comprehensive +scheme of legislation with this object in view was inserted in the bill; +but wherever two or more means of accomplishing the primary purpose of +the bill were open, that one was evidently selected which it was +believed might tend toward decentralization. In general the desire to +decentralize credits explains why the act makes very much greater +changes in existing arrangements than were proposed in the bill of the +Monetary Commission. In the latter, the practice of depositing a part of +the required reserves of the banks with reserve agents was left +undisturbed. Under the terms of the Federal Reserve Act, such deposits +are to be reduced by successive installments, and discontinued entirely +three years after the passage of the act. From a purely banking point of +view, much can be said for this great change; but it was certainly not +absolutely necessary in order to secure the desired improvements in the +working of our banking system. + +The new banking institutions for which the Federal Reserve Act makes +provision cannot be put in successful operation (and in this it +resembles the bill of the Monetary Commission) unless a considerable +number of the existing banks enter into relations with them. An +institution might have been established with large capital, and a +monopoly of the right of note issue, authorized to act as government +fiscal agent, and to deal with the general public. Such an institution +would presumably in the course of time have become a central bank, the +main reliance of other banks in emergencies. In order to avoid +competition with existing banks, the act provides that the receipt of +deposits by the Federal Reserve Banks, and their normal lending +operations shall be confined to those banks which subscribe to the +capital and maintain balances with them. Obviously, then, if banks in +large numbers do not accept the arrangement, subscribing to the capital +and relying upon the new banks for accommodation, the system cannot be +put into effective operation. Moreover, it is necessary that many banks +shall enter the system at the outset. An attitude of hesitation would +change to one of positive distrust, if the initial response were +inadequate. + +In the case of the bill of the Monetary Commission, reliance was placed +simply upon the attractiveness of the measure. No bank would have +suffered positive loss from failure to enter the system, though certain +slight inducements were held out to those banks which accepted the +arrangement at the outset. Whether a sufficient number of banks would +have entered that system, if it had been established, may be thought +probable but is not certain. Bankers are naturally and properly a +conservative class and the inclination of many would have been to wait +until the system was in successful operation. The attitude of bankers +toward the Federal Reserve Act while it was passing through Congress was +distinctly unfavorable. Most of its provisions already referred to, as +well as others in which it differed from the Monetary Commission bill, +were disliked. It was evident that in the absence of positive pressure, +the number of banks which would accept its terms would be too small to +make successful operation possible. No attempt was made, however, to +insert provisions which would bring pressure upon state banking +institutions. Perhaps it would be possible, either under the inter-state +commerce or the postal clause in the Constitution; but it would have +been contrary to the constitutional traditions of the party in power, +and it was not necessary. If the national banks very generally enter the +system, the resources of the Federal Reserve Banks will be sufficient to +test the effectiveness of the measure. Accordingly the Federal Reserve +Act contains a number of provisions designed to bring pressure to bear +upon these to enter the system immediately. Failure to accept the terms +of the act within one year after its passage involves forfeiture of the +national charter. This alone would be no great business sacrifice, since +banking in most States is quite as profitable under a state as under a +national charter. Loss of the national charter, however, involves a loss +of the right to issue bank notes and calls for the deposit of lawful +money in Washington equivalent to the amount of outstanding circulation. +Most national bank notes are secured by 2 per cent. government bonds, +the price of which, in the absence of the circulation privilege, would +be perhaps about two-thirds of the price (somewhat above par) at which +they were purchased by the banks. No considerable number of national +banks could refuse to enter the system without involving themselves in a +heavy immediate loss. A further provision in the act puts more immediate +pressure upon the national banks in reserve cities. If within sixty days +after the passage of the act, a reserve agent bank fails to signify +acceptance of its terms, it must cease to exercise the reserve-holding +right upon thirty days' notice from the Federal Reserve Board. + +Many bankers bitterly condemned the compulsory features in the act while +it was on its passage through Congress. This feeling was perfectly +natural, but it was not very generally shared outside banking circles. +Impartially considered, the act imposes no unreasonable burden upon +those who have invested capital in national banks. No one fears the loss +of the funds which may be subscribed to the capital stock of the federal +reserve banks or placed on deposit with them. If loss should be +incurred, it would be primarily due to unsound banking on the part of +the boards of directors of the Reserve Banks, a majority of the +membership of which is to be chosen by the banks themselves. Some +bankers have doubted whether the act would prove an effective measure of +banking reform; but few if any have felt that results under its +operation could possibly be more unsatisfactory than those under the +present system; and all agree that it is a long step toward a perfected +system. + + +ORGANIZATION + +The new system is to be organized under the supervision and direction of +the "Reserve Bank Organization Committee," consisting of the Secretary +of the Treasury, the Secretary of Agriculture, and the Comptroller of +the Currency. The most important function of this committee is to +determine, "with due regard to the convenience and the customary course +of business," the number and area of the Federal Reserve districts into +which the country is to be divided, and to designate the city in each +district in which a Federal Reserve Bank is to be established. Not less +than eight, nor more than twelve districts are to be created. This is a +most difficult task. However carefully the initial lines of demarcation +may be drawn, more or less modification is to be expected after there +has been some experience with the working of the system. Changes in area +of districts, and additional districts if the organization committee +designates less than twelve, may be made at any time in the future by +the Federal Reserve Board. While the rivalry of cities may tempt the +committee to start the system with a larger number, it is to be hoped +that it will be found feasible to begin with no more than eight or nine +districts. The problems which will confront the management of the +Federal Reserve Banks are in many respects unlike those with which our +bankers have had experience. A somewhat higher average of capacity in +the management may more confidently be looked for if the smaller number +of banks is established. Moreover, especially at the outset, mere size +will contribute not a little to the prestige of the banks, and so +inspire public confidence in the new system. A greater variety of +occupations in large areas will lessen, though not much, extremes of +seasonal variation in demands for accommodation upon the federal reserve +banks. Then, too, the task of the Federal Reserve Board in supervising +and co-ordinating the system will be materially simplified, if the +minimum rather than the maximum number of federal districts is decided +upon. + +Within sixty days after the passage of the act, in other words before +February 22, 1914, national banks are required, and properly qualified +state banks are invited, to signify their acceptance of the terms of the +act. Within thirty days after the reserve districts have been +designated, each national bank must subscribe to the capital of the +reserve bank of its district an amount equal to 6 per cent. of its +capital and surplus. One-sixth of this subscription is to be paid at the +call of the organization committee, another sixth within three months, +and still another within six months thereafter. The remaining half of +the subscription may be called at any time by the Federal Reserve Board. +All these payments are to be made in gold or in gold certificates. It +will be observed that the exact time when the system will be established +is uncertain. The organization committee is only required to designate +the reserve districts as soon as is practicable; thirty days is then +allowed for the banks to subscribe; and payments will begin sometime +thereafter at the call of the committee.... + +After the minimum capital (four million dollars for any federal reserve +bank) has been subscribed, the certificate of organization is to be +executed by any five member banks designated for the purpose by the +organization committee. The final duty of the committee will be to +supervise all arrangements for the election of the six of the nine +directors of each Federal Reserve Bank, who are to be chosen by the +member banks. For electoral purposes the banks of each district are to +be divided into three groups--each group to "contain as nearly as may be +one-third of the aggregate number of the member banks ... and as nearly +as may be banks of similar capitalization." While the number of banks in +each group will be the same, the capitalization will be very different. +All the banks with a capitalization above the average in a district will +certainly be in one group; those of somewhat less than average capital, +in the second group; while the third group will be composed of banks +having a very small capitalization. Under this ingenious arrangement, it +is evident that the direct influence of the banks of the large cities in +selecting the directorates of the Federal Reserve Banks is limited. +Local alignments are also avoided. On the other hand, this is not a +grouping to which the banks have been accustomed in the past, and +therefore there is some uncertainty as to whether at the outset it will +be conducive to the selection of capable directorates. + +Each group of banks is to choose two directors: a Class A director, who +is to be an active banker representing the stock-holding banks, and a +Class B director, who must be actively engaged in commerce, agriculture, +or some other industrial pursuit in his district. The board of directors +of each member bank is to elect a district reserve elector. Candidates +for the position of director of a Federal Reserve Bank may be nominated +by any member bank; but nomination is not necessary. Electors are to +signify their first, second, and other choices for one director in each +class on a preferential ballot. + +In addition to the six directors chosen by the banks, three directors +(Class C) are to be appointed by the Federal Reserve Board. Two of these +must be persons of "tested banking experience," one to serve as chairman +of the board of directors and district reserve agent, the other as +deputy chairman and deputy reserve agent. These reserve agents are the +official representatives of the Reserve Board, through whom it will +exercise its powers of supervision and control over the reserve banks. +The act contains no provision regarding the officers to whom the +operation of the banks will be entrusted. Presumably each board of +directors will appoint one of its members (probably one of the Class A +directors) as president and manager. The term of office of all directors +is three years, but at the outset they are to be classified so that the +term of one director of each of the three classes shall expire annually. +The appointment of Class C directors will be the first duty of the +Federal Reserve Board; inasmuch as the organization of the system can +hardly be completed before the beginning of the summer, the appointment +of this board could be deferred until that time. The selection of these +directors for each of the eight or more Federal Reserve Banks is, +however, no small task in itself; and since public confidence in the new +system will largely be based at the outset upon the character of the +Federal Reserve Board, its early selection is much to be desired. + +The Federal Reserve Board itself is to consist of seven members: the +Secretary of the Treasury and Comptroller of the Currency _ex officio_, +and five members appointed by the President of the United States by and +with the [advice and] consent of the Senate. Of the five appointed +members, at least two must be persons experienced in banking or finance. +Not more than one shall be appointed from any federal reserve district, +and due regard is to be given to the different commercial, industrial, +and geographical divisions of the country. The term of office of the +appointed members is ten years; but those first selected are to serve +one for two, one for four years, and so on, so that the term of office +of one member may expire every two years. + +Under this arrangement a majority of the board, in the absence of death +and resignation, will never be reconstituted at any one time. Each +President will select two of the appointed members: one in the second +year of his term of office, and one in the fourth. The Secretary of the +Treasury will, of course, be a new member appointed at the beginning of +each presidential term. The term of office of the Comptroller of the +Currency is for five years, so that here a variable element is +introduced. It may happen that some Presidents will never appoint more +than three members during their term of office. Generally, however, each +President will appoint four members; but the last appointment, giving a +majority on the board, will not be made until his final year of office. +Lack of continuity and the possibility of a political board were much +greater under the provisions for selecting the Federal Reserve Board +which were in the measure at various stages while it was passing through +Congress. The arrangements finally adopted would seem to make it +reasonably certain that the Federal Reserve Board will be free from both +these defects. + +Organization of the system will be complete[289] with the selection of +the members of the Federal Advisory Council. This Council is to consist +of as many members as there are Federal Reserve districts, the board of +directors of each Federal Reserve Bank selecting one member. The +function and powers of the council are purely consultative. It is to +meet regularly four times each year at Washington, and at other times +there or elsewhere if deemed necessary by the Council itself. It is +authorized to confer directly with the Federal Reserve Board, to call +for information, and make oral or written representations concerning +matters within the jurisdiction of the Federal Reserve Board. It may +prove to be an important part of the organization, but this does not +seem probable. With a scattered membership and holding regular meetings +only at long intervals, it is not to be expected that the Council will +be in close touch with the Federal Reserve Board, or in a position to +formulate policies and urge them effectively. From individual members of +the Council, the Federal Reserve Board should secure valuable +information regarding conditions in different parts of the country; but +the work of the council itself as an organized body seems likely to be +of a formal and perfunctory nature. The importance of the Council would +doubtless have been measurably increased if the proposal had been +adopted that its chairman should sit, even though without a vote, on the +Federal Reserve Board. + + +CAPITAL, EARNINGS, DEPOSITS OF THE FEDERAL RESERVE BANKS + +Since the capital stock of each of the Federal Reserve Banks is to be +exactly 6 per cent. of the capital and surplus of the member banks in +its district, it will always be subject to slight variations. If all +national banks enter the system at the outset, the total subscribed +capital of the Federal Reserve Banks will be a little more than one +hundred million dollars. Subscriptions may perhaps fall somewhat below +this amount, since with the exception of the reserve agent banks, no +penalty attaches to failure to subscribe until twelve months after the +passage of the act. Few state banking institutions will enter the system +at the beginning. In many states legislation is necessary to permit them +to invest in the stock of the Federal Reserve Banks, and to enable them +to count balances with the Federal Reserve Banks as a part of their +required reserves. It is to be presumed also, that such institutions, +since they can enter at any time, will wait to see whether the system is +working to the satisfaction of neighboring national banks.[290] + +There will always be wide differences between the capital and other +resources of the various Federal Reserve Banks. Neither the capital nor +the resources of existing banks can be made the basis for dividing the +country into Federal Reserve districts. Geographical consideration will +necessarily require the creation of a number of districts in sparsely +settled parts of the country, in which banking resources are +comparatively small. No Federal Reserve Bank may, however, be +established until it has a subscribed capital stock of at least four +million dollars. It would, therefore, seem to follow that the +organization committee is precluded from forming any district in which +6 per cent. of the capital and surplus of the national and state banks +is less than this minimum amount. There are indeed provisions in the act +designed to meet the contingency of failure by banks to subscribe in +sufficient numbers to provide a minimum capital; but they would not seem +to authorize the organization committee to create districts in which +resort to these provisions would be inevitable.[291] + +Whether the capital of the Federal Reserve Banks is large or small is a +matter of no great importance. Subscriptions to capital provide a +comparatively small part of the resources of banks. The capital is an +indication that those conducting a bank have something at stake, and is +also a margin of safety against loss to depositors. These Federal +Reserve Banks are, however, to accept deposits from banks only, and are +ordinarily to confine their dealings to the banks. In these +circumstances, there is practically no difference between the funds +which the federal reserve banks will secure from member banks in payment +of subscriptions to capital stock, and the funds which will be deposited +with them by member banks. The depositors are the stockholders and, +therefore, there is no separate interest to be protected by a margin of +safety. + +Shareholders in the reserve banks are entitled to a cumulative dividend +of 6 per cent. A limited dividend is obviously wise, since it tends to +eliminate the profit-making motive in the management. Whether all the +Federal Reserve Banks will regularly earn the 6 per cent. dividend is, +of course, not certain; but it seems highly probable, since the danger +of serious losses is remote, and interest will presumably not be paid to +the member banks on their balances. All earnings in excess of the +dividend are to be paid to the Government of the United States as a +franchise tax; but half of these surplus earnings are to be paid into a +surplus fund until it has become 40 per cent. of the capital stock. +Whatever is received by the Government from the Federal Reserve Banks is +to be used at the discretion of the Secretary of the Treasury, either to +increase the gold reserve against United States notes or for the +reduction of the interest-bearing debt. + +The federal reserve banks will doubtless secure very large resources +through the deposit with them of the moneys held in the general fund of +the Treasury of the United States, although no power over the +disposition which shall be made of these funds is granted either to the +Federal Reserve Banks or to the Federal Reserve Board. Entire discretion +remains with the Secretary of the Treasury. He may continue the +independent treasury system without change; he may continue to deposit +funds with member banks, just as hitherto he has placed deposits with +national banks; and finally he may deposit with any or all of the +Federal Reserve Banks, using them as government fiscal agencies. The +responsibility of the Secretary of the Treasury is in no way changed. +Almost certainly in practice, however, the bulk of the free funds of the +Government will be placed with the Federal Reserve Banks, and doubtless +the opinion of the Federal Reserve Board will determine the distribution +of these funds between the various banks. + +The lion's share of the cash resources of the Federal Reserve Banks will +come from the reserves and working balances deposited with them by +member banks. Under the terms of the act, part of the required reserves +of member banks _must_ be placed with Federal Reserve Banks. This is a +novelty in central banking legislation, but is based upon sound +principle, and is especially to be commended for this country where, on +account of the absence of branch banking, the number of banks to be +served by the regional banks will be very great. It makes certain some +increase in the resources of the Federal Reserve Banks, along with the +expansion of the credit liabilities of the member banks. It also lessens +somewhat the danger of unnecessary withdrawals of funds from the reserve +banks in emergencies. + +Reserve requirements of the national banking law are radically changed. +In addition to the requirement that a part of the reserve of the banks +be kept with the Federal Reserve Banks, the reserve ratio is reduced for +all classes of banks: the practice of keeping a part of the reserve of +country and reserve city banks with reserve agents is to be +discontinued; and a distinction for reserve purposes is made between +time and demand deposits. Some of these changes become effective as soon +as the new system is established; others are to be made in a succession +of steps and completed three years after the passage of the act. + +Time deposits are to comprise deposits payable after thirty days, and +are to include certificates of deposit and savings accounts subject to +thirty days' notice. A reserve of 5 per cent. is required against these +deposits, and no distinction is made between country and city banks. +This low reserve requirement will certainly lead the banks to encourage +the conversion of demand obligations into time obligations. A relatively +large part of the deposits of banks in most European countries is +payable at notice. It is obviously an arrangement which shields the +banks somewhat from the effects of sudden waves of distrust. + +Against demand deposits the ratio of reserves is also to be reduced at +once; but the existing classification of banks is to be retained. The +required ratio for country banks is reduced from 15 to 12 per cent., for +reserve city banks, from 25 to 15 per cent., and for central reserve +city banks from 25 to 18 per cent. A provision in the bill excluding +from reserves the 5 per cent. fund held in Washington against +outstanding circulation is a slight offset to this reduction in reserve +ratios. + +As regards the banks in central reserve cities, the initial arrangement +regarding the disposition to be made of their reserve is also the +_final_ arrangement. They must hold 6/18 of their reserve in vault, 7/18 +in their Federal Reserve Bank, and the remaining 5/18 either in vault or +with their federal reserve bank. Other banks are allowed a period of +transition. Reserve city banks for three years must hold 6/15 of their +reserve in vault, thereafter 5/15; for twelve months they must keep with +their Federal Reserve Bank 3/15, adding an additional 1/15 every six +months; so that at the end of two years they will have a deposit of +6/15. During the three year period the remainder of the reserve may be +deposited with reserve agent banks in a central reserve city, or by what +would seem to be an inadvertent extension of existing practice with +those in reserve cities; but thereafter it must be either in vault or +with a Federal Reserve Bank. Country banks must hold in vault 5/12 of +their reserve for three years, thereafter 4/12; for twelve months must +deposit with their Federal Reserve Bank 2/12, and an additional 1/12 +every six months until 5/12 are deposited at the end of two years. The +remainder of the reserve may be kept for three years with reserve agent +banks, but at the end of that period must be either in vault or in a +Federal Reserve Bank. + +Whether these changes in reserves, together with payments by the banks +of subscriptions to the capital stock of the reserve banks, will make +necessary any considerable amount of loan contraction, cannot be +precisely determined. If numbers of state banking institutions enter the +system at the beginning, some strain may be occasioned, since, although +these requirements are less than those to which the national banks have +been subject, they exceed those imposed upon banks by the law of many of +the states. In order to enable the banks to avoid contraction, the act +contains a provision under which one-half of each instalment of reserve +to be placed in reserve banks may be received in the form of the kinds +of commercial bills of exchange which the reserve banks may purchase in +the open market. It is, however, most unlikely that the banks will be +able to make much use of this arrangement, because of the scanty amount +of such paper available. + + +FEDERAL RESERVE NOTES AND NATIONAL BANK NOTES + +The power to issue notes is a useful but not indispensable resource for +institutions having the responsibilities which are placed upon the +Federal Reserve Banks. The issue of notes by a central bank enables it +to supply domestic requirements for currency without reducing its +holdings of reserve money. In the absence of the right of issue, it +would only be necessary to accumulate in ordinary times a somewhat +greater amount of reserve money, to provide for seasonal and emergency +needs. General public confidence in the Federal Reserve Banks would, +however, be far less secure if they were not empowered to issue notes. +This is because of the exaggerated importance almost universally +attached to the right of note issue, even in countries in which the +check has become a universal medium of payment. + +The particular provisions in the act regarding the issue of notes are +extremely complicated, and are in some respects quite without precedent. +The notes for which provision was made in the bill of the Monetary +Commission were to be bank notes pure and simple, subject to a variety +of restrictions designed to keep the total amount issued within safe +limits. The notes which are to be issued under the provisions of the act +are certainly quite as well safeguarded in this respect. In addition, +the notes are made obligations of the Government of the United States, +which also undertakes to redeem them at Washington. The obligation of +the Government is in addition to and does not take the place of any +banking safeguard. It is designed to meet the desires of the very large +number of people throughout the country who believe that the issue of +money is a government function. To many bankers and others familiar with +our past financial history, this provision in the bill was most +distasteful. Their opposition, though natural, was, however, neither +very practical nor reasonable. It was based very largely upon the fear +that the government obligation on the notes would prove an entering +wedge for an issue of fiat money at some future time. But paper money +cannot be issued under the terms of the act for the purpose of meeting +government expenditures. Additional legislation would be necessary, and +the possibility of such legislation is not appreciably increased by +making the notes which are to be issued by the reserve banks an +obligation of the Government. On the other hand, this provision won many +friends for this important piece of banking legislation; it allayed +opposition which would always have been a serious menace to the +permanence of the new system. + +The quantity of the new notes which may be issued is wholly within the +control of the Federal Reserve Board; but the initiative in taking out +circulation rests entirely with the boards of directors of the reserve +banks. Applications for notes may be made at any time by a reserve bank +to its district reserve agent, the member of its board of directors who +is the medium of communication between the bank and the Board. +Rediscounted commercial loans equal in amount to the notes applied for +must be deposited with the agent, and a reserve in gold of 40 per cent. +must be maintained. (A reserve of 35 per cent. in gold or lawful money +is required against deposits.) The Board may grant in whole or in part, +or reject entirely, applications for notes, and may also impose such +interest charge upon the notes as it may deem advisable. The notes are +to be a prior lien on the assets of the issuing banks, and there is, +therefore, no possibility of loss to note holders, nor any to the +Government on account of the obligation which it assumes. + +Such part of the 40 per cent. gold reserve against the notes as may be +deemed advisable by the Secretary of the Treasury, but in no case less +than 5 per cent., must be deposited in the Treasury of the United States +for the redemption of the notes in Washington. Each Reserve Bank is +required to redeem not only its own notes but also those of the other +Reserve Banks either in gold or in lawful money; redemption in +Washington is in gold alone. In practice it is certain that Reserve +Banks will redeem the notes in gold over the counter; and it is also +certain that slight use will be made of the redemption machinery at +Washington. Member banks will certainly deposit the notes with their own +reserve banks, which are required to accept the notes of other banks at +par. The reserve banks, in turn, are required under the law to return +for redemption the notes issued by other reserve banks. Redemption at +Washington has apparently been provided because national bank notes are +redeemed there in large volume every year; a result of the circumstance +that the present number of issuing banks is so large as to make counter +redemption much more costly. + +Various provisions in the act are evidently designed to keep the issue +of notes within safe limits; but not much reliance should be placed upon +them. Reserve Banks may not, under penalty of a prohibitive tax of 10 +per cent., pay out the notes of other Reserve Banks. If these banks, +like the Scotch banks, were working in the same territory, regular +redemption would check over-issue on the part of any one of them. But +under a system of regional banks, each with its own territory, there +will be only a very irregular relation between the amount of notes put +out by any one and the amount which will be received by the others. +Moreover, it should be borne in mind that regular redemption is no check +whatever upon general expansion, either in the form of notes or of +deposits, when all banks are expanding credit at the same time. + +Not much effect also in checking over-issue is to be looked for from +those provisions in the act which require a 40 per cent. reserve in gold +and impose a graduated tax upon reserve deficiencies. A considerable +part of the total reserves of the Reserve Banks is certain to be in +gold; and deposit liabilities are certain to be vastly greater than +those for notes in circulation. The circumstances are hardly conceivable +in which a Reserve Bank would not have an amount of gold in its entire +reserve ample to provide a gold reserve for such notes as it might +issue. The special tax on note reserve deficiency can therefore be +readily evaded by shifting the deficiency to the reserve against +deposits. Deficient reserves are only allowed when reserve requirements +are suspended by the Federal Reserve Board. The Board is to impose a +graduated tax on all deficiencies except in the note reserve. On note +reserve deficiencies, the tax imposed in the law is to be added to the +rate of discount of the reserve banks. The arrangement would seem to be +a most unworkable one, since there is no means of knowing to what extent +a borrowing bank will have occasion to use the proceeds of its loan in +the form of notes. Fortunately this provision of the act is never likely +to become operative. + +After all, for proper use of the right of issue under the act the main +reliance must and should be on wise and experienced management for the +reserve banks, and above all on a conservative Federal Reserve Board. +Restrictions which would make over-issue impossible would also deprive +the right of issue of all usefulness as a means of extending credit. +Moreover, the danger of the over-expansion of credit in the form of +deposits is vastly greater than it is in the form of bank notes in any +country in which deposit credits have become the more important credit +medium. + +One of the most perplexing questions that presented itself in framing +the act was the disposition to be made of the national bank notes and +the 2 per cent. government bonds which secure very nearly all of them. +When the measure reached the Senate, it contained provisions which +contemplated the gradual substitution of Federal Reserve notes for the +national bank notes. But when it was pointed out that this would require +the Reserve Banks regularly to rediscount at least seven hundred million +dollars of commercial paper, in order to support the existing volume of +currency, it was felt that some other arrangement must be made. A plan +to unify all the varieties of paper money now in circulation, with the +exception of the silver certificate, by the issue of an equal amount of +United States notes, backed by an ample gold reserve, found influential +support; but it was wisely decided to present this in a separate +measure. The particular provisions regarding the national bank notes and +the bonds contained in the act should be regarded, therefore, as a +temporary arrangement pending future legislation. + +In order to avoid the contraction of the currency which would follow the +refusal of many national banks to enter the system, each Reserve Bank is +authorized to purchase bonds and take out circulation similar in all +respects to the notes issued by the national banks. After the end of a +period of two years, additional bonds may be purchased, but only from +member banks, and at the discretion of the Federal Reserve Board. Member +banks desiring to retire circulation and dispose of their bonds, may +make application to the Board, which may require the Reserve Banks to +purchase them. No more than twenty-five million dollars of bonds may be +purchased in any one year, and the amount purchased is to be distributed +among the various Reserve Banks in proportion to their capital stock. +Bonds thus purchased may be used as a basis for additional national bank +notes by the reserve banks, or they may be converted into 3 per cent. +government obligations--one-half into thirty-year 3 per cent. bonds, and +one-half into one-year 3 per cent. notes, both issues without the +circulation privilege. In taking the one-year notes, a Reserve Bank +enters into an obligation to purchase an equal amount at each successive +maturity for thirty years. The purpose of the notes is to provide the +Reserve Banks with a readily marketable asset, the sale of which abroad +may prove serviceable in periods of strain, and the domestic sale of +which will enable the Reserve Banks to make their discount rates +effective in the money market. Government short-term obligations are +used for these purposes by many of the European central banks. + +The existing volume of national bank notes will not be reduced under the +terms of the act, except in so far as the Reserve Banks convert 2 per +cent. bonds into 3 per cent. bonds or notes. There may even be some +slight increase in the total of national bank notes in circulation, +since banks may use for this purpose the small quantity of bonds not +already absorbed in this way. Little concern, however, need be felt +because the national bank notes are not to be retired. Present +requirements for money to be used outside the banks are sufficient to +absorb all the notes at present; and with the growth in population a +somewhat greater quantity could be absorbed in future. + + +LENDING OPERATIONS OF THE FEDERAL RESERVE BANKS + +The normal lending operations of the Federal Reserve banks are limited +to the rediscounting for member banks of commercial loans maturing +within ninety days. Commercial loans are generally defined in the act as +"notes, drafts, and bills of exchange arising out of actual commercial +transactions; that is, notes, drafts, and bills of exchange issued or +drawn for agricultural, industrial, or commercial purposes, or the +proceeds of which have been used or are to be used for such purposes." +The Federal Reserve Board is authorized to define more precisely the +nature and character of eligible paper. To make assurance doubly sure, +the rediscount of loans secured by stocks and bonds is specifically +prohibited. The act also provides that six months' maturities of paper +drawn and used for agricultural purposes or based on live stock may be +rediscounted. + +In confining rediscounts to commercial loans, the act is more stringent +than that governing the operations of central banks in Europe. In +practice, however, the bulk of the loans of these institutions are in +connection with commercial transactions. While this restriction may in +some particular emergency hamper the Reserve Banks in giving assistance +to some threatened bank, it is upon the whole amply justifiable. Under +our banking system in the past the collateral loan has enjoyed a +prestige which it is hoped will be transferred to commercial loans. +Exclusion of collateral loans from rediscount will certainly contribute +much to bring this about. The restriction also gives the public greater +confidence that the resources of the Reserve Banks will be generally +available throughout the entire country. + +One of the reasons which has been advanced for confining rediscounts to +commercial loans is based upon certain misconceptions of the true nature +of commercial paper--misconceptions which, if adopted by the management +of the Reserve Banks in formulating their policy, may have disastrous +consequences. It has been contended on all sides during the last few +years that commercial paper was from its very nature liquid; and +further, that credit could therefore safely be granted to an extent +limited only by the amount of such paper. Both of these contentions are +hopelessly fallacious. In an emergency, no kind of loan is liquid to any +considerable extent. Business cannot suddenly be deprived of the amount +of credit to which it has become adjusted. It is, indeed, often said +that loans based upon any commodity entering into general consumption +can be quickly liquidated. This can be done as regards any particular +loan; but supplies for the immediate and distant future must be in +process of production and they will require a new batch of loans. The +view that credit can be safely granted to the full extent of merchandise +in process of distribution and even in process of manufacture is equally +fallacious. Credit affects price. Liberal discounts may cause +speculative advances in commodity prices, stimulating excessive prices +by wholesalers, jobbers, and retailers, as well as by speculative +holders pure and simple. There is no mechanical or statistical test for +the amount of credit which may be safely granted, whether the loans be +commercial or collateral. Over-expansion is possible by both operations. + +Commercial loans will become the most liquid asset that member banks can +hold, simply because they can be rediscounted with the Reserve Banks. A +smaller amount of Bank funds will be employed in the call loan market. +But whatever amount remains available for that use will be subject to +far less seasonal fluctuation both in volume and in rates. The retention +of fixed reserve ratios, even though they may be suspended by the +Federal Reserve Board, will probably lead many city banks to use the +call loan market to a moderate extent, since it will enable them to +avoid the necessity of resorting to the reserve banks for rediscounts +whenever reserves momentarily drop below legal requirements. A somewhat +larger proportion of time loans will doubtless be used in connection +with stock exchange dealings; but the available supply of call money +will presumably be sufficient to permit the continuance of the present +American practice of daily delivery of securities. + +At the outset, on account of the widespread prejudice among bankers +against rediscounting, the demand for accommodation from the Reserve +Banks may not be large; but this prejudice will surely die away in time, +and most if not all of the Reserve Banks will suffer from no lack of +regular business, except in periods of business depression. Member banks +in those parts of the country in which the supply of credit is +inadequate for local requirements will lend more closely, while banks +which regularly have more funds than can be thus employed will purchase +more commercial paper from note brokers and perhaps rediscount for banks +in those parts of the country in which rates are normally high. + +Aside from the government account, member banks are to provide the funds +for the reserve banking system. Competition with member banks would +therefore and justly occasion serious dissatisfaction. Managed by boards +of directors a majority of the membership of which is to be selected by +the member banks, there would seem to be little danger of serious +competition from the Reserve Banks. Nevertheless the act places such +restrictions upon dealings by the Reserve Banks with the general public +that little or no competition will be possible. + +The Reserve Banks are permitted to engage in three kinds of open market +operations: (1) dealings in government securities, and also in +obligations of the states and local bodies, maturing within six months +and issued in anticipation of taxes; (2) dealings in foreign exchange; +and (3) dealings in domestic bills of exchange. + +The purchase and sale of government bonds and notes and state and local +short-term obligations require no detailed consideration. In periods of +inactive demand for rediscounts, investments of this kind will doubtless +be made by the Reserve Banks in order to employ surplus funds. + +The right to engage in foreign exchange dealings will also be similarly +useful, surplus funds being invested in foreign bills. Moreover, if any +of the Reserve Banks find that their resources are regularly in excess +of domestic requirements, they may be used to facilitate the financing +of the foreign trade of the country with domestic capital. It is also +very generally believed that the power to engage in foreign exchange +operations may be so used that it will be possible to rely upon securing +abundant foreign funds in periods of financial strain. This is most +unlikely. It is entirely possible for a small country to rely upon +holdings of foreign bills as a means of influencing the foreign +exchanges, and even for such supplies of gold as may be needed on +occasions when confidence is threatened. But the banks of a large +country must rely mainly upon domestic resources, since the amount of +cash and credit needed in an emergency is too great to be secured from +foreign money markets. It should be the policy of the Reserve Banks to +maintain themselves in a condition of such abundant strength as to be +wholly independent of foreign assistance. Moreover, if they maintain +strong reserves in ordinary times, they will not be disturbed on account +of gold exports. Gold exports amounting to fifty, or even a hundred +million dollars should not be made the occasion for obstructive measures +such as are adopted by many of the European central banks. Measures of +this kind are generally an indication that the credit structure rests +upon an inadequate foundation. New York has been a free gold market in +the past, and even under our imperfect banking system, there has always +been a sufficient amount of gold for every banking purpose. Moreover, +restrictions placed upon gold movements can have but temporary effects; +in the long run the distribution of gold among the various commercial +countries is determined by fundamental influences which override all +such artificial barriers. + +The act permits only one kind of banking business between Reserve Banks +and the general public. They are allowed to buy and sell to or from +individuals, firms, and corporations, as well as domestic and foreign +banks, bills of exchange of the kinds which are made eligible for +rediscount. The purpose of this provision in the act is to enable the +Reserve Banks to secure some employment for their funds when the demand +for rediscounts slackens, and to develop a broad discount market. A +broad discount market may be developed under the new banking +arrangements; but the prediction is ventured that this provision in the +act will not contribute to its development and that in general it will +be barren of results. It should be observed that the promissory note, +the usual borrowing instrument in this country, although it may be used +for rediscounting purposes, cannot be bought and sold in the open market +by the reserve banks. Aside from foreign trade, the mercantile bill of +exchange, payable at a future date, has largely fallen into disuse in +most advanced commercial countries. More and more cash payments are +either insisted upon, or are favored by the offer of trade discounts for +cash considerably greater than bank discounts. When a purchaser pays +cash, obviously a mercantile time bill of exchange cannot come into +existence. In European countries, many purchasers who pay at once often +draw a bill of exchange on their own bank and, after it has been +accepted, discount it in the open market. In this country banks are to +be allowed under the act to accept only bills drawn in connection with +merchandise exports and imports. Material will, therefore, be lacking +for a broad discount market, if its development is dependent upon open +market operations by the Reserve Banks. + +Fortunately the development of a broad discount market does not require +open market operations on their part. A broad discount market is one to +which many borrowers resort with full assurance that they will find many +lenders. Even under past banking arrangements, many borrowers and +lenders have been brought together through note brokers; but owing to +the lack of an available supply of cash and credit with which to meet +emergencies, this market has been subject to violent perturbations, and +at times dealings have been almost entirely discontinued. In the future +a solvent borrower will feel more certain that his paper can always be +marketed by his note broker; and banks will purchase more largely, since +they will prefer to use such paper for rediscounting purposes rather +than that of their own regular customers. + + +ADDITIONAL POWERS OF NATIONAL BANKS + +Nearly half of the national banks have established savings departments +and now hold more than eight hundred millions of savings deposits. This +has been a recent development, and one for which there was no specific +authority in the national banking law; but under the liberal +interpretation of that law by the Comptroller of the Currency in recent +years, it has been permitted because it was not forbidden. Many have +doubted, however, whether the banks could enforce the thirty and sixty +days' notice of the withdrawal of deposits which, following the practice +of regular savings banks, appeared on the passbooks issued to +depositors. This uncertainty has been removed by implication by the new +act, which includes in its definition of time deposits, savings accounts +subject to at least thirty days' notice. It is of course a great +advantage to the national banks, that in the employment of these +deposits they are subject to much less restriction than is imposed upon +savings banks in many of the states. + +Subject to the permission of the Federal Reserve Board, and when not in +contravention of state laws, national banks may act as trustees, +executors, administrators, and registrars of stocks and bonds. Many +banks will find this a useful extension of their powers. If trust +companies may properly engage in banking, there can be no good reason +why banks should not undertake trust functions. The department store +principle in banking has made rapid headway in most countries in recent +years. Under proper supervision every kind of reasonable and safe +financial business can be handled by a single institution safely and in +a way which is convenient for the business community. In some states +legislation may be necessary to permit national banks to undertake +trust functions. In Massachusetts, it seems to be the opinion among +lawyers that no legislation is required. + +Inability to lend on mortgage security has been the most serious +disadvantage experienced by country national banks in competition with +state institutions. Land has been by far the best local security +available over large parts of the country. Rural bankers have, in fact, +taken it into account in making loans and by various devices have +succeeded in making it the security for many of the loans which they +have granted. Under the Federal Reserve Act all banks, except those in +central reserve cities, may lend for periods not exceeding five years 25 +per cent. of their capital and surplus, or one-third of their time +deposits, on the security of unencumbered and improved farm land to 50 +per cent. of its market value. + +Two changes are made in the law for the purpose of facilitating +financial business with foreign countries. National banks having a +capital of at least one million dollars may establish foreign branches, +subject to the approval of the Federal Reserve Board, and to such +regulations as it may formulate for conducting this business. Banks may +also accept bills of exchange maturing within six months drawn in +connection with exports and imports of merchandise. These are desirable +changes in the law. It is not, however, probable that many foreign +branches will be established in the near future, and it is most unlikely +that the American acceptance will make rapid headway in foreign markets. + +The scope of the following provision in the act is uncertain. "Other +than the usual salary or director's fee paid to any officer, director, +or employee of a member bank, and other than a reasonable fee paid by +said bank to such officer, director, or employee for services rendered +to such bank, no officer, director, employee, or attorney of a member +bank shall be a beneficiary of, or receive, directly or indirectly, any +fee, commission, gift, or other consideration for or in connection with +any transaction or business of the bank." This prohibition obviously +covers payments to bank directors and officers in return for aid in +securing accommodation from the banks. It may be held that all purchases +by a bank of commercial paper from a firm of note brokers, or of +securities from a banking house, are forbidden if any of the partners of +such firms are on its board of directors. In this event, a few banks +would lose valuable directors; but the question of the wisdom of such +exclusion is too complex to be given consideration in this paper.[292] + + +SUPERVISORY FUNCTIONS OF THE FEDERAL RESERVE BOARD + +A variety of functions of a supervisory or administrative nature are to +be exercised by the Federal Reserve Board. It is to formulate detailed +regulations regarding various matters concerning which only general +provisions are contained in the act. Among important matters regarding +which the Board is to formulate regulations may be mentioned: rules for +conducting branch offices; the regulation of state banks which become +member banks; rules defining precisely commercial loans eligible for +rediscount; and the regulations for the operation of foreign +branches.[293] The Board is to exercise many supervisory functions over +the reserve banks which are similar to those which have long been +exercised by the Comptroller of the Currency over the national banks. +Examination of the Reserve Banks is under its direction. There must be +one examination each year, and additional examinations must be ordered +upon the application of ten member banks.[294] The Board is also to +publish once each week, a statement showing the condition of each +Reserve Bank, and a consolidated statement for all these institutions. +It is also given a number of important powers to be exercised at its +discretion. It may suspend reserve requirements for a period of thirty +days, and renew such suspension for successive fifteen day periods. For +violations of law, it may suspend the operation of a reserve bank, and +administer or liquidate it. The Board may also reclassify cities as +reserve or central reserve cities, or terminate their designation as +such. + +The method of banking reform which has now been adopted, necessarily +involves placing somewhere enormous power to expand credit. This power +cannot be surrounded by sufficient safeguards to prevent all possibility +of its misuse, because in so doing, its wise use would be quite as +seriously interfered with. Competent management is therefore absolutely +essential if satisfactory results are to follow the passage of the +Federal Reserve Act. In the operation of the new system, the boards of +directors of the reserve banks may prove the most important part of the +organization; or that place may be occupied by the Federal Reserve +Board. The boards of directors will exercise all the ordinary powers of +such boards, except in so far as they are subject to control by the +Board. All the loans of the Reserve Banks are to be made by the boards +of those banks. In this matter, the Board has no power whatever, except +that it may require, on the affirmative vote of five members, one +Reserve Bank to rediscount paper for others. Here is a power that seems +to be designed merely to prevent any working at cross purposes among the +Reserve Banks. Few or no occasions for its use will present themselves +if all the Reserve Banks are well managed by their own boards. All rates +of discount are to be fixed in the first instance by the boards, subject +to review and determination by the Federal Board. Here again the +decision of the Reserve Bank boards is altogether unlikely to be +overruled if these banks are skilfully managed. + +[Illustration: THE FEDERAL RESERVE DISTRICTS] + +The power of the Federal Reserve Board to restrain the Reserve Banks is +vastly greater than its power to force them to take positive action +which might lead to the inflation of credit. This was clearly the +purpose in view in giving the Board the more important of its many +powers. It may, for example, reject applications of Reserve Banks for +notes, but this will not endanger assets, it will simply lessen power to +expand operations. Its power over the discount rates of Reserve Banks +will obviously be more effective when used to advance rates which it +deems too low than it will be if used to enforce a rate lower than the +management approves. The directors of the Reserve Bank would still +determine the amount of accommodation which it might safely grant to +member banks at the enforced low rate. Officers and directors of Reserve +Banks may be removed at any time by the Federal Board, which is merely +required to communicate its reasons for removal in writing; but the +right of member banks to choose successors will still remain. + +While it is impossible to make any prediction as to the relative place +which the Reserve Bank directors and the Federal Board will hold, it is +evident that, in the absence of harmonious co-operation, the system will +not work smoothly, even if it can be made to work at all. If all the +Reserve Banks and the Federal Board adopt a wise and conservative +policy, the system will surely work well. If the Reserve Banks alone are +conservative, the system may work well but with much friction. If the +Federal Board alone is conservative, it may force good results from the +system. On the other hand, if some of the Reserve Banks and the Federal +Board are reckless, the system will probably break down; and if all the +Reserve Banks and the Federal Board adopt a reckless policy, the results +will be disastrous. + +Both the directors of Reserve Banks, and the Federal Board will be +confronted with numerous problems, many novel and some intricate. The +possibilities of the new system cannot be foreseen, and the extent and +nature of the responsibilities resting upon the Reserve Banks cannot be +determined beforehand.... + + +THE FEDERAL RESERVE ACT--AN EXPERIMENT + +[295]Banking is the most delicate and sensitive of all businesses in +which men engage. It goes without saying that it is a business in which +the law maker should not needlessly interfere. Perhaps some of you may +not know that modern banking is a product of evolution. In this respect +it is like all great human institutions. No language worth while was +ever invented by a human being. Speech, with all its intricacies and +inconsistencies of grammar and syntax, was not planned by some master +mind centuries ago, but is the result of countless ages of effort on the +part of the human animal, guided only by his sub-conscious +intelligence--that which we call instinct in the lower animals--to give +expression to his emotions and his more or less hazy concepts. Language, +like the comb in which the bee stores its honey, has come to us as the +product of the labor of our ancestors through many millions of years. +Money, credit, and banking are in like manner evolutionary products. If +we attempt to tinker with them artificially without regard to the +lessons of experience and in disregard of the forces of evolution, +believing that our reason transcends the consolidated experience of our +ancestry, we shall meet the fate that we deserve, the fate of the +conceited bee who thinks he can improve the honey comb, or of the +conceited grammarian who would make me walk a literary Bridge of Sighs +for saying "it is me."... + +I am quite willing to admit that in some of its details the Federal +Reserve Act[296] has taken leaves from the experience of banking +institutions of this and other countries, but in its essentials, in its +anatomy, in its bony structure as it has been called, it is an animal +absolutely unknown to the natural history of finance. Let me briefly +call attention to the following novelties in banking: + +First. It provides for a system of twelve competing banking institutions +which shall control the currency supply of this country, and over which +there shall be no controlling body with power sufficient to compel them +to regard the national welfare in the issue of currency and in the +extension of their credit. It is taken for granted that the financial +welfare of the people will be safe provided that these competing +regional banks are required to hold gold or lawful money reserves of 35 +per cent. against deposits and 40 per cent. gold (free from tax) against +notes, and are not permitted to issue notes except upon deposit of good +commercial paper.[297] + +Second. The act provides that the Federal Reserve Banks shall have the +right to deal only with banks, nay more, they may deal only with such +banks as have contributed to their capital stock. This again is a +novelty in the banking world. If these banks are to be in touch with all +American business and industry and be powerful agents for the prevention +and alleviation of panic, why should they be thus restricted in their +operations? + +Third. The capital of these regional banks is not a matter of voluntary +subscription. It is not founded on business principles. The framers of +the measure seemed to fear lest the banks they were planning might not +prove profitable investments, hence, they have provided that our +national banks must subscribe the necessary capital or forfeit their +charters. No country on this green and prosperous earth has ever found +it necessary to resort to such undemocratic compulsion in order to +persuade people to go into the profitable business of banking. + +Fourth. The bank notes issued by these Federal Reserve Banks are called +government obligations and must be redeemed on demand by the United +States Treasury. In no country will you find that any such bank note has +ever been issued or even proposed, and I submit that in the United +States, whose people for half a century have confessedly been subject to +periods of anxiety and distress and panic because of the Government's +liability for the daily redemption of paper money, this provision of the +Federal Reserve Act is amazing, inexplicable, and indefensible. The +United States Treasury is not a bank and is not made one by this act. It +cannot control the issue of the notes, nor the credit operations of the +banks who do issue them. Why then should the treasury be compelled to +redeem these notes? + +Fifth. The Federal Reserve Act provides for an arbitrary shifting of +bank reserves such as has never been attempted before. Nobody can +foretell what the result will be, but we know nothing of the sort has +ever been attempted before and we also know that many banks will be +obliged to reduce their loans and discounts, and that their customers, +the business men of the country, may suffer serious losses in +consequence. + +The United States has tried many financial experiments--indeed, our +present national banking system was an experiment in finance and has +been found wanting--but the Federal Reserve Act, if it could be put on +exhibition in a world's financial museum, would, I feel sure, be voted +the newest and most spectacular thing we have yet constructed. + + +THE FEDERAL RESERVE ACT AND DEMOCRACY IN BANKING + +[298]Beneath his skin every American citizen of every station and +avocation, and whatever party name he may wear, is a Democrat in all the +essentials and fundamentals. That is, he is attached passionately to the +principles of local self-government, of the widest individual liberty +compatible with the general weal and order of society. This new currency +measure is democratic essentially. It looks to decentralisation of +direct financial control, to financial local self-government, so far as +is consistent with stability and the general safety; to a currency which +will be worth its face value everywhere, which will be based on the +actual values it purports to represent, as well as the faith and credit +of the General Government, and which yet will be elastic, expanding to +meet needs where and when they develop, receding when not needed; a +system fitted to meet any emergency, moving smoothly and noiselessly for +the ordinary uses of business in tranquil times. + +Too much money and too little money are alike evil and dangerous. +Opinions differ as to which is the worse. Probably one is as bad as the +other. The design of the new law is to supply just enough money or +credit, when and where business needs it, to create for our commerce, as +has been said, foundations so even, so broadly laid, and so deeply +planted that they can not be shaken. + +As it is, the country bleeds and sweats to the big financial centres. +Take the South as an instance--and the conditions with which you here in +North Carolina are familiar exist everywhere in the country. Most of our +railway systems are controlled frequently through the trust known as the +voting trust--by men who are interested in the great banks in the three +central reserve cities. So it happens that the large deposits of the +railways, their collections from the Southern people, as also from the +Western people, are sent on largely to those banks. The same is true of +the telegraph and telephone companies, the life and fire insurance +companies, and of many of the larger manufacturing enterprises. The +merchants and manufacturers of North Carolina pay their freight bills to +the railways. The money goes largely and promptly to New York, and is +lent out and used there in stock-market operations, or as the directors +of the banks, who are also often the directors of the roads and other +corporations, may elect. Of course there is no law which provides for +the carrying of the reserves and bank balances of railways and +industrial corporations in the central reserve cities, where the +national banks of the country have also been accustomed to keep their +reserves. + +When North Carolina needs money to move the cotton crop her banks must +call on New York for money which should be in their own vaults; for the +return of money paid in here in freight bills, insurance premiums, and +otherwise; and your banks sometimes think themselves lucky if they can +be allowed the use of any part of it.... + +It is not hard to see how centralization of financial resources and +money supply and concentration of financial power has been forced, and +the invisible and irresponsible despotism created by acts of Congress +and policies of government made necessary by those acts. + +Now, we do not propose to use violence to force disintegration and +decentralization, to do anything with a jolt and a jerk. It is +understood clearly that to rush headlong and at full speed over an evil +or an obstacle may cause derailment or jarring, uncomfortable and bad +for passengers. The thought or plan, as I understand it, is to invite +decentralization, to encourage it, to give opportunity for it, to make +local self-government possible, to remove the influences which draw to a +few centres the money that is paid out to the corporations and deposited +in the local banks.... + +The law does not require a single business man to change his account +from the bank with which he has kept it or any business man or bank to +suspend dealings with the bank or banks in the central reserve or +reserve cities with which they have in the past been doing business. It +does offer to banks freedom of choice. It says to the banker that he can +follow his preferences, sentiments, or habit in selecting the source of +his borrowing; and the member banker of any federal reserve district may +feel free and peaceful and at ease when he knows that he has in his +portfolio notes, drafts, and bills of exchange arising out of actual +commercial transactions, which he can convert into money at his federal +reserve bank with greater ease and promptness than it has sometimes been +possible for him to withdraw his cash balances from his reserve agents +and almost with as much ease as it has ever been possible to draw on +credit balances with any correspondent. He is not dependent on the whims +or fortunes of any other bank. He need not shiver at the prospect of +abundant crops for fear he may not have available the funds with which +to meet demands for moving them. He will know that if he needs money to +accommodate the bank's customers he can, as a matter of right, call on +his federal reserve bank. + +Among other benefits the new currency law, by its direct system of +clearances, will release and make available for purposes of trade and +commerce hundreds of millions of dollars which under the old system have +been tied up in tedious processes of collection. It will also save to +banks and to merchants and business men generally some millions of +dollars which they are now paying, directly and indirectly, for the +collection of country checks and checks on outside cities. + +To refer more particularly to your own district, the fifth, I will try +to explain to you how the new method will work in transactions of +domestic exchange. + +In this district, embracing the States of North and South Carolina, +Virginia, West Virginia (except four counties), the District of +Columbia, and Maryland, there are some 475 member banks. + +A cotton mill at Columbia, S. C., under the old plan sends its check on +its Columbia bank for a shipment of coal to the coal company at +Bluefield, W. Va. The local bank at Bluefield forwards this check to its +correspondent in Richmond. This correspondent sends the check to its own +correspondent in Columbia, who makes the collection from the Columbia +bank and then draws a check on New York for New York exchange, which it +remits to Richmond. The Richmond bank thereupon notifies the Bluefield +bank of the collection of the item. The collection and exchange charges +on distant country banks amount usually to from one-tenth to one-fourth +of 1 per cent., or possibly more, and probably a week or more elapses +between the remittance of the South Carolina check to the Bluefield bank +and the time when the Bluefield bank gets its report that the item has +been collected and placed to its credit in Richmond. + +Under the new currency act "every Federal Reserve Bank shall receive on +deposit at par from member banks ... checks and drafts drawn upon any of +its depositors." That means that the Bluefield bank receiving the check +on the Columbia, S. C., bank mails it to the federal reserve bank at +Richmond. The federal reserve bank at Richmond thereupon charges the +Columbia bank with the amount of the check, credits the Bluefield bank +with the proceeds, and notifies the two banks accordingly. + +The Federal Reserve Act also provides that each federal reserve bank +shall receive at par, and credit accordingly, all checks and drafts +drawn upon any of its member banks, from every other federal reserve +bank; that all checks and drafts drawn by any depositor--that is to say, +by any member bank--on any federal reserve bank shall be received and +credited at par by every other federal reserve bank. This means that the +checks of the member banks in the country towns throughout these five +States are worth their full face value, without deduction for exchange +or collection charges, to every other member bank, and that the amount +of each check may be cashed at par immediately, without following the +devious and roundabout courses now observed in the collection of checks. +Virtually every bank in the fifth district is only one night distant +from Richmond, and a check mailed one afternoon in the most distant +portions of the district should reach Richmond the following day in time +to be included in that day's operations of the federal reserve bank. + +Let us now consider another aspect of the new law: Under the old +National Bank Act a national bank with a capital of, say, $200,000, +deposits of, say, $1,500,000, bills receivable amounting to $1,200,000, +and $300,000 reserve, would only be permitted to borrow a total of +$200,000, the amount of its capital. If a run should start on such a +bank, the amount which it could raise by loans, if strictly held to the +old law, would be but $200,000, the amount of its capital, which might +be quite inadequate to meet a run, and the bank, though thoroughly +solvent, might be forced to suspend. + +Under the new law, however, if a bank with $200,000 capital and deposits +of $1,500,000 should have loaned $1,200,000 to its customers on +commercial paper and should encounter an unexpected run, in addition to +borrowing $200,000, the amount of its capital, such a bank would have +authority to rediscount with the federal reserve bank of which it is a +member, notes, drafts, and bills of exchange issued or drawn for +agricultural, industrial, or commercial purposes, having not more than +ninety days to run, to any reasonable extent which may be approved by +the federal reserve bank to which application for such rediscounts may +be made.... + +We can not overestimate the value of the additional security which this +provision of the act confers upon every honestly, capably managed member +bank, and the relief from strain and anxiety and from the fear and +apprehension of panics and unreasoning runs which it gives to the +officers of every member bank. + +Another important change provided by the Federal Reserve Act is the new +arrangement for the compensation of national bank examiners. Under the +present law the compensation of national bank examiners is based, except +as to reserve cities, on the capital stock of the bank examined. Under +the operations of this law a national bank examiner has been receiving +for the examination of a certain national bank in the fifth district, +with over $9,000,000 of assets and many thousands of accounts, the +munificent sum of $25. It is, of course, clear that an examiner could +make only an imperfect examination of such a bank in the space of three +days at a compensation of, say, $8 per day, out of which $8 allowance he +has to pay his own railroad fare, hotel expenses, as well as clerical +assistance. It is not unnatural that but few examiners would willingly +spend the ten days or two weeks which it might require to make a +thorough examination of such a bank when he is running personally in +debt in doing so. + +Under the new currency law the Federal Reserve Board, upon the +recommendation of the Comptroller of the Currency, is given authority to +fix the compensation of bank examiners on the basis of annual salary, so +that those banks which need additional time and attention from the +examiner may receive the careful, close scrutiny which the case may call +for. It is believed that the new system of bank examinations will reduce +materially the number of bank failures and enable the department to +check up many abuses and correct many evil situations which in the past +have been ignored or glossed over by examiners in their hasty and +incomplete investigations. + +I thank you, gentlemen, for the opportunity to address you. Approaching +the study of this new and revolutionary measure with the caution natural +to every man trained in banking under the system with which we have +grown up, I have become more thoroughly aroused to its merits and more +deeply impressed as I have watched the methods of construction, the +processes of growth, and have considered the underlying principles +directing those who did the work. + + +THE ELASTICITY OF NOTE ISSUE UNDER THE NEW CURRENCY LAW[299] + +To anyone who has been interested in currency reform for, say, twenty +years, probably nothing is more striking than the change in emphasis +which has taken place among the advocates of reform during this period. +The typical reform plan of the earlier time, for example the so-called +Baltimore plan brought forward in 1894, devoted itself almost +exclusively to providing a thoroughly elastic note issue, based on +ordinary assets. In contrast, the new law has as its central, primary +object the organization into at least regional unity of something like +the entire banking system of the country. Doubtless this difference in +the two reform plans was not altogether due to a fundamental difference +of opinion with respect to what would be the ideal scheme. The reformers +of the earlier period were not indifferent to the need for centralized +organization in the banking system. But they considered any scheme +involving a central bank, like the old Bank of the United States, quite +chimerical; and they were probably right. But times change; and men +change with them. For one reason or another we have all become more +tolerant of centralization in business matters, as also more tolerant of +that increase in governmental control which increased centralization in +business seems to make necessary. With at least fairly general approval, +a system of regional organization has been set up, involving a very high +degree of centralization and a very high degree of governmental control. +But with this change in the method of reform, it became inevitable that +the more important ends which earlier schemes sought to accomplish by +giving the note a high degree of elasticity should be, in no small +measure, attained by other means. In consequence, the need for +elasticity in the note issue will be much diminished under the new law. +Nevertheless, it is admitted that this need will not disappear +altogether. Elasticity in the note issue will be wanted partly to assist +in utilizing the newer methods of dealing with the difficulties +involved and partly to supplement those newer methods. Accordingly, the +question "How far does the note issue under the new system seem likely +to prove an elastic one?" is still important. + +From the beginnings of agitation for currency reform the advocates of +elasticity have recognized more or less clearly two kinds: (1) what we +may call _seasonal_ or ordinary elasticity, and (2) what we may call +_emergency_ elasticity. By the former was meant the power of a note +issue to adjust its volume to those moderate changes in the need for +money which show themselves in the course of an ordinary year. By +emergency elasticity was meant the power of a note issue to adjust its +volume to those extraordinary changes in need which connect themselves +with the typical banking panic. The evils which it was believed that +seasonal or ordinary elasticity would remedy were principally (1) the +summer shortage of currency for moving crops, together with the +temporary but more or less serious stringency in the New York money +market which accompanies that shortage, and (2) the plethora or excess +of currency which usually appears three or four months after the +crop-moving period has terminated. The evils which emergency elasticity +was expected to relieve were principally (1) the stringency which +precipitates the panic, (2) the money famine consequent on general bank +suspension after the panic has fully developed, and (3) the glut of +currency which attends the depression following a panic, often leading +to excessive exports of gold and thus endangering the whole credit +system of the country. + +Let us, now, take up seasonal or ordinary elasticity, and ask ourselves +whether the new notes are likely to possess this characteristic. First, +how about the expansibility needed to supply adequate funds for +crop-moving? At this point, it must at once be admitted that the new +currency does not meet the demands of the case in quite the +thoroughgoing way which the earlier schemes thought to be necessary. The +ideal of the earlier plans was to provide an adequate and easily +utilized power of issue, located at the very place where the need for +expansion is felt, _i. e._, in the local bank. The new law gives up this +idea entirely. The local bank will not have power to issue the new +currency at all. In so far as its customers are to get any benefit from +that currency the benefit must come through two channels which the +country bank could use in getting the needed funds, even if the currency +had no expansibility, namely, (1) calling in its balances kept with +banks more centrally situated, and (2) borrowing from such central +banks. In other words, the new power of issue will help out in the +crop-moving period merely because it will put the reserve banks in a +better position to respond to the call of the country banks for the +return of their own balances and for advances on discounted paper. +Judged from this point of view only, the elasticity provided by the new +law is doubtless adequate. If the reserve banks have not kept themselves +in a position to meet the calls of their country members from money +already in possession, they will surely be able to put themselves into +such a position by expanding their issue of notes. In one sense, then, +the new issue has adequate expansibility for ordinary needs. There still +perhaps remains a doubt whether effective elasticity is after all +assured, for it is not clear that the country bank which needs money for +crop-moving purposes will have the wherewithal to get advances from the +reserve bank--that is, that it will have paper of the proper kind and in +sufficient amount for rediscount. However, it seems probable that the +act as finally passed has met this need by providing that agricultural +paper shall be admitted on rather more liberal terms than paper arising +out of ordinary commercial or manufacturing business. If this be so, it +would seem that the provisions of the new law for securing one phase of +seasonal elasticity--expansibility--are fairly adequate. + +Passing, now, to the other side of elasticity--_i.e._, +contractility--can we say as much? Will the new issues promptly retire +when their special task is over? _Prima facie_, the verdict here is less +favorable than in the previous case. In general, there are two principal +processes by which a note circulation may be contracted: (1) _driving_ +the notes out of circulation, and (2) _drawing_ them out. In so far as +the former process is depended upon, means are devised to make sure that +the notes shall persistently return to the issuer even against his +will--they shall have good homing power. By the second process, it is +made to the advantage of the issuer of the notes to hasten their +withdrawal himself. + +As respects insuring contractility by the former of these processes, the +act certainly cannot claim to promise high efficiency. The driving-out +process requires roughly the fulfilment of two conditions: (1) keeping +the channels for the return of notes to the issuer fairly open, and (2) +supplying outsiders with a motive for sending the notes home. As regards +the former of these conditions, the new system probably is all right. +The return of the notes to the issuer seems not to be impeded by the +inconvenience or expensiveness of the process. All member banks and all +reserve banks must receive these notes; and the reserve banks will +probably have branches within easy reach of any part of the district. +Hence, any holder desiring to get notes back to the issuing bank will +find the process easy and the way open. But good homing power requires +more than this. It requires, namely, that adequate motives be supplied +to people generally, or, at least, to banks generally, for seeing that +the notes get back. It is not enough that the track be smooth; people +must desire to use it. Now, earlier plans for securing elasticity relied +on two principal motives for inducing holders to send notes back to the +issuer: (1) the desire of such holders to make room for their own notes, +and (2) their desire to exchange money which has various limitations +imposed upon it for money which is free from those limitations. It is +plain that the new system makes only a limited use of the former of +these methods of procedure. _Within_ the district for which any +particular reserve bank is the central bank, this particular force will +be practically inoperative; for the power to issue notes on the basis of +common assets is not given to any but the reserve banks, and the +profitableness of the power to issue the old type of note has always +proved too low to induce banks generally to take much trouble to get +their own notes into circulation. As between the reserve banks of the +different districts, however, this particular motive will, of course, be +more or less in evidence, since these reserve banks will all be +competitors for this opportunity. But even here the motive in question +will not play a large part, since more effective means for insuring the +return of the notes from outside reserve banks are provided in other +parts of the law. + +As regards the second motive for returning idle notes--that is, the +desire to exchange a money subject to various limitations or +disabilities for one not subject to those limitations--the new act does +somewhat better than it does in respect to the first motive. It is, +indeed, true that, within their own district, no special disability, +like being forbidden to be paid out by other banks, is put on the new +notes. But they are always subject to the disability of not being legal +reserve money in the case of federal banks; and hence such banks will be +more or less disposed to return the notes issued by their own reserve +banks, in order to exchange them for reserve money. It may be doubted, +however, whether in ordinary times this will prove a very potent force, +since country banks will usually keep reserves considerably in excess of +legal requirements, and so will not need to discriminate nicely between +the two sorts of money. As between different districts, the case for the +homing power of the new notes is rather stronger, since reserve banks +are prohibited from paying out the notes of other reserve banks under +penalty of a 10 per cent. tax. Even here, however, the provisions are +none too adequate. While the notes of a particular reserve bank must not +be paid out by the reserve banks of other districts, there is no +prohibition against their being paid out by the member banks of other +districts; and it is doubtful whether there is sufficient motive to +induce said member banks of other districts to send in these notes to +their own reserve banks and so start them on their homeward journey. The +desire to exchange money which cannot be used as reserve for that which +can be would have some force; but, under many circumstances, it would +probably prove rather inadequate. + +Another disability which contributes to the homing power of a bank note, +and which is actually used in the case of our old note, is not used with +this new note--I mean, the fact that they are not receivable for customs +dues. The decision to omit this provision was perhaps wise; but it +throws out a potent motive for sending notes home, and thus throws away +an opportunity to make better provision for their contractility. + +On the whole, then, it must be acknowledged that, in so far as homing +power is dependent on giving to outsiders strong and persistent motives +for sending notes home, the new law is not altogether satisfactory. + +We have seen that there is very little in the new system to secure that +the notes shall have good homing power--shall get home by what we have +called the _driving-in_ process. Is the system better off as respects +the _drawing-in_ process? Are matters so arranged that the issuing bank +will have the power and the desire to withdraw its notes--or at least +contract the currency proportionately--when the need for the notes has +fallen off? As respects the first part--making sure that the issuing +bank shall have the power to retire its notes, or at any rate to effect +a corresponding contraction of the currency--the new system is +practically perfect, as indeed was the old one. That is, any reserve +bank desiring to contract its note obligations may at its discretion +deposit with the federal reserve agent reserve notes, gold, or lawful +money. Obviously, this, if not strictly a contraction of its note +circulation, at least brings about the desired contraction of the +general circulation. + +When, however, we consider the provisions of the new law for insuring +that reserve banks shall desire to contract their circulation when the +special need has passed, we find that the law does not promise quite so +well. The favorite device for accomplishing this result has been, of +course, a tax on issues, similar to the 5 per cent. tax of the German +system. Apparently, the new law provides for something equivalent to +this in the shape of an interest charge by the Federal Reserve Board, +the rate to be fixed by said board. How far this device will prove +effective in practice it is not safe to predict. In order that it should +induce the banks to contract their circulation, circumstances must have +arisen under which the issuing bank would be earning on its outstanding +notes a profit smaller than the tax itself. Now, it does not seem +certain that an excessive issue of notes would necessarily bring about +this condition. In the first place, in the absence of good homing power, +a volume of notes in excess of business needs would not necessarily +cause an accumulation of those notes in the vaults of the bank issuing +them. Secondly, so long as member banks are free to keep their balances +in banking institutions other than their reserve banks, an excess of +notes would not necessarily cause the general cash holdings of reserve +banks to be abnormally large. For, so long as the ordinary New York +banks are permitted to pay interest on bankers' balances, country banks +will to a considerable extent keep their balances with these outside New +York banks; and it seems not unlikely that the excessive monetary stock +thus accumulating in New York City would, instead of getting into the +hands of the New York reserve bank, largely remain in the hands of the +outside banking institutions and be employed more or less as it has been +in the past, that is, in financing doubtful enterprises and supporting +excessive speculation. But if the reserve banks do not feel the pressure +of excessive issues in the shape of accumulations of notes or some form +of money in their own vaults, they may conceivably be able to invest +advantageously all the funds in their possession, and, in that case, the +rate of interest charged by the Federal Reserve Board will not furnish +an adequate motive for the retirement of their issues. Doubtless, +however, this may in some degree be answered by saying that even an +excess which was felt only outside the reserve bank would, after all, +compel the reserve bank to contract its issues, since it would lower the +rate of discount so greatly that reserve banks could not profitably +invest their ordinary holdings, and consequently would wish to get rid +of the interest charge. Perhaps this is true; but it would by no means +insure the prompt and full contraction which most reformers have +considered desirable. + +From the foregoing it would seem that one of the devices for inducing +the reserve banks to contract their issues after the need for them had +passed--that is, charging interest upon such issues--is not certain, at +any rate, to prove adequate; it will not surely eliminate the winter +plethora in New York City which is supposed to stimulate and support +excessive stock speculation. But the new law contains another provision +which may be viewed as a device for supplying the issuing banks with a +motive for contracting their issues, namely, the requirement that such +banks shall keep a gold reserve equal to 40 per cent. of their issues. +Is this likely to prove effective? Probably not. Whatever might be true +in panicky times, it seems certain that in an ordinary year the gold +holdings of a reserve bank will be much above 40 per cent. of its note +issue. If this be true, the maintenance of this 40 per cent. could +become difficult only when the excess of money was so great as to cause +a dangerous exportation of gold from the country, and this surely would +show a very inadequate degree of contractility. In short, the new law +does not insure that issuing banks shall be sufficiently disposed to +draw in their notes any more than it insures that outsiders will drive +them in. It would seem, then, that the new law does not promise to give +to the note issue the degree of contractility which has hitherto been +considered desirable. In other words, there is some point in the fear +expressed by many bankers that the new law will result in note +inflation--at least in so far as the avoiding of this danger is +dependent on the contractility of the note issue. Very likely, however, +the possibility of such inflation is sufficiently guarded against by +other provisions of the law. + +We have discussed the adequacy of the new note issue in respect to +seasonal or ordinary elasticity. We pass on now to consider its adequacy +in respect to emergency elasticity--the elasticity which enables a +currency to adjust itself to those extraordinary fluctuations in need +which mark a banking panic and the depression that follows. Broadly +speaking, it is pretty certain that at this point the new law will get a +more favorable verdict than in the previous case. As pointed out in an +earlier connection, the banking panic, when fully developed, gives rise +to three difficulties and so to three needs: (1) funds to relieve the +antecedent stringency which threatens a complete collapse of the credit +structure; (2) a circulating medium for ordinary trade when a general +suspension of payment by the banks has brought on a money famine; and +(3) a prompt and thoroughgoing contraction of the circulation in the +depression which follows the panic. Now, there surely can be no doubt +that, under the new law, the availability of an issue sufficient in +volume instantly to relieve the antecedent stringency, and so to put a +stop to a panic before it had developed serious dimensions, is assured. +In fact, it is not at all improbable that, under the new system, the +reserve banks will be able to check the development of such a panic at +the very outset without increasing at all their note issues. But, if +this does not prove true--if it turns out that more currency is needed +for this purpose--there would seem to be no shadow of doubt that the new +system will insure the forthcoming of such currency both of a quality +and in a quantity which will be fully adequate to the task put upon it. +(1) The notes to be issued, being obligations of the Federal Treasury, +will be as acceptable as gold even on the eve of a panic. (2) There is +no limit to the absolute amount of these notes. (3) The practical limit +set by the requirement that discounted paper shall be furnished as a +basis for their issue is of no real significance, since such paper will +undoubtedly be vastly greater in volume than any need which could arise. +Accordingly, there can be no doubt that the new system provides all the +expansibility needed to abort, or reduce to comparative harmlessness, +any panic which might arise. + +A word now with respect to the second need which an emergency +circulation is supposed to meet, that is, an ordinary circulating medium +for trade when banks have by common consent suspended payment. In the +first place, if we are right in supposing that the new law will surely +prevent any panic from reaching such a degree of intensity, it is +obvious that we shall not have occasion to meet the particular +difficulty here under consideration--that our note issue will not be +called on to display this particular sort of elasticity. If, however, it +be supposed that the foregoing prediction does not turn out to be +correct--if experience proves that panics can still go so far as to +cause banks generally to suspend payments, to hold on to every form of +reasonably solid money, and to try to satisfy the public with +substitutes--our verdict for the new currency would necessarily be less +favorable. We should have to admit that the new law does little or +nothing to relieve such a situation. Broadly speaking, the new money +will be altogether too good to meet this particular need. Banks that had +reached a stage of panic sufficiently intense to cause them to suspend +payment--to hoard the ordinary forms of money--would be sure to hoard +money as good as those notes are bound to be. That is, the new issue +would immediately pass into hoards, as did the greenbacks which the +Secretary of the Treasury reissued during the panic of 1873, and, +therefore, would bring little if any relief to the currency famine which +had developed. In fact, it is almost impossible to conceive any form of +note fitted for this particular task except one which was so bad that +there was no danger of its being hoarded. That is, the only proper way +to meet this particular need of a severe panic is to make sure that it +does not arise at all; and, in this respect, the new law promises well. + +We come, finally, to the third need which emergency elasticity is +supposed to meet, that is, a prompt and great contraction of the +circulation when the panic has passed and the inevitable business +depression consequent upon such a panic has set in. Here, again, though +not in the same degree as in the last case, if the new law proves as +successful as many conservative students expect, the need in question +will be little, if at all, experienced. We shall usually escape the +extreme business inflation of the antepanic period; the panic itself +will be much abated, if not completely eliminated; and, in consequence, +the trade reaction which naturally follows a panic will be much +diminished in intensity. If this turns out to be true, the circulation +will never again show such an extraordinary glut as characterized the +winter of 1893-94. Nevertheless, it can hardly be doubted that, after +even an incipient panic, there will be some reaction, and consequently a +more or less plethoric condition of the currency will follow. Will the +new issue have sufficient contractility to meet this need? Earlier in +this paper we have seen that the conditions attached to the new issue +are in general not favorable to contractility, in that they do not +provide for either the prompt driving home or the prompt drawing home of +the notes when the necessity for their issue is past. Outsiders lack +adequate motives for sending the notes home; issuers lack adequate +motives for calling them home. The case for emergency contractility, +however, is somewhat better than the case for ordinary contractility. +First, it is probable that the homing power of the note will prove +greater at such a time than in an ordinary year, for, at such a time, +outside banks will not be able to find investments for their funds, +since speculative trading will disappear altogether and business +generally will be at a very low ebb. Again, it seems certain that the +issuing bank will, in this case, have more than the usual motive for +bringing about a contraction of the circulation. The chief reason why +such a bank may not be eager in ordinary times to hasten the retirement +of its notes is the fact that, provided the notes do not accumulate in +its own vaults, such a bank will gain more by using the funds in its +possession to make loans than it would by using them to retire notes, +assuming that the interest charge made by the Federal Reserve Board is +not placed excessively high. But it is practically certain that, in the +depression which follows a panic, no reserve bank will have +opportunities for keeping all of its funds busy; and since, in that +case, the interest charge, however small, will be a dead loss, the bank +will have adequate motive for effecting, as promptly as possible, an +adequate contraction of its note liabilities. This motive would be still +further strengthened should the glut prove sufficient to cause a decided +drain of gold, since, in that case, the reserve banks will find +difficulty in maintaining the required 40 per cent. reserve. On the +whole, then, we seem warranted in affirming that, as respects emergency +elasticity, the new notes will give no serious disappointment. + +Finally, as respects elasticity in general, though the note issue, +viewed by itself, does not seem quite fitted to satisfy the tests which +an old-fashioned advocate of elasticity is inclined to impose upon it, +yet, when we take the new law as a whole, it seems not unreasonable to +affirm that it promises to accomplish, directly or indirectly, most of +the ends which we had hoped to attain through elasticity and hence +promises to give us a system which in essentials is truly and adequately +elastic. + + +NOTES PRINTED AND ISSUED + +[300]During the year 1915 the circulation of Federal Reserve notes has +increased to $188,817,000 as of December 31, 1915. Believing that the +country should be prepared against any contingency, the Board had +authorized the printing of about $700,000,000 of these notes. Almost +one-quarter of the total supply printed has been placed in circulation. +On December 31, 1915, however, only $16,675,000 of notes secured by +commercial paper pledged with the Federal Reserve Agents was outstanding +as an obligation of the Federal Reserve Banks. The liability of the +Federal Reserve Banks as to the remainder has been discharged by the +deposit with the Federal Reserve Agents of a like amount of gold and +lawful money. This result has been achieved by the Federal Reserve Banks +in responding to requirements, for currency by issuing Federal Reserve +notes rather than by parting with gold. While the gold pledged with the +Federal Reserve Agents represents a very valuable protection in case of +a substantial demand for gold, it must be observed that the process is +expensive without, at the same time, giving to the Federal Reserve Banks +that additional strength and lending power which they would secure in +case the law were amended so that the Federal Reserve Banks would remain +liable for the outstanding notes, but, on the other hand, would retain +property title to the gold delivered to the federal reserve agents, +which, in that case, would not be paid in to extinguish the liability +upon the notes but would be deposited as collateral security against +them. + + +IMPOUNDING GOLD + +[301]On November 16, 1914, the first shipment of Federal Reserve notes +was received by the Federal Reserve Agent [of the Federal Reserve Bank +of New York] from the Comptroller of the Currency. On November 19 the +bank pledged with the Federal Reserve Agent $500,000 of commercial paper +rediscounted by member banks and received from him a similar amount of +Federal Reserve Notes. These notes were not required by the banks +which made the rediscounts, as they had already withdrawn by checks +the credits so established. They were taken by this bank for its +general use. The issue of Federal Reserve notes gave the reserve +bank the opportunity of affording to its member banks complete +interchangeability between book and note credits. The bank therefore +established the policy of issuing Federal Reserve notes freely to +any member bank desiring them whether the credit thus withdrawn was +established by it through rediscounting, or the deposit of checks, or +the deposit of gold or lawful money. In practice, however, most credits +withdrawn by notes have been established by the deposit of checks which +have been collected by this bank in gold or lawful money through the +clearing house. Accordingly, the accumulation of cover in the hands of +the Federal Reserve Agent has been mainly gold, with but a small amount +of rediscounts. The processes provided by the act for the issue of +Federal Reserve notes to the reserve bank permit complete +interchangeability between gold and rediscounts held by the agent. Gold +may be substituted for rediscounts and rediscounts for gold, in +accordance with the requirements of the reserve bank. During the entire +period its requirements have been for notes with which it might exercise +its statutory right to "exchange federal reserve notes for gold, gold +coin, or gold certificates." + +The policy of the Federal Reserve Bank has resulted in greatly +strengthening its gold position and its ability to assist its member +banks or other Federal Reserve Banks should they at any future time seek +credit in order to withdraw gold for domestic or foreign uses. Through +this policy also it has been able potentially, at least, to retard the +expansion of credit by impounding in the hands of the agent a large +volume of gold which might otherwise have found its way into bank +reserves already superabundant. + +Furthermore, through this policy it has been able to take the first step +toward accomplishing one of the purposes of the act set forth in its +title, _e. g._, "to furnish an elastic currency." There are two forms of +elasticity, one of _quantity_ and the other of _quality_, both provided +for in the act. + +From the point of view of cover, the gold certificate is completely +inelastic. It stands at one extreme of our currency, with a dollar of +gold set aside behind each dollar of paper. At the other extreme stands +the national-bank note, with only 5 cents of gold set aside behind each +dollar of paper. The assets of the issuing bank make it good, but its +elasticity is nullified by the requirement that it must be secured +dollar for dollar by government bonds. + +Between these two extremes the Federal Reserve note, a new form of +currency, has been introduced. For each dollar of this paper there is +set aside from 40 cents to $1 of gold. As in the case of the +national-bank note, the obligation of the United States and the assets +of the issuing bank secure it. + +The process in which this and other Federal Reserve Banks have been +engaged is the substitution, as a circulating medium, of a note which is +elastic in quality for the inelastic gold certificate. Gold is the most +uneconomical medium of hand-to-hand circulation since, when held in bank +reserves, it will support a volume of credit equal to four or five times +its own volume. What the reserve bank does in accumulating gold behind +its Federal Reserve notes is to establish with the holder of each note a +credit which may be availed of whenever the occasion requires. With this +credit established it can convert at will its gold-covered notes into +notes covered partly by gold and partly by commercial paper. In times +when credit is becoming strained and bank reserves need strengthening or +when gold must be exported, this conversion will take place, and after +the strain is over the gold cover will be restored through the repayment +of the rediscounts substituted for it. In this way elasticity of quality +in our currency is obtainable. But it should not be construed as in any +way a deterioration of the currency contemplated by the act. Quite the +reverse is true. The act provides for the issue of Federal Reserve notes +in unlimited amounts, with 40 cents of gold behind each dollar of paper. +This is elasticity of quantity and it becomes operative with the minimum +of gold cover. Elasticity of quality, on the other hand, operates with a +gold cover always above the 40 per cent. minimum and ranging as high as +100 per cent. + +In order to be prepared for any currency demands which might be made +upon it, the Federal Reserve Bank of New York in the spring of 1915 +adopted the policy of having printed and keeping constantly on hand a +supply of Federal Reserve notes substantially in excess of the amount of +emergency currency which, experience shows, this district might be +called upon to supply. The maintenance of this policy and of the policy +of issuing Federal Reserve notes freely has entailed a heavy cost upon +this bank. Unissued Federal Reserve notes are carried at cost on the +books of the bank, and at the end of each month the amount of notes +issued to the bank during the month is charged off at cost. The shipment +of notes unfit for circulation to the Comptroller of the Currency at +Washington for cancellation and destruction is a further item of expense +in connection with the maintenance of these policies. The directors and +officers of the bank, however, feel that the results accomplished amply +justify the expense incurred, and consider that the added strength +furnished the bank by the gold thus accumulated is perhaps the most +important result of the operations of the period. + +Some reduction has already been made in the cost of printing Federal +Reserve notes, and it is to be hoped that further experience and study +will enable other substantial reductions to be made in the cost of +preparing for issue what has already become an important element of the +circulating medium of the country. The act provides that all expenses in +connection with the issue and redemption of Federal Reserve notes shall +be borne by the Federal Reserve Banks, and in view of the service the +banks are performing in accumulating gold through the medium of these +notes, the feeling is quite general among their officers that the notes +should be furnished to them at the lowest possible cost consistent with +the high quality of workmanship required. + +The design of the notes is not altogether satisfactory for efficient +handling. In sorting notes it is necessary to be able readily to +distinguish between notes of this bank and notes of other reserve banks. +This would be greatly facilitated if the printing of the distinctive +number and letter of each bank were made more general on the face of the +note. + + +THE FINANCIAL POLICY OF THE FEDERAL RESERVE BANKS[302] + +It seems clear that the cardinal principle in the management of the +Federal Reserve Banks will be to disregard the course which will lead to +maximum profits, following instead the path which will lead to the +greatest safety and which will permit these banks to be of the greatest +service to the nation. Large reserves should be maintained, and these +should consist chiefly of gold. The payment of interest upon bankers' +deposits and government deposits should be avoided, if possible, for the +reason that the payment of interest will force the keeping of smaller +reserves, if the cumulative dividend is to be earned. The banks should +be managed, not from the standpoint of profit, but from the standpoint +of safety. + +Yet this is but one side of the policy of the Federal Reserve Banks. +Their power and influence can be made to extend much farther than would +result solely from the wise management of their own affairs. These banks +are the financial trustees of the nation. The country will look to them +to see that they exercise over the member banks a closer supervision and +discipline than has been possible in the past. Supplementing a negative +control by the bank examiners, who are powerless so long as the letter +of the law is observed, the federal reserve banks will be a great +positive force. The Federal Reserve Banks, with the approval of the +Federal Reserve Agent or the Federal Reserve Board, may conduct +examinations of a member bank, both for the purpose of ascertaining its +condition, and, what will be of equal importance, for the purpose of +determining the lines of credit which are being extended by it. + +In the long run, the greatest work which the Federal Reserve Banks can +do for the business men of this country is to improve and standardize +the methods of commercial borrowing. I believe it is possible for these +banks, with the approval of the Federal Reserve Board, under the power +just quoted, to establish a comprehensive credit information clearing +service through which the aggregate loans of all large borrowers can be +known by any bank official and through which excessive borrowing or the +lending of money to concerns pursuing unwise financial policies can be +checked before disaster overtakes them. This is one of the greatest +needs of our banking system.... + + +RELATIONS OF FEDERAL RESERVE BANKS WITH MEMBER BANKS[303] + +The aim of this bank [Federal Reserve Bank of New York] at all times has +been to maintain frank and friendly relations with its member banks. At +every meeting of the New York or New Jersey Bankers' Associations, or of +their groups, to which invitations have been received, one or more of +the directors or officers have been present and discussed the +development of the various functions of the system. + +When the establishment of an intradistrict collection system was under +consideration, the directors and officers invited representative member +bankers from all parts of the district to confer with them at the office +of the bank. The plan finally adopted was thoroughly discussed in all +its aspects and a consensus of opinion seemed to prevail that it was a +fair and reasonable plan. + +When the conditions under which State banks should be admitted to the +reserve system were under consideration three conferences were held by +the directors and officers of the bank, one with national bankers, one +with State bankers, and one with trust company officers, from various +parts of the district, to ascertain their views upon the question at +issue. In every case the policy has been pursued of dealing frankly with +those present, in order that they might understand fully how the action +under consideration would affect them. + +The officers have expressed themselves at all times as desirous of +establishing personal relations with officers of member banks and have +invited them to call at the bank when in New York City. Yet a year has +gone by and officers of probably not over 15 per cent. of the member +banks have done so. Many of them still have the feeling that the bank is +a branch of the Government. Their experience with the Government +consists principally of the statutory and supervisory relationship which +exists between them and the Comptroller's office. The conception of the +relation of this institution with them as co-operative makes headway +slowly. The fact that the national banks were practically compelled to +join the system naturally retards the development of the co-operative +idea. The change of attitude, upon which the success of the system will +ultimately depend, will probably come slowly, but there are already +signs, as we enter upon the second year of the system, that the banks +are getting more accustomed to it and appreciate the results it has +already accomplished. It is hoped that during the coming year, with +organization pressure somewhat lessened, more time can be devoted by the +officers to developing personal relations with the officers of member +banks. + +The present attitude of the member banks toward the reserve bank may be +summarized as follows: + +The New York City banks, upon which the strain of all crises first and +chiefly falls, fully understand the value and benefits of the system. +While regretting the loss of bank deposits which will probably be drawn +from them (estimated to be as high as $250,000,000), they are +nevertheless hearty supporters of the system, at all times co-operative +in their attitude. + +Many of the banks in other large cities are unable to take full +advantage of the lowered reserve requirements, but in spite of the loss +of interest on their reserve balance, most of them understand what the +system in its larger aspects means for American banking and generally +give it their support. + +While the same may be said of many of the country banks, yet it is among +the country banks as a class that most of the apathy and hostility to +the federal reserve system which still persists is found. Their +opportunities and earnings are relatively small, and in order to live +they must figure closely. They feel the loss of interest on reserve +deposits; the absence, as yet, of dividends on their capital +contribution; and the prospective loss or decrease of the exchange they +generally charge on remitting for checks drawn upon them. Many banks in +industrial centres are precluded by the activity of their business from +taking advantage of the reduction in the required reserve. They believe +that they will, in fact, be required to carry an even larger reserve +than heretofore in order to obtain collection service for notes, drafts, +and non-member bank checks and the various other services now rendered +by their reserve agents, but not yet undertaken, by the reserve banks. +It is very natural that they should view with reluctance the termination +or diminution of long-standing business associations with their reserve +agents. Few of them, as yet, conceive of the reserve bank as their +active reserve agent, performing all the services which go with the +relationship. The dormant accounts most of the banks maintain with the +reserve bank are, perhaps, indicative of their attitude toward it. +Relatively few banks of this district are borrowers; in good times and +bad they have been able when necessary to borrow from their city +correspondents on bonds or on the indorsement of their directors, two +avenues which are now to be closed to them. The rediscounting privilege +has been little availed of and the larger functions of the Federal +Reserve System, such as influencing domestic rates and international +gold movements through the development of a discount market and by +dealing in foreign bills, appear remote from their spheres of activity. +They feel that the system has few advantages to offer in return for the +cost it entails upon them. + +All of these points will be felt with increasing acuteness by the +country banker as his reserve transfers approach completion and as +reduced balances result in reduced service from his city correspondent. +His point of view is outlined thus frankly in order that the +difficulties he sees may be clearly recognized and steps taken gradually +to remove them. The development of a more satisfied relationship +requires progress on the part of the reserve bank and a willingness to +co-operate on the part of the country banker. + +The reserve bank should organize a complete collection system embracing +the handling of notes, drafts, and items on non-member banks, which +eventually will bring all the members into daily active relations with +the bank. It must be ready to act for member banks in the purchase, +sale, and custody of securities; to supply credit information on names +whose paper is offered by brokers; to give its members information +concerning methods of developing the new functions which the act +authorizes them to exercise; to perform the services now rendered by +their reserve agents; and generally to assist them in every reasonable +way. + +The member banks should look upon the reserve bank not as an alien but +as their own institution. They own all its capital and most of its +resources, and they control its management through the directors they +elect, subject always to the supervision of the Reserve Board. At the +reserve bank they may borrow as a standing right and not as a favor +which may be cut off. They no longer have to buy or carry bonds to serve +as security for loans; the paper of their own customers, large or small, +will now serve as their security. While panics in the past may not have +affected them, they have been disastrous to the business interests of +the country, who are their customers; and their contributions to the +reserve bank should be recognized as a form of insurance not merely for +themselves but for their customers as well. If this insurance is +expensive and makes some changes in the nature of their business, the +act should be carefully studied with a view to making the most of the +new functions it provides. New avenues of activity should be looked for. +The banks which will get the most out of membership are those which are +the first to see and develop the opportunities it provides and to +educate their customers to the protection and facilities they will enjoy +through the system. The occasion is a favorable one also for the +correction of abuses. Customers will do things in the name of the +Federal Reserve System which they have never done before. The experience +of banks in using the forms provided by the reserve bank to get +statements from their borrowers is evidence of this. The occasion should +be seized also to increase the balances of depositors who carry +unprofitable accounts. To assist member banks in studying their accounts +this bank has had under preparation by chartered public accountants a +reasonably simple form for analyzing accounts which may be obtained by +banks desiring to use it. + +It is the duty of the directors and officers to understand not only the +problems of the reserve bank but those of the member banks as well; and +it has been their endeavor during the past year to give special study to +those of the country bank. Several suggestions for the relief of the +country bank have come to their notice. + +One of these, which the American Bankers' Association at its 1915 +Seattle convention favored, was to permit the 3 per cent. of reserve +which the member bank may carry either in its vaults or in the reserve +bank, to be deposited with member banks not more than 300 miles distant +and count as reserve. This seems to be contrary to the spirit and intent +of the act, which is primarily to centralize reserves in Federal Reserve +Banks. + +Another suggestion which seems more worthy of consideration is that the +percentage of reserve required for country banks should be somewhat +further reduced. When the reserve transfers are completed checks in +transit can no longer count as reserves. It is clear, therefore, that +the reserve reduction contemplated by the act will not be realized in +practice. A further reduction in the reserve requirements would, in the +case of many banks, result in a reserve less than the amount their +business actually required, and would enable them to carry the amount +thus freed wherever it would best serve their particular business, and, +if they so desired, to maintain some relations with present city +correspondents. It would lead away from the present rigidity of bank +reserves toward greater flexibility and a better understanding of their +meaning and purpose. + + +RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF MINNEAPOLIS AND ITS +MEMBERS + +[304]The Ninth Federal Reserve Bank has sought to make the Federal +Reserve Act fully operative within its district. During the spring of +1915 it had opportunity to demonstrate its effectiveness in meeting the +requirements of agriculture in the Northwest during the planting season, +and rediscounted liberally for member banks, in order to enable them to +better satisfy the requirements of farmers. It relieved local pressure +at a number of points where manufacturing enterprises and general +business were depressed because of war conditions, and had opportunity +to show that it can efficiently meet the demands of industry. Again, in +the fall of the year, when an adverse season had created large amounts +of immature corn, it was able to perform a very valuable service in +assisting member banks to meet the requirements of farmers who were +suddenly compelled to make provision for utilizing a valuable forage +crop. During the prevalence of the foot-and-mouth disease it was able to +come to the assistance of many banks in the western part of its +territory, which had applications for loans from numerous stockmen who +had cattle ready for market, but were unable to ship on account of +quarantine conditions. The service above indicated, while not perhaps of +notable consequence in any single case, consists in the aggregate of a +very valuable degree of assistance, which would not have been available +except for the Federal Reserve Bank, and without which, portions of the +district would have encountered considerable hardships. + + +RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF BOSTON AND ITS MEMBER +BANKS + +[305]Owing to the unusual conditions existing in the money market, and +to the fact that the reserve city banks offer facilities to the country +banks which this bank has not yet developed, more particularly in +connection with the collection of checks and other items, the latter +banks have carried only their minimum reserve requirements with this +bank and have used its facilities only to a limited extent. The +relations between country bank officials and the officials of this bank +have been most cordial. While many of the banks in this district are +borrowing, most of them find it much more convenient to go to their +correspondent bank and borrow, either in the form of a demand loan, with +or without collateral, or against a certificate of deposit. + +The Comptroller's calls on the several dates show the total borrowings +of member banks in the district as compared with their rediscounts with +this bank, as follows: + + _Total _Borrowed, + Borrowed._ F.R.B._ + Dec. 31, 1914 $4,738,416 $105,000 + Mar. 4, 1915 4,047,708 234,531 + May 1, 1915 3,969,796 410,723 + June 23, 1915 4,284,445 270,441 + Sept. 2, 1915 3,398,856 190,849 + Nov. 10, 1915 2,985,406 131,725 + +The officials of the city banks on the other hand are apparently +satisfied with the progress made in the development of this bank's +functions. While but few of the Boston banks have rediscounted with us, +almost all have intimated that should occasion arise they would do so. +Furthermore, several Boston banks have entered into the acceptance +business to a large extent, and the assistance that this bank has given +in the matter of rates and market for acceptances has done much to bring +it into favor with those banks. The Boston banks have also used this +bank to a large extent in exchange transactions, and the services +offered by the gold settlement fund have been used almost exclusively by +those banks. + +Thus far Boston banks have received more benefits from this bank than +have the other banks in this district. A possible exception to this is +in Aroostook County, Me., where, owing to an unusual situation +surrounding the principal industry, the potato crop, banks have relied +on this bank to a considerable extent to carry them through a trying +period. The moral effect of having the Federal Reserve Bank of Boston +stand behind them was not only appreciated by those banks, but enabled +them to handle their business much more satisfactorily and to finance +themselves without having to call upon this bank to an undue extent for +rediscounts or without embarrassing their customers. + + +FEDERAL RESERVE BANKS AND THE ACCEPTANCE MARKET + +[306]The right to accept drafts was conferred on New York State banking +institutions by the act of April 16, 1914. Shortly afterwards a few +acceptances were reported, principally against securities. It was not +until the derangement of international credit facilities at the opening +of the European war that American bankers' acceptances, especially those +relating to foreign commerce, came into existence in substantial volume. +At that time some of the trust companies with foreign connections +extended credits freely to their customers to replace credits formerly +granted by European banks which had been either withdrawn or reduced; +they also accepted drafts in large volume. On and after May 18, 1914, +member banks were authorized also to accept drafts drawn upon them +involving the importation or exportation of goods.... + +The monthly purchases of acceptances by this bank [the Federal Reserve +Bank of New York] in the New York market have been: + + 1915 _Number_ _Number_ + _of pieces._ _Amount._ _of pieces._ _Amount._ + + _For itself._ _For other reserve banks._ +February 41 1,659,740.21 86 1,263,871.25 +March 140 3,343,143.17 250 3,799,809.42 +April 86 1,272,694.36 84 1,700,396.57 +May 46 867,420.18 48 1,305,873.80 +June 132 3,083,261.75 34 602,558.89 +July 106 2,496,865.67 147 2,348,050.89 +August 103 1,597,630.63 89 1,910,417.47 +September 89 1,769,880.50 172 1,948,243.05 +October 68 2,199,679.95 163 2,028,098.36 +November 115 1,899,606.56 246 2,594,951.04 +December 310 5,648,708.78 313 2,809,823.59 + +Total 1,236 25,833,631.76 1,632 22,312,094.33 + +The policy pursued by this bank thus far has been to purchase good +acceptances whether or not the acceptor was a member bank.... + +The reserve bank and the market rate for the discount of such bills in +New York has been for nearly a year, and is now, lower than the rate for +similar bills in London. The relatively small volume of such credits +which American banks have succeeded in making operative even under the +unusually favorable opportunity which the war presents for their +extension, is evidence of the difficulty which will be encountered in +developing the acceptance business in the United States. Some of the +fundamental difficulties are: + +(1) The disinclination to break old banking connections. + +(2) The difficulty of educating handlers of bills in distant places as +to American credits. + +(3) The lack of bill buyers in foreign countries who will quote as low +rates on dollar as on sterling bills. + +(4) The natural prejudice of bill buyers in foreign countries in favor +of a bill of known currency and against a bill of as yet unknown +currency. + +(5) The lack of men trained to exercise the judgment and financial +responsibility required of them as managers of branches or agencies +which American banks might establish in foreign countries. + +(6) The inferior communications for both goods and mail between the +United States and foreign countries as compared with those between Great +Britain and foreign countries. + +Only time, experience, and patient effort will remove these handicaps to +the elevation of dollar exchange to its proper position in international +finance. The business, however, is developing and will continue to grow +as our banking machinery and connections extend throughout the world. + +The Act permits member banks to accept an amount of bills not exceeding +50 per cent. of their capital and surplus. By the amendment of March 3, +1915, under certain conditions they may be authorized by the Federal +Reserve Board to accept up to 100 per cent. of the capital and surplus. +The following banks in this district have received such authorization: + + _Amount of + capital and + surplus._ +Bank of New York, New York $6,000,000 +Mechanics & Metals National Bank, New York 12,000,000 +Atlantic National Bank, New York 1,600,000 +American Exchange National Bank, New York 8,000,000 + +As this bank has probably been the largest single purchaser of bankers' +acceptances, it has been able, as it gained experience, to exert some +influence toward standardizing practice and form.... + +The amended regulation[307] issued September 7, 1915, considerably +broadened the field of acceptances eligible for purchase and encouraged +an increased volume of these instruments. The further amended regulation +issued December 4, 1915, covering the purchase of bankers' acceptances +arising out of domestic transactions relates to a class of bills which +national banks are not authorized to accept. When accepted by +institutions of high credit they have a ready market, though at a +fractionally higher rate than acceptances based on foreign transactions. + +[308]New England imports a large volume of hides and wool from South +America and cotton and jute from the Orient and other sections of the +world. These shipments in the past have been financed through credits +drawn on European centers. Since the opening of the Federal Reserve +Banks these foreign trade transactions have been financed to a large +extent through dollar credits drawn on this country and the acceptances +arising there from have found a ready market in the Federal Reserve +Banks. Several of the member banks in this district have entered this +new field of finance and the Federal Reserve Bank of Boston has used +every effort to further and develop that business, not only by buying a +large amount of that class of paper, but also through furnishing +favorable forward discount rates to assist in protecting its member +banks. The following member banks have entered this field: + + 1. First National Bank, Boston, Mass. + 2. Fourth-Atlantic National Bank, Boston, Mass. + 3. Merchants National Bank, Boston, Mass. + 4. National Shawmut Bank, Boston, Mass. + 5. Old Colony Trust Co., Boston, Mass. + 6. Second National Bank, Boston, Mass. + 7. Merchants National Bank, Worcester, Mass. + +Under special permission of the Federal Reserve Board the First National +Bank, of Boston, and the National Shawmut Bank, of Boston, have been +given authority to accept up to 100 per cent. of their capital and +surplus. It is of interest to note that the former bank has reported the +largest amount of acceptances of any member bank of the Federal Reserve +System. + + +CLEARINGS AND COLLECTIONS IN PRACTICE + +[309]Section 16 of the Federal Reserve Act made general provision for +the establishment of a system of clearance of checks throughout the +United States, each Federal Reserve Bank being required to act as a +clearing house for its members if directed by the Federal Reserve Board, +while the Federal Reserve Board was authorized to clear for the reserve +banks themselves. + +The Board had from the first recognized its duty to make this provision +of the law effective as fully and at as early a date as conditions would +permit; and in its first report spoke of this as "one of the most +important responsibilities with which it is charged under the Act." So, +regarding its duty in this particular, it undertook early in 1915 the +preparation of a general circular and regulations intended to provide +for the clearing of checks within the several Federal Reserve districts, +while it also took under advisement the establishment of a gold +settlement fund at Washington for the purpose of clearing obligations +between Federal Reserve Banks. The latter undertaking has been carried +to a successful conclusion and the gold settlement fund has been in full +and satisfactory operation since about the first of June. The Board, +however, had not advanced far with its work relating to the +intradistrict branch of the clearance system before technical and other +difficulties began to make their appearance. Many banks, both city and +country, throughout the system were opposed to the enforcement of the +provisions of the law because of the loss of exchange charges which +would thereby be entailed upon them. Legal questions were also raised, +it being argued that there is no power to compel a member bank not +located in a Federal Reserve city to pay or have charged to its account +at the Federal Reserve Bank of its district a check which it had not +seen and approved prior to the time of presentation at its own counter. +For the purpose of ascertaining the Board's powers in this connection +the opinion of the Attorney General has been requested. + +While the Board was not inclined to attach undue importance to +objections based upon self-interest, it felt that it must take +cognizance of all legal objections, and it recognized that the clearing +question was essentially a reserve problem rather than a technical +question or a mere matter of administration. Inasmuch as the Federal +Reserve Act had granted a period of three years within which to effect +the final transfer of reserves to Federal Reserve Banks (balances with +correspondents counting as reserves in the meantime), there was a +certain ground for objection to the immediate introduction of complete +clearance at Federal Reserve Banks. As is well known, reserve balances +in some reserve cities have heretofore been used for the purpose of +providing for exchange and collection operations, and so long as this +function on the part of city correspondents continued there was some +argument in favor of deferring any compulsory application of par +clearance at the reserve banks. Study of the problem, moreover, shows +that, pending the time when state banks enter the system in larger +numbers, it may be necessary for some member banks to collect and clear +through their correspondents in reserve cities. + +So complex was the situation and so serious the difficulty involved in +the compulsory application of any system, however carefully conceived, +that the Board felt it would be well if member banks could be brought to +recognize of their own free will the advantages of a general and +nation-wide clearing system--advantages which would inure not only to +the benefit of the public at large, but ultimately to the direct benefit +of the member banks themselves from the purely business standpoint. It +therefore took under favorable consideration the question of a voluntary +clearing system. Both the difficulties of a compulsory plan and the +probable merits of a voluntary system had been strongly represented to +the Board by the governors of the respective Federal Reserve Banks who +at various meetings had thoroughly canvassed the whole situation. Under +a plan, proposed by the governors, which in most districts became +effective during June, 1915, provision was made for the acceptance at +par by the Federal Reserve Bank of each district of checks drawn upon +any member bank of that district which had previously assented to the +provisions of the scheme. It was hoped that a very large number of +member banks would promptly affiliate themselves with the new system of +clearing and that the natural force of economic competition would +ultimately attract to it those who at first might hesitate. + +This system, as already stated, became operative in most districts +during June, 1915. Prior to this whole discussion, however, two +districts had already undertaken the application of the clearing +provision of the law. Early in December, 1914, district No. 10 and +district No. 8 (Kansas City and St. Louis) had sought and obtained +permission to apply to their members a complete system of required +clearing. This system had been in full operation in both districts prior +to the general application of the voluntary system. Upon the +inauguration of the latter the directors of the Federal Reserve Bank of +St. Louis deemed it wise to offer to their member banks the option of +withdrawing from the clearance system if they so desired; but so +successful had been the working of the plan that comparatively few +retired, about 80 per cent. of all continuing their membership. The +Federal Reserve Bank of Kansas City continued its required system as +before for the benefit of all its member banks, numbering 950. As about +365 banks continued their membership in the St. Louis district, a total +of approximately 1,300 was included in the clearing system of the two +districts in question. Outside of these two districts about 1,100 member +banks voluntarily affiliated themselves with the clearing system within +a short time after its inauguration, and there was a subsequent net +inward movement of about 50 additional members, making approximately +1,150 banks which of their own free will have assented to the voluntary +clearing plan. This is considerably less than 25 per cent, of the +institutions eligible for membership, and the proportion has been so +small as to prove a severe disappointment to those who had confidently +expected that the foresight and enlightened self-interest of the member +banks would speedily accomplish the desired result. Some progress has +been made through the action of the banks, both member and non-member, +in improving exchange conditions and in providing for the clearance of +country checks at points where this practice has never before prevailed; +but in the main comparatively small advance has thus far been made in +rendering effective the provisions of the law requiring the +standardization of exchange and clearance practices. This slowness is +largely due to the failure of jobbers and merchants to appreciate the +advantages of the clearance system and to enlarge its membership by +insisting that their own banks join and co-operate in the plan. The +subject has recently been reopened at the conferences between the +governors of the Federal Reserve Banks, the Federal Reserve Agents, the +transit managers of the reserve banks, and the Board itself, with a view +to extending the present system not only in the several districts +themselves but as between the various districts. For many years it has +been lawful for banks to count as reserves deposits with other banks. It +was never the intention of the Federal Reserve Act that member banks +should continue the maintenance of these reserve accounts. On the +contrary, the full meaning of the act is manifestly opposed to such an +idea. It is the plain conception of the Act that the reserve banks +should, to a very large extent, if not entirely, perform the work that +is now being done by correspondent banks in this respect. This means +that the reserve balances to be carried in the future by the reserve +banks instead of by the correspondent banks should serve as the basis +for a system of clearing and collecting the exchanges of the country. +Whatever can be done to bring about the prompt and effective use of this +new system of bank settlement will be done. + + +BRANCHES AND AGENCIES + +[310]The question of branches of federal reserve banks has received +careful attention during the past year. There has been intimation from +several quarters that the establishment of a branch at a given point +would be acceptable to the banks of that place. Only in one +instance--that of New Orleans--did the Board receive a definite request +from a Federal Reserve Bank to establish a branch. Believing that New +Orleans and the adjacent territory could make advantageous use of this +additional banking machinery, the Board authorized the establishment of +a branch of the Federal Reserve Bank of Atlanta to be located in New +Orleans, and this branch was opened for business on September 10. +Operations at the New Orleans branch have proceeded satisfactorily, and +the institution has been of considerable use to the local banks. The +branch is already more than self-supporting. + +Investigation and experience have seemed to show that, at least for some +years to come, the organization of branches with completely equipped +offices, vaults, and the like, and with a full staff of salaried +officials, will be too heavy an expense for most of the reserve banks, +yet, that valuable service could be performed by local offices of the +several banks in not a few places. The Board has, therefore, had under +consideration the question whether establishing local agencies might not +meet the requirements of the case better than the more fully organized +branch office. Competent legal opinion is to the effect that the +creation of such local offices is permissible under the terms of the +law, and the Board believes that it may prove practicable to meet +banking necessities in many sections of the country by this means. + + +PROPOSED AMENDMENTS TO FEDERAL RESERVE ACT[311] + +A year's experience in the operation of the Federal Reserve Act has +confirmed the Board in its profound conviction that the act has been one +of the most beneficial pieces of legislation ever adopted by Congress. +Not only have its fundamental principles been fully vindicated but in +most details the working of the measure has been successful. The act, +however, is a progressive piece of legislation and creates new +conditions as the result of its own operation. Modification in its terms +growing in part out of these new conditions will subsequently be +required from time to time. + +For the present the Board presents the following suggestions for +amendments to the act: + +(1) In addition to powers now possessed in this connection by Federal +Reserve Banks and national banks, the latter should be permitted to +subscribe for and hold stock in banks organized for the special purpose +of doing a banking business in foreign countries. + +(2) With the approval of the Federal Reserve Board the issue of Federal +Reserve notes to Federal Reserve Banks should be permitted either +against the deposit of an equal amount, face value, of notes, drafts, +bills of exchange, and bankers' acceptances acquired by Federal Reserve +Banks under sections 13 and 14 of the Act, or of gold, or of both, +provided, however, that gold so deposited with a Federal Reserve Agent +shall count as part of the reserve required by the Act to be maintained +by the bank against such notes outstanding. + +(3) The acceptance system, provision for which is made in foreign trade +operations by the Federal Reserve Act, should be extended to the +domestic trade in so far as relates to documentary acceptances secured +by shipping documents or warehouse receipts, covering readily marketable +commodities or against the pledge of goods actually sold. + +There can be but little question of the safety of such acceptances, and +their use will tend to equalize interest rates the country over and help +to broaden the discount market. + +(4) Permission should be granted to national banks to establish branch +offices within the city, or within the county, in which they are +located. + +(5) In order to enable member banks to obtain prompt and economical +accommodations for periods not to exceed fifteen days, the Federal +Reserve Banks should be permitted to make advances to member banks +against their promissory notes secured by such notes, drafts, bills of +exchange, and bankers' acceptances as the law at present permits to be +rediscounted or purchased; or against the deposit or pledge of United +States Government bonds, the purchase of which is now permitted under +the law. + +(6) The Board furthermore recommends that the power of national banks to +make loans on farm lands as provided in section 24 be extended so as to +permit any national bank not situated in a central reserve city to make +loans secured by improved and unencumbered farm land situated within its +Federal Reserve district, or within a radius of 100 miles from the place +in which such bank is located, irrespective of district lines. It also +recommends that the powers of national banks be further extended to +permit any such bank to make loans on any improved and unencumbered real +estate located within 100 miles of the place in which such bank is +located, irrespective of district lines; provided, however, that the +aggregate of farm land loans and other real estate loans made by any +national bank shall not exceed 25 per centum of its capital and surplus +or one-third of its time deposits; and provided further, that no such +real estate loan, as distinguished from a farm land loan, shall exceed a +period of one year nor exceed 50 per centum of the actual value of the +property offered as security. + +It is believed that the enactment of these amendments will, besides +enlarging the usefulness of the national banks, result in greatly +strengthening the operation of the Federal Reserve Act, and more +completely realize the purposes of its framers. The text of the +amendments designed to carry out these recommendations will be submitted +by the Board at an early date. The Board has under consideration other +suggestions for amendments to the Federal Reserve Act concerning which +no conclusions have yet been reached, and regarding which the Board will +take occasion to submit its views to the Congress at an appropriate time +in the future. + + +STATEMENT OF CONDITION OF FEDERAL RESERVE BANKS.[312] + +_Combined resources and liabilities of all Federal Reserve Banks as at +close of business on the last Friday of each month during 1915._ + +RESOURCES. +[In thousands of dollars.] +---------------------------+---------+---------+---------+---------+---------+ + | Dec. | Jan. | Feb. | Mar. | Apr. | + | 31. | 29. | 26. | 26. | 30. | + | 1914. | | | | | +---------------------------+---------+---------+---------+---------+---------+ +Gold coins and certificates| | | | | | +in vault | 228,641 | 235,417 | 248,256 | 241,344 | 237,278 | +Gold settlement fund | | | | | | +Gold redemption fund | 428 | 488 | 653 | 824 | 950 | + +---------+---------+---------+---------+---------+ + Total gold reserve | 229,069 | 235,905 | 248,909 | 242,168 | 238,228 | +Legal tender notes, silver,| | | | | | +etc. | 26,578 | 20,882 | 29,085 | 23,098 | 26,518 | + +---------+---------+---------+---------+---------+ + Total reserve | 255,647 | 256,787 | 277,994 | 265,266 | 264,746 | +Commercial paper | 9,909 | 13,955 | 18,577 | 22,001 | 22,774 | +Bankers' acceptances | | | 1,892 | 9,682 | 13,812 | +United States Bonds | 205 | 2,015 | 5,406 | 6,639 | 6,813 | +Municipal warrants | 734 | 11,165 | 12,011 | 14,940 | 18,656 | +Federal Reserve notes, | | | | | | +net assets | 5,418 | 3,179 | 3,215 | 6,091 | 6,909 | +Due from other Federal | | | | | | +Reserve Banks, net | 7,930 | 7,421 | 8,088 | 5,573 | 9,468 | +All other resources | 5,931 | 7,712 | 4,550 | 3,019 | 4,425 | + +---------+---------+---------+---------+---------+ +Total resources | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 | +---------------------------+---------+---------+---------+---------+---------+ +LIABILITIES. +---------------------------+---------+---------+---------+---------+---------+ + | Dec. | Jan. | Feb. | Mar. | Apr. | + | 31. | 29. | 26. | 26. | 30. | + | 1914. | | | | | +---------------------------+---------+---------+---------+---------+---------+ +Capital paid in | 18,051 | 20,440 | 36,069 | 36,105 | 39,669 | +Government deposits | | | | | | +Reserve deposits, net | 263,948 | 279,516 | 290,336 | 288,217 | 294,832 | +Federal Reserve notes, | | | | | | +net liability | 3,775 | 2,278 | 5,328 | 8,889 | 11,038 | +All other liabilities | | | | | 2,064 | + +---------+---------+---------+---------+---------+ +Total liabilities | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 | +---------------------------+---------+---------+---------+---------+---------+ + + +RESOURCES. (continued) +[In thousands of dollars.] +---------------------------+---------+---------+---------+---------+---------+ + | May. | June | July | Aug. | Sept. | + | 28. | 25. | 30. | 27. | 24. | + | | | | | | +---------------------------+---------+---------+---------+---------+---------+ +Gold coins and certificates| | | | | | +in vault | 219,187 | 222,746 | 212,988 | 211,145 | 229,972 | +Gold settlement fund | 23,426 | 31,360 | 52,140 | 55,930 | 59,050 | +Gold redemption fund | 1,027 | 1,081 | 1,064 | 1,104 | 1,202 | + |---------+---------+---------+---------+---------+ + Total gold reserve | 243,640 | 255,187 | 266,192 | 268,179 | 290,224 | +Legal tender notes, silver,| | | | | | +etc. | 31,989 | 47,848 | 22,092 | 19,878 | 22,920 | + +---------+---------+---------+---------+---------+ + Total reserve | 275,629 | 303,035 | 288,284 | 288,057 | 313,144 | +Commercial paper | 24,747 | 25,996 | 29,102 | 29,275 | 31,373 | +Bankers' acceptances | 9,204 | 10,379 | 11,625 | 13,564 | 13,058 | +United States Bonds | 6,947 | 7,601 | 7,923 | 8,836 | 9,328 | +Municipal warrants | 23,094 | 11,509 | 16,107 | 25,808 | 24,945 | +Federal Reserve notes, | | | | | | +net assets | 7,765 | 9,124 | 11,029 | 12,491 | 14,866 | +Due from other Federal | | | | | | +Reserve Banks, net | 7,435 | 8,311 | 7,078 | 6,990 | 7,409 | +All other resources | 5,426 | 5,501 | 5,904 | 4,962 | 3,577 | + +---------+---------+---------+---------+---------+ +Total resources | 360,247 | 381,456 | 377,052 | 389,983 | 417,700 | +---------------------------+---------+---------+---------+---------+---------+ +LIABILITIES. +---------------------------+---------+---------+---------+---------+---------+ + | May | June | July | Aug. | Sept. | + | 28. | 25. | 30. | 27. | 24. | + | | | | | | +---------------------------+---------+---------+---------+---------+---------+ +Capital paid in | 54,158 | 54,200 | 54,181 | 54,689 | 54,748 | +Government deposits | | | | | 15,000 | +Reserve deposits, net | 292,050 | 311,349 | 306,183 | 316,989 | 329,941 | +Federal Reserve notes, | | | | | | +net liability | 10,921 | 12,617 | 14,965 | 16,738 | 15,348 | +All other liabilities | 3,118 | 3,290 | 1,723 | 1,567 | 2,663 | +---------------------------+---------+---------+---------+---------+---------+ +Total liabilities | 360,247 | 381,456 | 377,052 | 389,983 | 417,700 | +---------------------------+---------+---------+---------+---------+---------+ + + +RESOURCES. (continued) +[In thousands of dollars.] +----------------------------+---------+---------+--------- + | Oct. | Nov. | Dec. + | 29. | 26. | 30. + | | | +----------------------------+---------+---------+--------- +Gold coins and certificates | | | +in vault | 218,224 | 245,986 | 266,546 +Gold settlement fund | 61,960 | 73,830 | 77,293 +Gold redemption fund | 1,222 | 1,252 | 1,124 + +---------+---------+--------- + Total gold reserve | 281,406 | 321,068 | 344,963 +Legal tender notes, silver, | | | +etc. | 37,058 | 37,212 | 13,525 + +---------+---------+--------- + Total reserve | 318,464 | 358,280 | 358,488 +Commercial paper | 30,448 | 32,794 | 32,368 +Bankers' acceptances | 13,619 | 16,179 | 23,013 +United States Bonds | 10,505 | 12,919 | 15,797 +Municipal warrants | 25,014 | 27,308 | 12,220 +Federal Reserve notes, | | | +net assets | 19,723 | 19,176 | 21,910 +Due from other Federal | | | +Reserve Banks, net | 8,533 | 14,053 | 20,767 +All other resources | 3,645 | 4,633 | 6,547 + |---------+---------+--------- +Total resources | 429,951 | 485,342 | 491,110 +----------------------------+---------+---------+--------- +LIABILITIES. +----------------------------+---------+---------+--------- + | Oct. | Nov. | Dec. + | 29. | 26. | 30. + | | | +----------------------------+---------|---------+--------- +Capital paid in | 54,838 | 54,846 | 54,915 +Government deposits | 15,000 | 15,000 | 15,000 +Reserve deposits, net | 343,554 | 397,952 | 400,012 +Federal Reserve notes, | | | +net liability | 13,918 | 13,385 | 13,486 +All other liabilities | 2,641 | 4,159 | 7,697 +----------------------------+---------+---------+--------- +Total liabilities | 429,951 | 485,342 | 491,110 +----------------------------+---------+---------+--------- + +FOOTNOTES: + +[287] O. M. W. Sprague, _The Federal Reserve Act of 1913_, _The +Quarterly Journal of Economics_, Vol. 28, No. 2, February, 1914, pp. +213-254. + +[288] [The country has been divided into twelve districts in each of +which a Federal Reserve Bank began operations November 16, 1914.] + +[289] After the Reserve Banks have been in operation long enough to be +running smoothly, not a few branches will doubtless be organized. +Branches are to have boards of directors, three of the members of which +are to be chosen by the Federal Reserve Board, and four by the directors +of the parent Reserve Bank. Branches are to be operated under rules and +regulations approved by the Federal Reserve Board. + +[290] State banks and trust companies are eligible for membership, if +they have a sufficient capital to entitle them to become national banks +in the places where they are situated. On becoming member banks, they +must comply with the provisions of the national banking law regarding +reserves, examinations (the state examinations may be accepted), and +various other general provisions of the national banking law. + +[291] In case subscriptions by the banks of a district are inadequate, +stock is to be offered to the general public; and if the response of the +public is inadequate, the stock is to be taken by the Government of the +United States. Neither privately owned nor government stock is entitled +to voting power. [In no district were subscriptions by the banks +"inadequate."] + +[292] The inability of the Pujo money trust committee to secure desired +information from the banks evidently occasioned the following clause: +"No bank shall be subject to any visitatorial powers other than such as +are authorized by law, or vested in the courts of justice, or such as +shall be or shall have been exercised or directed by Congress, or by +either House thereof, or by any committee of Congress of either House +duly authorized." + +[293] [Several of the more important regulations of the Federal Reserve +Board are contained in Appendix B.] + +[294] The law regarding the examination of national banks is recast. The +only important changes are that hereafter all examiners are to be paid +salaries, and that the Federal Reserve Banks are empowered to conduct +special examinations of member banks. + +[295] Adapted from Joseph French Johnson, _Fundamental Weakness of the +Glass-Owen Bill_, an address delivered before the Economic Club of New +York City, Monday evening, November 10, 1913. + +[296] Although the address in part here reproduced was delivered as a +criticism of the Glass-Owen Bill, one of the measures that led up to +the passage of the Federal Reserve Act, that criticism, as a result +of a few slight changes made, applies with almost equal force to +the Federal Reserve Act itself. The preceding article by Professor +Sprague answers with striking directness Professor Johnson's trenchant +argument.--EDITOR. + +[297] [It is commonly held that ample controlling power has been +conferred upon the Federal Reserve Board by the act as finally passed. +It is of interest that Senator Owen listened to the address of which an +adaptation is here given.] + +[298] John Skelton Williams, Comptroller of the Currency, "Democracy in +Banking," an address delivered before the annual convention of the North +Carolina Bankers' Association in the House of Representatives at the +capitol at Raleigh, May 13, 1914. Printed in _Congressional Record_, 63d +Congress, 2d Session, Vol. 51, pp. 10150-53. + +[299] F. M. Taylor, _The Elasticity of Note Issue under the New Currency +Law_. _The Journal of Political Economy_, Vol. 22, No. 5, May, 1914, pp. +453-463. + +[300] _Second Annual Report of the Federal Reserve Board_, p. 16. 1916. + +[301] _First Annual Report of the Federal Reserve Bank of New York_, pp. +19, 20. 1916. + +[302] Thomas Conway, Jr., _The Financial Policy of the Federal Reserve +Banks_, _The Journal of Political Economy_, Vol. 22, No. 4, April, 1914, +pp. 319-331. + +[303] _First Annual Report of the Federal Reserve Bank of New York_, pp. +34-36. 1916. + +[304] Second Annual Report of the Federal Reserve Board, pp. 313, 314. +1916. + +[305] _Ibid._, pp. 134-6. + +[306] _Ibid._, pp. 23-25. + +[307] [For regulations issued by the Federal Reserve Board see Appendix +B.] + +[308] _Second Annual Report of the Federal Reserve Board_, pp. 134. 135, +1916. + +[309] _Ibid._, pp. 14-17. + +[310] _Ibid._, p. 18. + +[311] _Ibid._, pp. 21, 22. + +[312] _Ibid._, pp. 45, 46. + + + + +CHAPTER XXXII + +THE EARLY EVENTS OF THE EUROPEAN WAR IN RELATION TO MONEY BANKING AND +FINANCE + + +AMERICAN FINANCE AND THE EUROPEAN WAR + +[313]During the half-century that has elapsed since the Civil War, there +has probably been no period of six months within which there have +occurred transformations of so far-reaching a nature in American banking +and finance as during the half-year between July 1, 1914, and January 1, +1915. It will be long before the full meaning and significance of these +events are thoroughly understood; for what has been done cannot be +finally interpreted until facts which have not yet been ascertained have +developed their consequences. On the other hand, it would be impossible +to forecast the ultimate effect of the European war should any one of +certain tendencies which are still at least possible be fully carried +out. What has already taken place, however, comprises a range of events +full of important lessons and significant for the light they throw upon +the methods to be employed in the near future in the management of +industrial and commercial enterprises. This experience has been +particularly rich in its bearing upon the relationship between banking +and finance in the strict sense of the terms on the one hand, and the +future of commerce and industry in general on the other. Though it be +true that only hasty thinkers will endeavor to draw final conclusions +from what has thus far occurred, it is, nevertheless, also true that +much can be learned from the mere marshaling of recent events in their +relation one to another. + + +I + +Upon the outbreak of the European war, it was at once evident to all +that very striking changes would result in every department of business +life. There was, of course, at the outset no knowledge of the strategy +or probable methods to be employed by any of the belligerents, and the +general attitude of the business community was based upon the assumption +that commerce would, for a time at least, become nearly impossible. As a +corollary to that assumption, there prevailed the belief in many circles +that American indebtedness to foreign countries would have to be +liquidated in cash, and that this process would result in draining away +from the United States a corresponding amount of gold. It was natural, +therefore, that the first phenomenon of the war should be the suspension +of dealings which it was believed would promote this gold movement, or +would cause more serious trouble in any direction than would otherwise +be inevitable. The closing of the principal stock exchanges of the +country almost immediately upon the definite announcement that war was +unavoidable was thus dictated by two considerations: (1) the belief that +prices for stocks and other securities would be reduced to a point so +low as to bring about the repurchase of the securities by Americans, who +would then be obliged to pay for them in gold; (2) the belief that, in +consequence of this reduction of prices, many bank loans based upon +securities would have to be "called," thereby bringing about failures +and incidentally assisting in the movement of specie out of the country. + +In the case of the cotton exchanges, it was at once perceived that the +cotton crop, which is so largely produced for export, could not now move +abroad with any degree of facility, and that the demand for cotton would +undoubtedly be slack. The very fact of the war, therefore, implied heavy +reductions in the price of cotton, and the closing of the cotton +exchanges was a measure of self-preservation on the part of the +operators, who decided to protect themselves against the inevitable +failures which would result from the fulfilment of existing contracts at +very low prices. To close the exchanges would result in gaining time, +and would, therefore, enable operators to meet their maturing +obligations, besides perhaps affording an opportunity for actual +recovery in cotton prices. This very fact, however, of the closing of +the exchanges and the consequent removal of any other established method +of determining prices for standard securities and for a staple like +cotton involved most profound and far-reaching effects. The exchanges +had closed in previous years, but never for the reasons which now +controlled them. That they should close because of the fear of failure +and the loss of gold implied a serious danger of disaster which appealed +powerfully to the public mind, and which presented a problem that could +not be explained away. The fact that, coincident with this closing of +the exchanges, international trade was practically suspended for several +days, and was seriously interrupted for several weeks, until British +vessels assumed virtual control of the North Atlantic, tended greatly to +increase the public anxiety. It formed, apparently, good ground for the +suspension of business operations and for the non-fulfilment of +contracts, even when the very difficult conditions did not themselves +compel a recourse to such methods. The fact that foreign countries had +adopted legislation deferring the date when debts need be paid or +contracts fulfilled, although not paralleled here, produced a +sympathetic influence upon business in the United States, which +practically resulted in the partial or tentative adoption of a somewhat +similar relaxation of commercial requirements in many industries and +branches of trade. + +It is notable that the Produce Exchange of New York and the other grain +exchanges of the country continued in operation and did an enormous +business in spite of the prevailing conditions. This was due to the fact +that grain of all kinds, provisions, and every sort of food-stuff were, +for the time being, subject to a very rapid upward movement. It was +early perceived that a long continuance of the war would bring about a +steady advance in the prices of all food products, the markets for which +are not dependent upon temporary fluctuations for support, but are +subject to far-reaching and semi-permanent influences. The fact that +these exchanges continued open while those whose staples were subject to +decline closed so speedily, naturally produced its own effect upon the +public mind. Many who had thought the exchanges invariably faithful +registers of price fluctuations were now reluctantly obliged to confess +that this could not be the case, since those exchanges where prices were +rising continued to operate without interruption, while those where +prices were falling were obliged to suspend business. From one point of +view, undoubtedly, the closing of the stock and cotton exchanges tended +still further to deepen the attitude of dissatisfaction with these +institutions that had been prevalent for some years among the American +public. On the other hand, however, as time went on, it became clear +that the exchanges of the country and the service they performed when in +operation were being appreciated as never before by the conservative +popular mind of the nation. With the exchanges closed it was seen that +the lack of a regular and established market subject to natural +conditions meant suffering and inability to secure the advantage of free +competition in the establishment of the price of products. This view was +once more emphasized when, later on, the cotton exchanges reopened; for +it was then seen that the effect of trading upon the exchanges was to +advance the price of the staple rather than to lower it, a view the +precise reverse of that which had been originally prevalent for a long +time past. Both in the psychological, as well as in the actual, effect +of these closings, and in the influence the episode exerted upon public +opinion, the suspension of the exchanges throughout the United States +must be regarded as a fact of first-rate importance in the financial +history of the United States during the European war. + + +II + +Even without the suspension of certain classes of trading throughout the +country, partially due as it was to the frenzied demand of European +holders of American investments for money, the strain thrown upon our +banks as a result of the great change in conditions would have been +enormous. The closing of the exchanges, as already seen, had relieved +matters to some extent by enabling the banks to avoid the calling of +loans, and thereby to avoid the necessity of forcing customers into +liquidation, with the resultant disastrous effect upon themselves. But +on the other hand, the suspension of operations and the corresponding +loss by the public would, it was felt, tend to the hoarding of +legal-tender money. In order to meet this situation, the banks in many +of the large financial centres sought to limit specie payments, taking +out emergency currency and clearing-house certificates for the purpose +of meeting their indebtedness to the public and to one another.... A +phase of this phenomenon was seen in the tremendous rise in foreign +exchange rates, the rates becoming practically prohibitive and thereby +causing what amounted to a suspension of financial relationship between +the United States and foreign countries, particularly Great Britain. + + +III + +It was early understood that the real difficulty and danger in the +international situation did not lie in the superficial symptoms of +trouble, but were found much deeper, being directly due to the fact that +international business had been practically suspended as the result of +the war. This was a factor of prime and material importance in the whole +situation, because the maintenance of established relations between the +United States and foreign countries was directly dependent upon the +regular exportation of goods. As was customary during the summer months, +there had been large expenditures by American tourists in Europe; and we +had become indebted to other countries, particularly Great Britain, for +material sums in excess of what we were currently able to liquidate. +This was on the assumption, as usual, that such indebtedness would be +liquidated through the shipment of agricultural products, particularly +of cotton, the country's principal cash crop. The breakdown of trade +with Europe through the inability of vessels to run regularly at the +outset of the war, and through the reduction of buying power, due to the +interruption of all regular industrial, commercial, and financial +operations, meant that in the absence of some restoration of the normal +course of business it would be necessary to find other means of +liquidating our obligations to foreign countries. The first phase of the +difficulty was met by investigating the extent of international +indebtedness, which, in the absence of other means of payment, would +necessitate the draining-away of gold from the United States. Such an +investigation was undertaken by the Federal Reserve Board, which, by +sending out questions to the principal international bankers of the +country, succeeded in forming a more or less trustworthy estimate of +the indebtedness on current accounts, these being, of course, of varying +maturities extending over several months. The problem thus raised was +how to provide for liquidating the debts without losing so much of the +underlying gold supply as to impair the convertibility of American +securities, and therewith general confidence in American ability to meet +obligations. The two chief proposals put forward for bridging over the +period of difficulty were the establishment of a joint gold fund by the +bankers of the country, and the undertaking of negotiations with Great +Britain whereby some relaxation of foreign demands on the United States +might be arranged for. These two phases of policy may best be cursorily +sketched at this point. + +Since the new banks had not yet been established and could not be put +into operation for some weeks, it was deemed desirable to furnish a +makeshift substitute for the co-operative effort which would have been +available for the relief of the situation had the banks been in +existence. It was therefore determined to suggest to a number of +representative bankers the establishment of a joint gold fund to be used +in providing exchange on Great Britain, and to have this joint fund +developed at the earliest possible moment. A letter was consequently +sent out to the presidents of clearing-house associations throughout the +country, under date of September 21, in which request was made for +subscriptions to a fund intended to aggregate about one hundred million +dollars. This letter had previously been considered and approved at +meetings of representative bankers summoned to meet in Washington on +September 4 and 19 respectively, and was, therefore, issued with their +moral support. The answer to this invitation was prompt and effective, a +total of over one hundred and eight million dollars being subscribed and +rendered available. + +It was almost immediately evident that the operation of this fund was +proving decidedly beneficial notwithstanding that only a comparatively +small percentage of the amount subscribed was asked for, and that a +still smaller percentage was actually used to furnish a basis for gold +shipments. Nevertheless, it seemed, during the ten days immediately +following the completion of the subscriptions, as if there might be +need for still further relief to the situation. Some of those who were +closely connected with the administration of the gold exchange fund +brought the subject to the attention of the Secretary of the Treasury +and he extended an invitation to the British Government to send +representatives to this country mainly for the purpose of considering +the possibility of further adjustment, in the event that the United +States did not succeed in liquidating its indebtedness to Great Britain +by the natural movement of commodities within a reasonably early period. +The British Government designated Sir George Paish and Mr. B. P. +Blackett, who came to the United States and on October 23 held a +conference with the Federal Reserve Board. Subsequently another +conference, attended by a number of representative bankers, was also +held and the situation was discussed in very great detail. Meantime the +establishment of a better understanding with reference to commodities to +be considered as contraband and the more effective policing of the North +Atlantic rendered possible the restoration of trade with European +nations, and the development of the export trade proceeded with a speed +which showed that current obligations of the United States to Great +Britain and other countries would be liquidated at an early date without +any necessity for further interference. By the time the reserve banks +were ready to open [November 16], exchange sales on London had fallen to +normal, and there was, therefore, no danger that when opened the reserve +banks might, as was for a time feared by some, find their gold rapidly +drawn away from them in order to meet the requirements of the gold +export movement. + +In another way it was deemed desirable that the Federal Reserve Board +should help to facilitate the restoration of customary conditions in the +financial market. Almost immediately after the outbreak of war it was +seen that, unless hostilities should terminate within a very much +shorter period than anyone thought likely, serious injury would be +inflicted upon the cotton-producing states. As is well known, the cotton +crop is largely grown for export, about two-thirds of the total +production of the United States being annually sold abroad. It happened +that an unusually large crop had been planted and was approaching +maturity at the moment of the outbreak of the war. This would in any +event have depressed prices of cotton, even under ordinary conditions. +The almost immediate closing of the cotton exchanges of the country was, +however, precipitated by reason of the interruption to the movement of +cotton and the general understanding that, in view of the great area +involved in the hostilities, it would not be reasonable to expect a +normal demand for the staple to manifest itself. With the exchanges +closed, and with shipments of cotton interrupted, the price was unstable +and abnormally low, many sales undoubtedly having occurred at five cents +per pound. Inasmuch as the cotton crop is raised very largely upon +credit, it was necessary to provide some means whereby the Southern +planter could be assisted to such extension of accommodation as he might +require in meeting the obligations he would ordinarily have provided for +by the sale of his crop in the open market. Various suggestions were +brought to the attention of the Federal Reserve Board, one of them being +that of Mr. Festus J. Wade of St. Louis, who suggested, both to the +Board and to the Secretary of the Treasury, the establishment of a +cotton loan fund somewhat similar in purpose and management to the gold +exchange fund. After very anxious consideration, the conclusion was +reached that some measure of the sort would probably furnish relief to +cotton-growers. Various conferences were held with banking interests for +the purpose of securing their co-operation and advice in regard to the +matter. Ultimately the bankers of New York pledged fifty million dollars +in subscriptions to the fund, provided that fifty millions more should +be raised from other bankers in non-cotton-producing states. It was +understood that to the one hundred million dollars thus raised should be +added thirty-five million dollars contributed by the bankers of the +cotton-producing states under a special plan devised for that +purpose.[314] + + +IV + +It was not, however, through any of these artificial means that real +relief was brought to the community. While bankers were laboring to +perfect the gold fund, and while the negotiations with Great Britain +were in progress, foreign trade was being re-established through the +effective policing of the North Atlantic, the re-establishment of +demands, and the resumption of the ordinary course of business. What +took place during the months of August and September can be understood +from ... comparative figures for importation and exportation which make +an impressive showing of the suffering to which the United States was +subjected through this decline in business. With the opening of October +there came, however, a decided improvement. Time had now been given for +the establishment of normal conditions.... + + +V + +With foreign trade in a fair way to recover, it was still necessary to +secure a restoration of normal trade conditions within the United +States, and for this purpose the thing most fundamentally necessary was +the setting in motion of the federal reserve banking system which had +been provided for by act of Congress the 23d of December preceding. The +time intervening between December 23, 1913, and the opening of the war +had been occupied in carrying out the preliminaries of organization; but +it still remained for the Federal Reserve Board, the controlling +mechanism of the new system, to appoint officers and to provide for the +active operation of the banks under its direction. The first detail to +which the Board necessarily addressed itself was the completion of the +boards of directors of the several institutions, it being necessary to +select and elect three in each institution, or thirty-six in all. The +task required an elaborate process of comparison of the names and +qualifications of the several candidates and was not completed until +early in October. With the announcement of the thirty-six directors, it +was possible to proceed to the active opening of the institutions. The +Board called for the first payment of capital stock on November 2, and +the Secretary of the Treasury, who by law had been vested with that +function, named November 16 as the actual date for opening.... + +The establishment of the system ... greatly relieved the banking +situation.... Sec. 19 of the Federal Reserve Act provided for a +readjustment of reserves upon a new and lower basis.... + +This readjustment, by the terms of the law, took effect immediately upon +the establishment of the new banks, _i. e._, on November 16. From the +outbreak of hostilities in Europe, there had been a difficult reserve +situation in most of the financial centers, New York banks particularly +being much of the time largely under their reserve requirements because +of the heavy drafts made upon them by interior banks and by the public. +The change in reserve requirements, however, made a very material +alteration in this condition of affairs, and released, not only in New +York, but throughout the country, a very considerable amount of funds +which had previously been held by the banks in order to bring themselves +within the requirements of law. Precisely what amount of reserves was +thus released throughout the country has not been accurately estimated, +and probably cannot be. It is, however, an undoubted fact that the +release of actual cash was very large, and that the release of lending +power as computed on the basis of reserves on the part of member banks +was correspondingly larger. Member banks were thereby enabled to extend +loans to their customers very much more freely than they had previously +been able to do, while at the same time they were able to grant lower +rates of interest in due proportion. The prevailing rate of discount for +prime commercial paper in New York at the beginning of November was +about 6 per cent., while other paper was considerably higher than that +figure, and even more difficult conditions prevailed elsewhere. The +opening of the reserve system enabled New York banks, because of the +very great relief given to them through the release of reserves, to +reduce this rate largely, and within two weeks after the new banks had +come into existence prevailing interest rates for the best paper went as +low as 3-1/2 per cent. and 4 per cent. while acceptances, which had been +provided for by the Federal Reserve Act, were marketed at a still lower +rate. In some parts of the South, Northern bankers were able to grant +accommodation as low as 4 per cent. and in considerable amounts. In view +of the greater ease and material relief which was thus accorded, the +federal reserve banks were naturally not called upon to assist member +banks with accommodation, such banks naturally refraining from asking +aid when they themselves were fully able to meet the situation. + +The opening of the reserve banks released, as already shown, a large +amount of bank funds, and thereby rendered it possible to extend many +loans which otherwise could not have been carried by the banks. It was +also seen, soon after November 16, that the existence of the cotton +fund, as was the case with the gold fund, had done its work by +stimulating confidence and by leading to a more liberal extension of +credit. With the cotton fund available for long-time loans, and with +short-term credit much more freely extended by member banks in view of +the reduction of national bank reserve requirements, it was possible for +the reserve banks to open with full confidence that the work thus done +in safeguarding the situation would relieve them from undue strain, +while fully protecting the cotton-producers who were willing to pay a +moderate rate of interest in order to carry their cotton until such time +as would enable them to realize full market value for it. + +As has been shown by the Secretary of the Treasury in his annual +report,[315] an early phenomenon of the war was the issue by +clearing-houses in many cities of clearing-house certificates. +Simultaneously therewith large quantities of emergency currency were +issued under the provisions of the act of 1908, which had been amended +and extended by the Federal Reserve Act, and which were still further +amended by Congress on August 4, so as to permit the freer issue of +notes.... The total amount of the emergency currency taken out by +associations had aggregated about three hundred and eighty million +dollars, but it is probable that the clearing-house certificates were +issued to a considerably larger sum. The channels of circulation were +thus clogged long before the end of the summer, notwithstanding the fact +that large quantities of gold and gold certificates were withdrawn and +hoarded either by banks or by individuals. This condition of affairs +made it certain that the reserve banks, upon their organization, would +not be instantly pressed for the issue of reserve notes. Two factors +combined to produce this result--the circumstance that many banks had +placed their best paper with the national currency associations in order +to protect emergency currency, and the further circumstance that the tax +on this currency at the lower rate established by Congress would not, +for some considerable time, be likely to approximate the rate of +discount which every bank would have to pay to federal reserve banks in +order to get the rediscounts that would enable them to obtain the notes +they needed. Combined with these factors was, of course, the natural +inertia which in all such cases tends to prevent the withdrawal of one +kind of currency and the issue of another. Upon the organization of the +federal reserve banks, moreover, the urgent pressure for note +accommodation passed away as quickly as it had come. Gold reappeared in +circulation at an early date, and the retirement both of the +clearing-house certificates and of the emergency currency was +undertaken. In those cities where rates of interest on clearing-house +certificates were very high, the reserve banks aided in the retirement +of the certificates remaining in circulation. + +The emergency currency itself immediately began to be retired by its +issuers.... Had the reserve banks been in operation at the beginning of +August, they would naturally have supplied the great volume of currency +which was called for; but not having done so, a field of business which +would naturally be theirs has been temporarily taken from them by reason +of the fact that it was occupied by the clearing-house certificates and +emergency notes.[316] + + +VI + +The result of the restoration of trade, banking, and credit to earlier +and more normal conditions has been steadily apparent. Cotton exchanges +reopened on November 16, and stock exchanges opened for restricted +trading shortly thereafter. In brief, by the close of the year, the +phenomenal conditions growing directly out of the European war had been +met and overcome. It is a notable fact that under the wholly unusual +circumstances prevailing, the recovery was so prompt and effective. What +share in this early improvement is to be assigned to the organization of +the new banking system and to the effectiveness with which the Treasury +Department co-operated in meeting the needs of the country cannot +accurately be stated, and will probably afford grounds for difference of +opinion. That it was great cannot be denied.... + + +NATIONAL BANK FAILURES AND SUSPENSIONS--1914 COMPARED WITH 1893 AND +1907[317] + +A comparison of the failures and suspensions of national banks during +the past year with failures and suspensions in the panic periods of 1893 +and 1907 may be interesting at this time. + +The figures show that for the 12 months ended October 31, 1914, 26 +national banks, with aggregate capital stock of $2,510,000, failed or +suspended payment. The total liabilities of these banks (in the case of +receiverships claims proved) amounted to $14,177,408. In the case of six +recent failures, the figures of total liabilities, less capital, +surplus, and undivided profits, are used in lieu of the "claims proved," +no report of the latter having yet been received as to these six banks. + +For the 12 months ending October 31, 1893, 158 national banks suspended, +with capital of $30,350,000. Sixty-five banks, with total capital stock +of $10,935,000, were insolvent and required the appointment of +receivers; 86, with capital stock aggregating $18,205,000, were able to +resume business; and 7, with capital stock of $1,210,000, were placed in +charge of examiners in the expectation of resumption. The total +liabilities of failed and suspended banks for the period mentioned was +$83,042,347--in the case of failed banks, "claims proved" being +considered as "total liabilities." + +During the six-months period from October 1, 1907, to April 1, 1908, +there were 22 national bank failures and suspensions, and the total +liabilities (in the case of receiverships these being "claims proved") +were $32,443,978; the total capital stock, $6,540,000. Of these banks, +however, 7, with capital stock of $1,440,000 and liabilities of +$22,124,662, resumed business. + +It is worthy of special note that in the crisis of 1914, unlike the +panics of 1893 and 1907, there was no suspension of currency payments on +the part of the banks of this country, either in the large cities or in +the smaller towns. In the panics of 1893 and 1907, in addition to +clearing-house checks, many artificial methods of supplying a temporary +currency were resorted to, while actual currency commanded a premium of +from 3 per cent. to 5 per cent.--$100 in currency costing anywhere from +$103 to $105, or more, in certified bank checks. + +In 1914 the banks of the country were enabled, as a result of the +instant and active co-operation of the Treasury Department, and through +the operations of the act of May 30, 1908, as amended by the Federal +Reserve Act, to supply actual currency, even during the period of +greatest stringency, to their customers and correspondents, both over +the counter and in response to requests for shipments. Whenever any +indications were seen of an attempt or disposition on the part of any +solvent bank or banks to withhold or suspend cash payments, the subject +was taken up immediately by the Treasury Department, and payments of +currency over the counter and shipments by the banks upon demand, from +the centers to the nearby and far-off districts, and vice versa, have +been maintained practically without interruption throughout this crisis. + + +THE EFFECTS OF THE WAR WITH SPECIAL REFERENCE TO THE CENTRAL BANKS OF +FRANCE, GERMANY, AND ENGLAND + + +I + +[318]In France the gold held by the Bank of France (February, 1916) is, +in actual quantity, larger by about 25 per cent. than that held in +normal times before the war. Instead of former gold reserves of about +$800,000,000, they are now well over $1,000,000,000. The percentage of +gold to the notes--the main demand liability--has, of course, fallen +from about 65 to 35 per cent. because of the increase of notes from +about $1,200,000,000 to $2,800,000,000. + +This increased supply of gold has come from hoardings and private +holdings which have been placed at the disposal of the bank in return +for bank-notes. There has been no reduction of this gold fund through +demands from note-holders, since the bank was freed from redemption in +gold at the very beginning of the war. That is, notes of the Bank of +France are inconvertible. As contrasted with the dollar of the United +States, when expressed in bills of exchange between New York and Paris, +the Bank of France note has depreciated nearly 14 per cent. Any paper +money not having immediate redemption will depreciate. As regards the +future it is a question of ultimate redemption. + +With so large an available gold supply, there can be little question as +to the future intention or probability of redeeming the notes in gold. +It looks very much as if the same policy adopted in the war of 1871-3 +had been consciously followed. Then, also, the _cours forcee_ was +declared, and the gold carefully retained in the vaults of the bank. The +presence of a large gold fund was an assurance of the ability to return +to specie payments after the close of the war. The war was short, and +the notes were not seriously depreciated, bearing a discount as compared +with gold of 1-1/2 to 4 per cent. In the present war, the same steps +have been taken; but this war is extending over a much longer time than +the former one, and the depreciation has already become much greater. + +It is equally clear, however, that if the gold were now to be paid out +for redemption uses, it would become scattered, exported, and might even +pass through Holland or Switzerland into Germany. The increase and +preservation of this large fund of gold is the strongest evidence of the +ability of the bank to resume the gold redemption of its notes soon +after the close of the war. The actual time, however will depend upon +the rapidity with which the Government can repay some of its large loans +from the bank, since the excessive note issues have been largely due to +loans to the State. + + +II + +In Germany, likewise, every effort has been made to accumulate gold, +even though the notes of the Reichsbank were made inconvertible at the +beginning of the war. Not only was the requirement to redeem the notes +in coin removed, but the regulations regarding a tax upon all notes +uncovered by a specie beyond a specified _Kontingent_ were suspended. +Thus, restrictions on the limit of note issues do not exist; and they +have risen from about $500,000,000 before the war to about +$1,500,000,000 (February, 1916), while the stock of coin and bullion has +changed from about $300,000,000 to over $600,000,000. That is, the coin, +which is mostly gold, is about 40 per cent. of the notes. Here, again +there is an obvious tendency to increase and maintain the gold reserves +so that Germany may have the means of resuming gold payments at no great +time after the close of the war. + +The campaign to collect gold from the public and from hoards was +remarkable. It was successfully made a test of patriotism to hand in +gold in return for Reichsbank notes, and a house-to-house canvass in +many places resulted in providing the gold which so signally increased +the reserves behind the notes. Of course, the usual international +operations for obtaining gold were denied to Germany. It was this +campaign which was imitated by France. At the present time, certainly, +no thought has ever occurred to Germans that they would not go back to a +gold basis. + +Nevertheless, Germany has clearly fallen into the same confusion of mind +which characterized our own policy in regard to the issue of greenbacks +in the Civil War. We confused the monetary with the fiscal functions of +the Treasury. So has Germany. Thinking the war would be short and +decisive, to be followed by large indemnities levied on her enemies, she +had expected to finance her expenditure by temporary expedients. That +is, the Government was led into the policy of borrowing through the +increase of monetary forms. + +It does not change the principle that this increase of paper money was +not made solely by Imperial Treasury notes, but by a very large addition +to the circulation in the form of Reichsbank notes and _Darlehnskassen_ +notes. It was the loans by the Reichsbank to the Government which +undoubtedly caused the main increase in the notes of this bank (just as +was true of the Bank of France), and the reduction of these issues, and +their redemption in gold, will depend directly on the power and +readiness of the Government to pay off its obligations to the Reichsbank +after the war. + +The amount of borrowing by processes which led to an increase of the +circulation was necessarily limited; and very soon borrowing through +issues of paper money had to be followed by regular fiscal operations in +the form of long- or short-term bonds which would not affect the +quantity of the circulation. Expenses could not well be met to any +extent by current taxation, because taxes were already high, and in the +few years before the war, no doubt in anticipation of it, some four or +five hundred million dollars in taxes over and above normal taxation had +already been levied. In 1913 a non-recurring tax of $250,000,000 had +been imposed on the wealthier classes. + +In addition a bonded debt, since the war, has been floated to the amount +of $10,000,000,000 over and above the existing public debt before the +war of about $1,200,000,000. But all these fiscal operations should be, +for our present purposes, separated from monetary operations. The +carrying of these heavy government debts is a question of the future +production of goods, of commerce, and of saving. + +Whatever the burden of debts, the gold question is concerned with the +mechanism of exchange by which taxes, subscriptions to loans, payments +by the Government for munitions and supplies, current purchases of goods +by the public, payments to and by banks, are made. At present this +medium is paper money depreciated, as in the case of the Reichsbank +notes, by nearly 30 per cent. Of course, the Darlehnskassen issues would +follow the value set by the notes of the Reichsbank. + +It is interesting to mention that the increase of paper money has not +been in answer to any need of the public for additional media of +exchange; for ordinary business transactions have decreased, and would +require a less quantity of money. It was an error not to separate +borrowing entirely from monetary issues. + +Moreover, as bearing on the maintenance of the gold standard after the +war, it is worth noting that the rule requiring the Reichsbank to keep +one-third of its note issues covered by gold has not been violated. At +last reports (February, 1916) the gold item stood at $613,750,000, as +against $1,612,500,000 notes, or about 38.1 per cent. That is, the +greatest efforts have been made to concentrate the gold holdings of the +nation, including the "war chest" of about $30,000,000, in the reserves +of the Reichsbank. + +At the same time no gold is paid out in redemption of notes, nor is it +allowed to be exported. Some sums have been sent to Holland in a vain +attempt to support German exchange in that country; but the difficulty +in exchange rates lies deeper than the relative supply of and demand for +bills, since the depreciation of German paper money determines the +general level about which the fluctuations of exchange due to demand and +supply range. In fact, wherever gold is not freely moved in +international exchange there are no shipping points, and hence no limits +to which exchange can fall short of the discount of the paper in terms +of gold. + + +III + +As regards Great Britain, the gold standard is yet preserved for all +practical purposes. To her credit be it said that she has not fallen +into the error of borrowing by excessive issues of paper money; so far +she has not confused the fiscal with the monetary functions of the +Treasury. She resorted at once to fiscal operations in the form of heavy +taxation and loans in the form of short-time Treasury bills and +longer-term bonds. The issue of government paper money is, indeed, a new +departure; but its purpose has been more distinctly monetary than +fiscal. + +The currency notes are emergency notes, issued under the act of August +6, 1914, directly by the Treasury, and not by the Bank of England, +although authorized by the same act which suspended the Bank Act in +regard to additional issues of bank notes not covered by gold. In other +crises the act of 1844 has been suspended to allow more notes based on +consols than permitted by the act (_i. e._, above the £18,750,000). In +August, 1914, such a suspension was in the future made legal, if +authorized by the Treasury, thus avoiding the old resort to a bill of +indemnity by Parliament. + +But in spite of the usual suspension of the Bank Act, no use was made of +it. That is, a demand for more currency in the hands of the public could +have been supplied by the bank, but was not. In truth, the Lloyd George +currency notes need not have been issued. Nevertheless, when once +issued, they made unnecessary any resort to additional Bank of England +notes. There was no need of both. But in one respect the currency notes +helped to maintain the country's gold standard. By issuing them in small +denominations of one pound, and ten shillings, they replaced the gold in +general use for these denominations, and allowed it to be used as +reserves. Yet, it must be remembered that sound policy required a gold +reserve (which has been generally kept at about 40 per cent.) behind +these currency notes, so that the whole amount of gold replaced was not, +in fact, a gain. + +As all know, the question of gold for Great Britain pivots on the +reserves of the Bank of England, which is the agent for the Government, +receiving its taxes and paying out its expenses, as well as the holder +of reserves for other banks--being thus a bankers' bank, as well as a +national agent. Moreover, the reserves mentioned, and which are of prime +importance, are those of the banking department--and these are chiefly +Bank of England notes (not gold). The percentage of reserves to +deposits, which marks the safety line for England, refers to the items +in the banking department. These notes, however, are protected (except +the bottom layer of £18,750,000 covered by consols), pound for pound, by +gold in the issue department. Hence, they can be turned into gold at any +moment. + +Then, to what do these facts lead us? Simply that gold has increased +just in proportion to the issue of bank notes. In addition, the currency +notes of the Government served in the place _pro tanto_ of the Bank of +England notes. Hence, at the end of the war, the provision for +redemption of Bank of England notes will work automatically. Nor can +there be any question as to the gold being there to redeem them; for +they cannot get out without a previous deposit of gold. Indeed, the +questions of difficulty cannot arise regarding the basic currency of +Great Britain; they will arise, if at all, in connection with the assets +in the loan item of the banking department, since they will determine +the safety of the deposits chiefly created as the result of loans. The +bank discounted large sums of pre-moratorium acceptances and paper; and +yet even in these assets it is protected by the guarantee of the +Government. + + +DARLEHNSKASSEN AND OTHER FINANCIAL NOVELTIES IN GERMANY + +[319]Germany, at the outbreak of the war, removed the limit of notes +issuable by the Reichsbank without tax; created about 1,800 +Darlehnskassen (loan banks), located throughout the Empire, wherever the +Reichsbank maintained a branch; they were started without capital, in +lieu of which they issued _Darlehnskassen Scheine_ (Imperial Loan Bank +notes) in denominations of one mark and upwards, the aggregate amount +being limited to 1,500,000,000 marks; these banks made loans against +stocks, shares, produce, any personal property of a non-perishable +character, as collateral, and issued certificates, having the quality of +bank notes, to the borrowers; the loans ran for three and sometimes six +months; the minimum loan was 100 marks; a very wide margin of safety was +required, making the loans good beyond question; these certificates were +receivable for public dues and by the Reichsbank; the smaller +denominations circulated as money, the Reichsbank received the larger, +giving its notes in exchange; these certificates were not legal tender, +but were given the quality of gold and "may be considered by the +Reichsbank as gold cover, which means that against 100 marks of these +Scheine in its vault the Reichsbank is allowed to issue 300 marks of its +own notes." (I. De Bruyn.)[320]... + +Sir Edward H. Holden, president of the London City and Midland Bank, in +a speech to his board of directors, January 29, 1915, said: + + Germany proceeded to establish War Loan Banks, War Credit + Banks and War Aid Banks under the patronage of corporations, + municipalities and private financiers, and to make use of + the Mortgage Banks already established.... + + The Mortgage Banks are under the control of Chambers of + Commerce and municipalities, and they make advances on the + mortgage of properties by an issue of notes.... + + Germany made greater use (than of the Darlehnskassen) of the + Mortgage Banks, the notes of which are identical in power + and use with the notes of the Darlehnskassen. Another part + of their scheme was to relieve the pressure on insurance + companies (life), by forming an insurance bank, which + advanced 40 per cent. on the value of policies. These + advances were paid on notes which were exchanged for + Reichsbank notes in the same way as the notes of the + Darlehnskassen and Mortgage Banks. + +Germany, with characteristic system and detail, provided different kinds +of banks to deal with different phases of the situation. War credit +banks were designed to aid Germans whose credits became unavailable, +owing to the exigencies of the war, as for instance those who had sold +and shipped goods abroad (the enemy's country), whose accounts would be +temporarily uncollectible, and those who might be otherwise embarrassed +in their foreign trade because of the interruption of business caused by +the war. War credit banks were more general in their dealings than war +loan banks. In Germany, business is largely done upon credit, and +especially so by small concerns and individuals, who possess no extended +bank credit nor available collateral, and hence are not in position to +make use of the Reichsbank or other commercial banks, or the +Darlehnskassen. + +A German banker says: "It was deemed advisable to create an institution +of an intermediary character which would bear the greater share of the +risks involved. The so-called war credit banks are designed to serve +this purpose. They were established throughout the country, have their +own capital, and the obligations undertaken by them are guaranteed, and +losses, if any, refunded by the respective municipalities and +commercial associations. The war credit bank of Greater Berlin, for +instance, was established with a capital of 18 millions of marks, of +which 25 per cent. are fully paid in. In addition thereto, there is a +liability of 11.5 million marks by official bodies of commercial +organizations." + +Still another kind of war credit bank was created on the co-operative +plan to assist the middle and lower classes. + +Through the instrumentality of these institutions, a large amount of +credit instruments, possessing a currency function, was brought into +existence in Germany.... + + +THE WAR AND THE WORLD'S FINANCIAL CENTRE + +[321]With the end of the moratorium on November 4, it may be said that +the crisis produced by the outbreak of war was over. When peace comes +and prices [of securities] adapt themselves to the new price of capital +that the present destruction of some eight to ten millions of it a day +will bring about, and creditors begin to try to collect debts from +impoverished debtors in war-wasted countries, then there will be a new +set of problems, the acuteness of which will largely depend on the +length of the war and the extent to which the fighters are worn out. +These problems will exercise all the ingenuity and strength that Lombard +Street can muster. For the present it is enough to see how we stand at +the end of the opening period of the war, and what have been the effects +of the financial tornado with which its beginning was heralded.... + +The crisis of last August was the greatest evidence of London's strength +as a financial centre that it could have desired or dreamt of. It was so +strong that it did not know how strong it was. Consequently, being a +little flustered by the suddenness of the outbreak of war, on a scale +that mankind had never seen before, it made the mistake of asking its +debtors to repay it, not the thousands of millions that it had lent in +the form of permanent investment, but the comparatively trifling +amount--perhaps 150 or 200 millions--that it had lent in the shape of +bills of exchange drawn on it, and other forms of short credits. +Thereby it put the rest of the economically civilized world, for the +time being, into the bankruptcy court, and so, finding that none of its +debtors could pay, it thought itself obliged to ask for time from its +own creditors at home. Foreign creditors it had none, except Paris. It +sent gold to Paris as fast as it could be shipped and insured, and so +seems to have liquidated its debt. For when a market in exchange +reopened after the first shock of war, the Paris cheque soon steadied +itself at a more or less normal level, above the point at which gold +could be sent to France as an exchange operation. It is possible, +however, that London was still in debt to Paris, and that Paris +preferred for obvious reasons to leave its money on this side of the +Channel. + +Of the three possible rivals to London as a financial centre, Paris was +the only one that gave any evidence of real financial strength. Behind +Paris stands the enormous power of the thrifty French investor, who +probably accumulates a greater proportion of his income than anybody in +the world, except, perhaps, some classes of Scotsmen. This accumulating +power of the French gives the Paris money market a position of +first-rate importance in the financial world, because capital has to be +saved, and a saving people has capital to lend. The advantage that +London holds in its more elastic credit system is partly balanced by the +advantage given to Paris by the thrifty habits of the French people. If +Paris adopted a more businesslike policy with regard to her huge store +of gold, which she has hitherto seemed to regard as a precious asset to +be sat on and protected by the charge of a premium to audacious people +who want to withdraw a bit of it, she might, in normal times, be a much +more dangerous rival to London than she is. But it need hardly be said +that Paris, as a financial centre, was soon wrapped in the cloud of war +and invasion, and had no chance of making any effort to oust London from +her pride of chief place. + +Berlin was equally cut off from competition, for Berlin had to devote +herself to the task of financing war for Germany. Moreover, the rapid +depreciation in the value of the mark that took place before the war +began showed that Germany was still a debtor country in the short-loan +market. The Berlin exchange, while war was as yet only a dreaded +possibility, rose from 20 m. 50 pf. to 20 m. 60 pf. Germany invests +money abroad, but she seems to borrow as much, and more, in the discount +markets of London and Paris. So it came to pass that, in spite of the +big sales of securities that she had thrown on the markets of New York +and London, she still had to pay when the big day of settlement came, +and to pay so fast that she had not a bill on London left to pay with. + +It was the chance of a century for New York. American ambition has long +ago informed the world that the United States, having been the world's +granary, is now the world's most progressive manufacturer, and means +soon to be the world's banker. This may happen some day, and might have +happened already if American policy in currency, financial and fiscal +matters had been more enlightened, and if her people had been more +thrifty. But they have tied their credit system in the bonds of narrow +banking laws and their trade in those of a cramping tariff. These bonds +they have just begun to shake off, and if the crisis had happened a few +years later they might perhaps have made a bid for London's place as +world banker. But it is hardly likely, for the development of the +enormous resources of the country still craves for much more capital +than its people can provide. The United States is still a debtor to the +world at large and seems likely to be so for some time to come, and it +is doubtful whether even New York, with all its skill in the jugglery of +finance, can make itself a great banking centre as long as its heavy +balance of indebtedness is always waiting to turn the world's exchanges +against it, whenever the monetary sky is overcast. + +It was the chance of a century, but New York could not take it. When +London called in its credits from other countries, any centre that could +have said to these countries, "We will give you the credit that London +has cut off, and lend you the money to pay London," would have stepped +straight on to London's financial throne and set London a very difficult +task to regain it after the war was over. In spite of the large amounts +of gold taken from America to Europe before the war, the United States +had still a huge store within its borders--some estimates of it ranged +up to 400 millions sterling. If the United States had had the courage +to use this mountain of metal and let other countries draw on it, London +would have had more gold than it knew what to do with, and New York +would have had a big slice of London's business. The United States were +at peace, and, with all the chief countries of this antiquated +hemisphere engaged in the mediæval business of killing one another's +citizens and destroying one another's property, the United States might +have been expected to leap into the position of economic leadership. But +America feared to use its gold, and held on to it as tightly as it +could, fearful of internal trouble and a run on its banks if too much of +the metal went abroad. In New York, as in most other centres, the +question of the moment was, not to take London's business, but to pay +what she owed to London and to buy bills on London at skyrocket prices +wherever they could be found. The strength of the fat old money-lender, +whom the Australian papers, angry with him because he did not lend fast +enough, used to call John Bull Cohen, was never more wonderfully made +manifest. Strength in money bags is not everything--very far from +it--but at least J. B. Cohen can claim that he has made good use of it. +He has peopled and fertilized the uttermost ends of the earth with his +sons and his capital, and he alone among the nations has had the courage +and the homely wit to throw his ports open to all and to tell all the +peoples of the world to send their stuff along if it is worth buying. +Moreover, he has lately shown that, in spite of all his alleged +decadence, he can still tuck up his sleeves on occasion and fight at +least as well as anybody else. + +So far was New York from being able to supplant London that, as we have +seen, the United States had to make special arrangements to tide over +the difficulty which London's claims on her had produced.... + +The American Government found it necessary to ask officials of the +British Treasury to come over and help it to find ways and means for +meeting part of the debt of the United States to England, without +shipping any more American gold. This could only be done by England's +giving America some sort of credit to take the place of the finance +bills and other forms of accommodation which Lombard Street had +withdrawn. + +At the same time there is no doubt that New York did some of the +business for herself that London had formerly done for her. If she was +not in a position to finance other countries, she did make a beginning +in financing her own imports. Exporters of goods from South America to +the United States who had formerly taken payment by drawing bills on +London, and were no longer able to do so, drew on financial institutions +in New York instead. Some of these bills were used to make +three-cornered payments from South America to London, and a very costly +means of payment they were to the debtor, owing to the high rate of +discount in New York, and the depreciation of the American dollar as +compared with the pound sterling.... + +It seems likely that this business of financing American trade New York +will keep in her own hands to a greater extent than she did before. +Probably she would have taken more of it to herself even if there had +been no war. Her new banking legislation has included in its aim the +establishment of branches of American banks abroad, and the development +of acceptance business in New York. It could not be expected that New +York would always be content to see the greater part of America's +external trade financed with English credit. Her next step will be to +endeavor to finance other people's trade, and she is already beginning +to set about taking it, being assisted by Lombard Street's shyness in +the matter of new acceptance business. If the war should be long +continued, its appalling drain on the combatants ought to help her by +exhausting the rivals whom she hopes to drive out of the field. + +So far, then, from the late crisis having given any evidence of weakness +on the part of London, or of any likelihood that she will lose her +supremacy as the world's banker, the commanding strength of her portion +has been made abundantly manifest. The only weak point was not in her +armor but in that of her foreign customers. The question arises whether +she was wise in lending so much to debtors who showed such unanimous +inability to pay on the due dates. I have heard it contended by a +disinterested and well-qualified critic, that the risk run by Lombard +Street in allowing bills to be drawn on her from all parts of the world +against goods shipped from one country to another, has been shown by the +late crisis to be too great to be worth the candle. Bills drawn against +goods coming to England are safe enough, for as long as the goods come +to port and can be sold for them, the acceptor is sure of his money. But +when the goods go from China to Peru, and Peru finds that it cannot +remit to meet the bill, the acceptor is inconvenienced, and the bank or +bill broker who holds the bill finds that he has got a security which +was not quite as gilt-edged as he thought it. This is all quite true, +but contrariwise it may be argued that this sort of world crisis is not +going to happen again very soon, and that if all finance had to be +arranged on the theory that it was likely to recur frequently, there +would be very little finance of any kind. These bills drawn against +international shipments of goods do much to make the bill on London +popular all over the world, and if they are to be frowned on there will +be a considerable restriction of international commerce, which will +react unpleasantly on England. In ordinary times these bills are safe +enough, if due precautions are taken. If mistakes are made they happen +rarely and the resources of the accepting houses are easily able to +repair the damage. + +As to finance bills, it has already been admitted that much credit was +given by their means which was used for purposes with which bills of +exchange ought not to be associated. The essence of a bill of exchange +is that it has to be met at its due date, and so it should only be drawn +to finance some commercial operation that will mature before the bill +falls due, or to provide means of remittance when they are scarce, owing +to seasonal causes which will have passed before the bill's maturity. +When rolling credits, as they are called, are established, which go on +from year to year, each bill being met by drawing another, and the money +so raised in the borrowing country is put into bricks and mortar or +machinery or other forms of fixed capital, the uses of the bill of +exchange are being strained. When a jolt comes to the machinery and the +rolling credit stops rolling, it is not possible to sell the factory or +plant to provide a means of remittance. But there is no doubt that for a +time, at least, this kind of finance bill is likely to be scarcer than +it was; in fact, as we have seen, it was the excessive suddenness of the +fit of virtue that seized Lombard Street on this subject that made the +crisis more acute than it need have been, by reducing the means of +remittance and so keeping the exchanges at an abnormal point. + +Lombard Street has thus shown that it has fully learnt the only lesson +that the external side of the crisis had to teach it. Too many finance +bills of the wrong kind were out, and Lombard Street saw the fact so +clearly that for some weeks it rang with the cry that there must never +be any more finance bills of any kind at all. This exaggerated view is +already discredited, and there is good reason to hope that opinion will +settle down to a sensible midway path, taking the finance bill as a +quite legitimate and necessary convenience, dangerous only when abused +and distorted.... + + +MR. WITHERS A GOOD ENGLISHMAN + +[322]Mr. Withers is a very good Englishman indeed and points out with +pardonable pride how the London market stood the shock which rocked the +rest of the financial world to its very foundations. What would have +been his attitude had the book been written a little later, however, +when the pound sterling had fallen to a discount of over 2 per cent. as +compared with the dollar, is an interesting subject of speculation. +London financing the world is, from the Englishman's point of view, an +inspiring sight, but the pound sterling obtainable in New York for $4.76 +... is something which it would be interesting to hear Mr. Withers +explain. _War and Lombard Street_ treats only with the beginning of a +very big subject. It is sincerely to be hoped that a little later we +shall have a continuation of the work from Mr. Withers' pen. + + +AMERICA'S CHANCE OF HOLDING WORLD PURSE-STRINGS[323] + +Since the outbreak of the war New York has assumed a position of +leadership in international banking. Will this position be permanent or +will its duration be limited practically to the period of the war? Is +the mantle of world financial leadership about to pass from London to +New York, as it passed after the Napoleonic Wars from Amsterdam to +London? These are questions which many are asking, but which no one can +answer positively, because so much depends upon those incalculable +items--the duration of the war and the financial strength of the +belligerents at its close.... + +At the end of 1913 our provincial banking system was overhauled by the +Federal Reserve Act, and put in shape to meet the needs of our growing +trade, both domestic and foreign. By this act American commercial paper, +which previously had been essentially local paper, was given an +opportunity to assume a national, or even international, character, +through the provisions for bank acceptances, rediscount, and "open +market operations." An open discount market began to develop on American +soil; and slowly, but surely, short-time paper of an international +character and standing began to appear.... + +By the beginning of 1914, therefore, it may be said, that the way was +opened for our financial metropolis, New York, to play an increasingly +important rôle in the international money market, and that there was +already a movement in that direction. + +To this movement the European war gave a strong impetus, and to-day New +York clearly holds the premier position in the field of international +finance, although at a time when national finance in the leading +countries of Europe has assumed proportions never before dreamed of. The +European exchange markets have been demoralized, and specie payments +among the belligerent countries of Europe have become little more than a +name. On the other hand, "dollar exchange" is now quoted in the +principal cities of Latin America, the Orient, and Australia; and the +American trade with those sections, which was formerly financed chiefly +through London, is now being financed directly, and in dollars.... + +The United States has brought back home from a billion to two billion +dollars' worth of the six billion dollars' worth of its securities +estimated to have been held abroad, and is preparing to take more, +either by purchase or as security for loans. It has loaned upwards of a +billion dollars to the belligerent countries, and has had a net +importation of gold during the year just closed greater than that of any +five years of its history. Our banks are carrying heavy surplus +reserves, those of the New York Clearing House banks alone on December +31 having amounted to $143,000,000, and the gold reserve against net +liabilities of the twelve federal reserve banks on December 23 having +amounted to 86 per cent.; and this, at a time when the large gold +reserves of the European banks are strained to the breaking point by the +tremendous liabilities placed upon them. + +Our export trade has reached unprecedented heights, and for the year +1915 was approximately equal to twice that of 1906.... + +This war is likely to leave her [England] still with a secure position, +a great and loyal colonial empire, an efficient banking system, and the +control of the seas. Her position as a creditor nation will lie greatly +weakened, and she may even become a heavy debtor nation, but her foreign +trade connections have been so long and so well established that it does +not seem likely that they will be permanently impaired in any large +degree by the readjustments necessitated by the war. If she disposes of +her Latin-American and Asiatic investments to the United States she will +doubtless greatly weaken her trade position in those countries, but the +present evidence is that these will be about the last foreign +investments she will dispose of. + +So far we have not made great progress in securing Europe's +Latin-American trade. Europe discontinued financing Latin America at the +same time that she discontinued her normal trading with Latin America. +For us to take her place it became necessary for us to loan before we +could sell and buy. But loaning to European belligerents and selling war +supplies offered larger immediate profits; and so our chief efforts have +been turned eastward rather than southward. An analysis of our large +export trade of last year shows that much of it was of a very abnormal +character, and gives promise of being but temporary. The following +figures comparing the exports of a few selected commodities for the ten +months ended October, 1915, with those for the same period of 1914 will +make this point clear: + + _Ten Months Ended Oct. 31_ + _Commodities. 1914. 1915._ + +Breadstuffs $212,025,814 $461,074,547 +Iron and steel and mfrs. thereof, incl. wire 109,232,270 294,822,223 +Meat products 110,180,785 214,212,955 +Animals (notable horses and mules) 6,668,121 107,201,175 +Explosives 6,439,693 103,527,382 +Cars, carriages, etc. 36,844,923 117,366,359 +Leather and mfrs. thereof 47,123,910 135,847,788 + +A glance at these articles will show that most of them were intended +chiefly for military uses, and that their heavy exportation presumably +will be but temporary. + +It is interesting to note that some other articles of customary export +showed large declines in 1915 as compared with 1914. During the same ten +months' period, for example, our exports of agricultural implements (and +parts) declined from $21,028,588 in 1914 to $11,162,609 in 1915; of wood +and manufactures thereof, from $68,904,895 to $45,325,146; of +fertilizers, from $7,735,613 to $3,758,598; and of sewing machines, from +$7,757,421 to $4,902,594. + +Viewed from the standpoint of the destination of the articles exported, +the significant fact is that the increase in exports was chiefly to +Europe, and not to Central and South America and Asia--the places in +which we have been strenuously endeavoring in recent years to build up a +permanent export trade.... + +... After the war is over Europe will presumably discontinue, or greatly +reduce, her importations from the United States of most of the articles +which figured so largely in the great increase of 1915. As her needs +tend to become normal again she will immediately endeavor to resume her +old-time trade connections, both import and export, at least in so far +as the trading centres are in countries that were friendly or neutral +during the war. In seeking to re-establish these connections the +merchants of the belligerent countries will be strongly backed by their +Governments, which the war will have made more socialistic and more +aggressive. They will have a great advantage in the fact of +long-established business relations, and in the fact that the war trade +will have been to such a large extent abnormal, both as regards the +products dealt in and the parties to the trade. + +Europe's banking machinery in South and Central America, although it may +not be very actively functioning in these trying times, still exists, +and will be ready to resume its former activities as soon as peace is +declared.... + +On the basis of London Stock Exchange listings British investments in +Latin America early in 1914 were computed at nearly $6,000,000,000. +Germany also has a large number of banking establishments in South +America and heavy investments.... United States investments in South +America are very small as compared with those of England and Germany, +while only one American bank has established branches on that continent. +These branches are only five in number, and the oldest of them is but a +little over a year old. + +The conclusion seems clear that the war will need to be very long and +very disastrous to England; and American merchants, bankers, and +investors will need to be much more active and far-sighted in their +exploitation of South American opportunities than they have been in the +past, if London is to yield to New York her financial premiership for +South America. + +Other obstacles to New York's becoming permanently the world's financial +centre are its great distance from the financial markets of Europe, +America's small merchant marine, its provincial protective tariff +policy, the absence of an adequate supply of men possessing the +necessary training both in foreign languages and in commerce and +international finance to go into these foreign fields and to "tie them +up" commercially and financially with the United States, and the +slowness with which our recently reorganized banking system and our +American discount market must grow, as regards international business, +if it is to have roots that are strong and grow deep. + +The United States has before it a great opportunity. Much depends upon +the foresight with which Americans prepare themselves to meet the +tremendous readjustments that will be demanded at the close of the war. +That will be the supreme test. Now is the time to build for the future, +and to avoid paying too much attention to immediate profits. New York +can hardly be expected to succeed to London's position as the world's +financial centre, at least for some time to come; dollar exchange will +not at once take permanent rank ahead of sterling, or even alongside it; +none the less, if the United States refuses to be blinded by the glamour +of large immediate profits from a type of trade that is necessarily +abnormal and temporary, and if she seriously turns her attention to the +opportunities now open to her in Latin America, she will make a long +step forward in the direction of financial leadership. + +FOOTNOTES: + +[313] H. Parker Willis, _American Finance and the European War_, _The +Journal of Political Economy_, Vol. 23, No. 2. February, 1915, pp. +144-165. + +[314] A fuller account of the gold fund and cotton loan plans will be +found in the _First Annual Report of the Federal Reserve Board_, +Washington, January 15, 1915. + +[315] _Report of Secretary of the Treasury_, December 7, 1914. + +[316] _First Annual Report of the Federal Reserve Board_, p. 16. + +[317] _Report of the Comptroller of the Currency_, 1914, pp. 15, 16. + +[318] J. Laurence Laughlin, _Will the Gold Basis Survive in Europe?_, +_The Annalist_, Vol. 7, No. 162, Feb. 21, 1916, pp. 244, 252. + +[319] A. Barton Hepburn, _A History of Currency in the United States_, +pp. 463-466. The Macmillan Company. New York. 1915. + +[320] Of Boissevain Co. + +[321] Hartley Withers, _War and Lombard Street_, pp. 98-111. E. P. +Dutton and Company. 1915. + +[322] Franklin Escher, Review of _War and Lombard Street_, _The American +Economic Review_, Vol. 5, No. 3, September, 1915, pp. 624-5. + +[323] E. W. Kemmerer, _America's Chance of Holding World Purse-Strings_, +_The Annalist_, Vol. 7, No. 158, Jan. 24, 1916, pp. 119-121, 144. + + + + +APPENDIX A + +AN APPROXIMATE FORMULA FOR DETERMINING THE VELOCITY OF THE CIRCULATION +OF MONEY + + +[324]For the purpose of tracing the circulation of money, and measuring +it by bank records,[325] we may classify the persons who use money in +purchase of goods into three groups: + +1. Commercial depositors, _i. e._, all engaged in business--firms, +companies, and others--who have bank deposits mainly or wholly apart +from personal accounts. + +2. All other depositors, chiefly private persons. + +3. All who, like most wage earners, are not depositors at all. + +These three classes we shall distinguish as "Commercial depositors," +"Other depositors," and "Nondepositors," or C, O, and N. The money in +the possession of "Commercial depositors" we shall call "till money," +and the rest "pocket money." + +The three groups necessarily include all in the community who circulate +money. By circulating money is meant expending it in exchange, not for +some other circulating medium, as checks, but for goods.... + +... The category of "commercial depositors" coincides for all practical +purposes with the category of business establishments. + +"Other depositors" include most proprietors, professional, and salaried +persons. Almost no wage earners are included, and almost no business +establishments or business men in a business capacity.... + +... Although "other depositors" include most proprietors and +professional and salaried persons, yet some proprietors and professional +men, especially in rural communities, and some salaried persons, chiefly +small clerks, are "Nondepositors."... + +... "Nondepositors" consist chiefly of those who are classed in +statistics as wage earners. While there are some wage earners who are +depositors,[326] they are rare: and while there are some "nondepositors" +who are not wage earners, especially (as just indicated) the +agricultural proprietors (farmers) and small clerks, the amount of money +circulated by them is small in comparison with the total circulation. +While the line separating wages and salaries is not definitely marked in +theory, it is usually easily recognised in practice.... + +We may now picture concretely the main currents of the monetary flow, +including the circulation of money in exchange for goods.... [The figure +here given] illustrates the three principal types. + +[Illustration] + +The corners of the triangle, C, O, and N, represent the three groups of +"commercial depositors," "other depositors," and "nondepositors," and +the B's represent banks. The arrows represent the flow of money from +each of these four categories to the others. Thus B_{o} represents the +annual withdrawals from banks by "other depositors," O_{c} the spending +of this withdrawn money by "other depositors" among "commercial +depositors," and C_{b} the return of the money from the "commercial +depositors" to the banks. This circuit (B_{o} O_{c} C_{b}) of three +links is very common. A second type of circuit is represented by a chain +of four arrows (B_{o} O_{n} N_{c} C_{b}). It is illustrated by private +depositors drawing money (B_{o}), and paying wages (O_{n}) to servants +who in turn spend the money (N_{c}) among tradesmen who finally deposit +it (C_{b}). A third type of circuit, also fourfold, is represented by +the arrows B_{c} C_{n} N_{c} C_{b}. It is illustrated by commercial +firms cashing their checks at banks (B_{c}) for pay rolls, with the cash +so obtained paying wages (C_{n}) to workmen who spend it (N_{c}) among +other tradesmen who redeposit it in banks (C_{b}). These three types are +not the only ones, but they are so much more important than any others +that they merit out undivided attention before a completer study is +undertaken.... [The accompanying figure] has been constructed for the +purpose of exhibiting them uncomplicated by other details. + +It will be noted that not all of the flows described are examples of the +_circulation_ of money. As already indicated, money may be said to +circulate only when it passes in exchange for _goods_. Its entrance into +and exit from banks is a flow, but not a circulation against goods. In +the diagram the horizontal arrows represent such mere banking +operations, not true circulation. On the other hand, the arrows along +the sides of the triangle represent actual circulation. The diagram +shows four such arrows, representing the four chief types of +circulation: O_{c} payments of money from "other depositors" to +"commercial depositors" in the purchase of goods; O_{o} payments from +"other depositors" to "nondepositors," as when a housewife pays wages; +C_{n} payments from "commercial depositors" to "nondepositors," as when +a firm pays wages; and N_{c} payments from "nondepositors" to +"commercial depositors," as when a wage earner buys goods of a merchant. + +There four types of circulation of money occur in the three circuits +already described, being sandwiched between the flows from and to the +banks. The first, O_{c}, is contained within the circuit B_{o} O_{c} +C_{b} and, since no "nondepositors" intervene, represents money changing +hands once between its withdrawal from bank and its redeposit there. The +remaining types (O_{n}, C_{n}, and N_{c}) are contained within the two +other circuits (B_{o} O_{n} N_{c} C_{b} and B_{c} C_{n} N_{c} C_{b}), +and, owing to the fact that "nondepositors" intervene, represent money +circulating twice between withdrawal and redeposit. + +In short, one of the three circuits (B_{o} O_{c} C_{b}) shows money +circulating once out of bank. Both the others pass through N, and show +money circulating twice out of bank. The diagram, then, represents all +circulating money as springing from and returning to the banks; all of +it as circulating at least once in the interim; and that portion handled +by "nondepositors" as circulating once in addition. Therefore, the total +circulation exceeds the total flow from and to banks by the amount +flowing through "nondepositors." In other words, the total circulation +in the diagram is simply the sum of the annual money flowing from and to +banks and the money handled by "nondepositors." The quotient of this sum +divided by the amount of money in circulation will give approximately +the velocity of circulation of money.... + +FOOTNOTES: + +[324] Irving Fisher, _Purchasing Power of Money_, Appendix XII. pp. +448-454. _The Macmillan Company. New York. 1911._ + +[325] For a complete formula for determining the velocity of the +circulation of money see pages 448-460, of the Purchasing Power of +Money. + +[326] The term "depositors," as here used, does not, of course, include +savings bank depositors. A savings bank is not a true bank of deposit, +providing circulating credit. + + + + +APPENDIX B + +SOME REGULATIONS OF THE FEDERAL RESERVE BOARD + +FEDERAL RESERVE BOARD + +WASHINGTON, January 12, 1915. + +ACCEPTANCE OF STATEMENTS IN LIEU OF CERTIFICATES AS TO CHARACTER OF +COMMERCIAL PAPER + +Whenever a member bank shall offer for rediscount any note, draft, or +bill of exchange bearing the indorsement of such member bank, with +waiver of demand notice and protest, the directors or executive +committee of the federal reserve bank may, until July 15, 1915, accept +as evidence that the proceeds of such note, draft, or bill of exchange +were or are to be used for agricultural, industrial, or commercial +purposes (and that such notes, drafts, or bills of exchange in other +respects comply with the regulations of the board), a written statement +from the officer of the applying bank that of his own knowledge and +belief the original loan was made for one of the purposes mentioned, and +that the provisions of the act and regulations issued by the board have +been complied with. + +CHARLES S. HAMLIN, +Governor. + +H. PARKER WILLIS, +Secretary. + +FEDERAL RESERVE BOARD + +WASHINGTON, April 2, 1915. + +BANKERS' ACCEPTANCES + +I + +DEFINITION + +In this regulation the term "acceptance" is defined as a draft or bill +of exchange drawn to order, having a definite maturity, and payable in +dollars, in the United States, the obligation to pay which has been +accepted by an acknowledgment written or stamped and signed across the +face of the instrument by the party on whom it is drawn; such agreement +to be to the effect that the acceptor will pay at maturity according to +the tenor of such draft or bill without qualifying conditions. + + +II + +STATUTORY REQUIREMENTS UNDER SECTIONS 13 AND 14 + + Section 13 of the Federal Reserve Act as amended provides + that: + + (a) Any federal reserve bank may discount acceptances: + + (1) Which are based on the importation or exportation of + goods; + + (2) Which have a maturity at time of discount of not more + than three months; and + + (3) Which are indorsed by at least one member bank. + + (b) The amount of acceptances so discounted shall at no time + exceed one-half the paid-up capital stock and surplus of the + bank for which the rediscounts are made, except by authority + of the Federal Reserve Board and of such general regulations + as said board may prescribe, but not to exceed the capital + stock and surplus of such bank. + + (c) The aggregate of notes and bills bearing the signature + or indorsement of any one person, company, firm, or + corporation rediscounted for any one bank shall at no time + exceed 10 per centum of the unimpaired capital and surplus + of said bank; but this restriction shall not apply to the + discount of bills of exchange drawn in good faith against + actually existing values. + +Section 14 of the Federal Reserve Act permits federal reserve banks, +under regulations to be prescribed by the Federal Reserve Board, to +purchase and sell in the open market bankers' acceptances, with or +without the indorsement of member bank. + + +III + +RULING + +The Federal Reserve Board, exercising its power of regulation with +reference to paragraph II (b) hereof, rules as follows: + +Any federal reserve bank shall be permitted to discount for any member +bank "bankers' acceptances" as hereinafter defined up to an amount not +to exceed the capital stock and surplus of the bank for which the +rediscounts are made. + + +IV + +ELIGIBILITY + +The Federal Reserve Board has determined that, until further order, to +be eligible for discount under section 13, by federal reserve banks, at +the rates to be established for bankers' acceptances: + +(a) Acceptances must comply with the provisions of paragraph II (a), +(b), (c) hereof; + +(b) Acceptances must have been made by a member bank, non-member bank, +trust company, or by some private banking firm, person, company, or +corporation engaged in the business of accepting or discounting. Such +acceptances will hereafter be referred to as "bankers'" +acceptances;[327] + +(c) A banker's acceptance must be drawn by a commercial, industrial, or +agricultural concern (that is some person, firm, company, or +corporation) directly connected with the importation or exportation of +the goods involved in the transaction in which the acceptance +originated, or by a "banker." In the latter case the goods, the +importation or exportation of which is to be financed by the acceptance, +must be clearly specified in the agreement with or the letter of advice +to the acceptor. The bill must not be drawn or renewed after the goods +have been surrendered to the purchaser or consignee. + +(d) A banker's acceptance must bear on its face or be accompanied by +evidence in form satisfactory to a federal reserve bank that it +originated in an actual _bona fide_ sale or consignment involving the +importation or exportation of goods. Such evidence may consist of a +certificate on or accompanying the acceptance to the following effect: + +This acceptance is based upon a transaction involving the importation or +exportation of goods. Reference No. ----. Name of acceptor ----. + +(e) Bankers' acceptances, other than those of member banks, shall be +eligible only after the acceptors shall have agreed in writing to +furnish to the federal reserve banks of their respective districts, upon +request, information concerning the nature of the transactions against +which acceptances (certified or bearing evidence under IV (d) hereof) +have been made. + +(f) A bill of exchange accepted by a "banker" may be considered as drawn +in good faith against "actually existing values," under II (c) hereof, +when the acceptor is secured by a lien on or by transfer of title to the +goods to be transported; or, in case of release of the goods before +payment of the acceptance, by the substitution of other adequate +security; + +(g) Except in so far as they may be secured by a lien on or by transfer +of the title to the goods to be transported, as under (f), the bills of +any person, firm, company, or corporation, drawn on and accepted by any +private banking firm, person, company, or corporation (other than a bank +or trust company) engaged in the business of discounting and accepting, +and discounted by a federal reserve bank, shall at no time exceed in the +aggregate a sum equal to 5 per centum of the paid-in capital of such +federal reserve bank; + +(h) The aggregate of acceptances of any private banking firm, person, +company, or corporation (other than a bank or trust company) engaged in +the business of discounting or accepting, discounted or purchased by a +federal reserve bank, shall at no time exceed a sum equal to 25 per +centum of the paid-in capital of such federal reserve bank. + +To be eligible for purchase by federal reserve banks under section 14, +bankers' acceptances must comply with all requirements and be subject to +all limitations hereinbefore stated, except that they need not be +indorsed by a member bank: _Provided, however_, That no federal reserve +bank shall purchase the acceptance of a "banker" other than a member +bank which does not bear the indorsement of a member bank, unless a +federal reserve bank has first secured a satisfactory statement of the +financial condition of the acceptor in form to be approved by the +Federal Reserve Board. + + +V + +POLICY AS TO PURCHASES + +While it would appear impracticable to fix a maximum sum or percentage +up to which federal reserve banks may invest in bankers' acceptances, +both under section 13 and section 14, it will be necessary to watch +carefully the aggregate amount to be held from time to time. In framing +their policy with respect to transactions in acceptances, federal +reserve banks will have to consider not only the local demands to be +expected from their own members, but also requirements to be met in +other districts. The plan to be followed must in each case adapt itself +to the constantly varying needs of the country. + +CHARLES S. HAMLIN, +Governor. + +H. PARKER WILLIS, +Secretary. + +FEDERAL RESERVE BOARD + +WASHINGTON, April 2, 1915. + + +ACCEPTANCE BY MEMBER BANKS + +By act of Congress approved March 3, 1915, section 13 (paragraphs 3, 4, +and 5 of the Federal Reserve Act) was amended and re-enacted so as to +read as follows: + +Any federal reserve bank may discount acceptances which are based on +the importation or exportation of goods and which have a maturity at +time of discount of not more than three months and indorsed by at least +one member bank. The amount of acceptances so discounted shall at no +time exceed one-half the paid-up and unimpaired capital stock and +surplus of the bank for which the rediscounts are made, except by +authority of the Federal Reserve Board, under such general regulations +as said board may prescribe, but not to exceed the capital stock and +surplus of such bank. + +The aggregate of such notes and bills bearing the signature or +indorsement of any one such person, company, firm, or corporation +rediscounted for any one bank shall at no time exceed 10 per centum of +the unimpaired capital and surplus of said bank; but this restriction +shall not apply to the discount of bills of exchange drawn in good faith +against actually existing values. + +Any member bank may accept drafts or bills of exchange drawn upon it and +growing out of transactions involving the importation of exportation of +goods having not more than six months' sight to run; but no bank shall +accept such bills to an amount equal at any time in the aggregate to +more than one-half of its paid-up and unimpaired capital stock and +surplus, except by authority of the Federal Reserve Board, under such +general regulations as said board may prescribe, but not to exceed the +capital stock and surplus of such bank, and such regulations shall apply +to all banks alike, regardless of the amount of capital stock and +surplus. + +In order to give effect to the above amendment of the law, the Federal +Reserve Board issues the appended Regulation K, series of 1915, stating +the conditions under which member banks may accept, up to 100 per cent. +of their capital and surplus, drafts or bills of exchange growing out of +transactions involving the importation or exportation of goods and +having not more than six months' sight to run. + +CHARLES S. HAMLIN, +Governor. + +H. PARKER WILLIS, +Secretary. + +FEDERAL RESERVE BOARD + +WASHINGTON, May 8, 1915. + +CLEARINGS BETWEEN FEDERAL RESERVE BANKS + + +I + +STATUTORY PROVISIONS UNDER SECTION 16 + +"The Federal Reserve Board shall make and promulgate from time to time +regulations governing the transfer of funds and charges therefore among +federal reserve banks and their branches, and may at its discretion +exercise the functions of a clearing house for such federal reserve +banks, or may designate a federal reserve bank to exercise such +functions, and may also require each such bank to exercise the functions +of a clearing house for its member banks." + + +II + +GENERAL PROVISIONS + +In the exercise of the functions of the clearing house authorised under +the provisions of section 16, quoted above, the Federal Reserve Board +and the federal reserve banks will be governed by and subject to the +following regulations and the Federal Reserve Board will be the +custodian of the funds hereinafter termed the gold settlement fund. The +board will appoint a settling agent who shall keep the necessary records +and accounts. + + +III + +DEPOSITS IN THE GOLD SETTLEMENT FUND + +(a) Each federal reserve bank shall, not later than May 24, 1915, +forward to the Treasury or the nearest Sub-Treasury, for credit to the +account of the gold settlement fund $1,000,000 in gold, gold +certificates or gold order certificates, and, in addition, an amount at +least equal to its net indebtedness due to all federal reserve banks. + +(b) The Treasurer of the United States or Assistant Treasurer will, in +accordance with arrangements made with the Treasury Department, advise +the Federal Reserve Board, by mail or telegraph, of the receipt of all +funds deposited on account of the gold settlement fund, and the +Treasurer will issue and deliver to the Federal Reserve Board gold order +certificates made "payable to the order of the Federal Reserve Board" +covering the sum so deposited. + +(c) Each federal reserve bank shall maintain a balance in the gold +settlement fund of not less than $1,000,000. + +(d) Excess balances may, at the convenience of each federal reserve +bank, remain deposited with the gold settlement fund. + + +IV + +CUSTODY OF FUNDS + +(a) A safe in the Treasury vault will be set apart for the exclusive use +of the Federal Reserve Board. + +(b) To open the Treasury vault, the presence of two persons designated +by the Secretary of the Treasury is required. The combination of the +safe set apart for the use of the board will be controlled by two +persons designated by the board. + +(c) A vault record shall be kept, giving a memorandum of all entrances +to the safe, by whom made, for what purpose, and the certificates +deposited or withdrawn. Each entry on the vault record book shall be +signed by the persons having access to the safe. + + +V + +ACCOUNTS + +In its relations with other federal reserve banks each federal reserve +bank shall keep an account showing balances "due to" other federal +reserve banks representing the proceeds of items which it has actually +collected, and payments and transfers which have been made to it for the +account of such other federal reserve banks; and an account showing +balances "due from" other federal reserve banks representing the +proceeds of items which it has sent to such other federal reserve banks, +and payments and transfer which have been made to such other federal +reserve banks for its account. + + +VI + +PROCEDURE + +(a) At the close of business each Wednesday night, each federal reserve +bank shall telegraph to the Federal Reserve Board, confirming such +telegram by mail, the amounts in even thousands due to each other +federal reserve bank as of that date, as indicated by its "due to" +account provided for in Rule V. If Wednesday is a holiday in the State +in which a federal reserve bank is located, then such bank shall +telegraph as herein provided on Tuesday, at the close of business. + +(b) The settling agent shall, on each Thursday, make the proper debits +and credits in the accounts of each federal reserve bank with the gold +settlement fund, and shall telegraph to each bank the amounts, in even +thousands, of credits to its settlement account, giving the name of each +federal reserve bank from which each of its credits was received and +also its net debit or credit balance in the weekly settlement. + +(c) Each federal reserve bank shall, on receipt of the telegram from the +settling agent, debit the "due to" federal reserve banks' accounts, and +shall credit the gold settlement fund; and shall credit the "due from" +federal reserve banks' accounts and charge the gold settlement fund. The +difference between the total debits and credits shall equal the net +debit or credit to the gold settlement fund, as advised in the telegram +from the settling agent. + + +VII + +DEFICITS + +(a) Should the debit settlement balance of any federal reserve bank be +in excess of the amount of its credit in the gold settlement fund, such +deficit must be immediately covered either by the deposit of gold, gold +certificates, or gold order certificates in the Treasury or nearest +Sub-Treasury, or by credit operations with other federal reserve banks +which have an excess balance with the gold settlement fund. Any delay in +covering such deficit shall be subject to such charge as the Federal +Reserve Board may impose. + +(b) As required in III (c) of this regulation, each federal reserve bank +shall maintain a balance in the gold settlement fund of not less than +$1,000,000. Should the credit balance of any federal reserve bank in +such fund fall below $1,000,000, such bank shall restore its balance to +that amount in either manner indicated under VII (a) of this regulation +on or before Tuesday of the following week. + + +VIII + +EXCESS BALANCES + +Any excess balance shall, on request, either by telegraph or letter, of +the federal reserve bank to which it is due, be refunded by the return +to the reserve bank of the gold order certificates held by the gold +settlement fund properly indorsed; or by the indorsement and delivery to +the Treasurer of a like amount of such certificates for which he will +give in exchange bearer gold certificates, which the Federal Reserve +Board may send by registered mail, insured, to the banks, if they want +funds other than gold order certificates, or in lieu of such payment, +the Treasurer may by wire or mail direct payment to be made by a +Sub-Treasury office through the medium of the general account, provided +funds are held in such office available for the purpose. Gold order +certificates will, when presented at the office of the Treasurer of the +United States or any Sub-Treasury, bearing the signatures of duly +authorised officers of the federal reserve bank, be payable in gold or +gold certificates. If the Treasury finds it necessary to ship from one +point to another in order to have the gold or gold certificates +available at the Sub-Treasury to which such gold order certificates are +presented, the Federal Reserve Board will, for the account of the gold +settlement fund, refund any expense incurred by the Treasury in making +such shipments. + + +IX + +RESERVE + +Each federal reserve bank shall count as a part of its legal reserve the +funds standing to the credit of its account on the books of the gold +settlement fund. + + +X + +EXPENSES + +Cost of operation of and shipment of currency by the gold settlement +fund shall be apportioned by a semi-annual accounting among the 12 +federal reserve banks on a basis to be hereafter determined by the board +after consultations with the federal reserve banks. + + +XI + +AUDIT + +At least once in each three months an audit shall be made of the gold +settlement fund by a representative of the Federal Reserve Board and +representative appointed by the federal reserve banks. + + +XII + +The Federal Reserve Board reserves the right to add to, alter, or amend +these regulations. + +CHARLES S. HAMLIN, +Governor. + +H. PARKER WILLIS, +Secretary. + + +FEDERAL RESERVE BOARD + +WASHINGTON, June 7, 1915. + +MEMBERSHIP OF STATE BANKS + + +I + +STATUTORY REQUIREMENTS + +Specific provisions of the Federal Reserve Act applicable to State banks +and trust companies which become member banks are quoted at the end of +this regulation. + + +II + +BANKS ELIGIBLE FOR MEMBERSHIP + +A State bank or a trust company to be eligible for membership in a +federal reserve bank must comply with the following conditions: + +(1) It must have been incorporated under a special or general law of the +State or district in which it is located. + +(2) It must have a minimum paid-up unimpaired capital stock as follows: + +In cities or towns not exceeding 3,000 inhabitants, $25,000. + +In cities or towns exceeding 3,000 but not exceeding 6,000 inhabitants, +$50,000. + +In cities or towns exceeding 6,000 but not exceeding 50,000 inhabitants, +$100,000. + +In cities exceeding 50,000 inhabitants, $200,000. + + +III + +APPLICATION FOR MEMBERSHIP + +Any eligible State bank or trust company may make application on Form +83, made a part of this regulation, to the federal reserve agent of its +district for an amount of capital stock in the federal reserve bank of +such district equal to 6 per cent. of the paid-up capital stock and +surplus of such State bank or trust company.[328] + +Upon receipt of such application the federal reserve agent shall submit +the same to a committee composed of the federal reserve agent, the +governor of the federal reserve bank, and at least one other member of +the board of directors of such bank, to be appointed by such board, but +no Class A director whose bank is in the same city or town as the +applying bank or trust company shall be a member of such committee. This +committee shall, after receiving the report of such examination as may +be required by the federal reserve bank in pursuance of directions from +the Federal Reserve Board, consider the application and transmit it to +the Federal Reserve Board with its report and recommendations. + + +IV + +APPROVAL OF APPLICATION + +In passing upon an application the Federal Reserve Board will consider +especially: + +(1) The financial condition of the applying bank or trust company and +the general character of its management. + +(2) Whether the nature of the powers exercised by the said bank or trust +company and its charter provisions are consistent with the proper +conduct of the business of banking and with membership in the federal +reserve bank. + +(3) Whether the laws of the State or district in which the applying bank +or trust company is located contain provisions likely to interfere with +the proper regulation and supervision of member banks. + +If, in the judgment of the Federal Reserve Board, an applying bank or +trust company conforms to all the requirements of the Federal Reserve +Act and these regulations, and is otherwise qualified for membership, +the board will issue a certificate of approval. Whenever the board may +deem it necessary, it will impose such conditions as will insure +compliance with the act and these regulations. When the certificate of +approval and any conditions contained therein have been accepted by the +applying bank or trust company, stock in the federal reserve bank of the +district in which the applying bank or trust company is located shall be +issued and paid for under the regulations of the Federal Reserve Act +provided for national banks which become stockholders in the federal +reserve banks. + + +V + +POWERS AND RESTRICTIONS + +Every State bank or trust company while a member of the federal reserve +system: + +(1) Shall retain its full charter and statutory rights as a State bank +or trust company, and may continue to exercise the same functions as +before admission, except as provided in the Federal Reserve Act and the +regulations of the Federal Reserve Board, including any conditions +embodied in the certificate of approval. + +(2) Shall invest only in loans on real estate or mortgages of a +character and to an extent which, considering the nature of its +liabilities, will not impair its liquid condition. + +(3) Shall adjust, to conform with the requirements of the Federal +Reserve Act and these regulations, within such reasonable time as may be +determined by the board in each case, any loans it may have at the time +of its admission to membership which are secured by its own stock, or +any loans to one person, firm, or corporation aggregating more than 10 +per cent. of its capital and surplus or more than 30 per cent. of its +capital, or any real estate loans which, in the judgment of the Federal +Reserve board, impair its liquid condition. + +(4) Shall maintain such improvements and changes in its banking practice +as may have been specifically required of it by the Federal Reserve +Board as a condition of its admission, and shall not lower the standard +of banking then required of it: and + +(5) Shall enjoy all the privileges an observe all those requirements of +the Federal Reserve Act and of the regulations of the Federal Reserve +Board applicable to State banks and trust companies which have become +member banks. + + +VI + +WITHDRAWALS + +Any State bank or trust company desiring to withdraw from membership in +a federal reserve bank may do so twelve months after written notice of +its intention to withdraw shall have been filed with the Federal Reserve +Board. The board will immediately notify the federal reserve bank of the +receipt of such notice. At the expiration of said twelve months, such +bank or trust company shall surrender all of its holdings of capital +stock in the federal reserve bank, which stock shall then be cancelled +and the withdrawing bank or trust company shall thereupon be released +from its stock subscription not previously called. Such bank or trust +company shall, immediately upon the cancellation of its stock, cease to +be a member of the federal reserve bank, and the federal reserve bank +shall then refund to such bank or trust company a sum equal to the +cash-paid subscription on the shares surrendered, with interest at the +rate of one-half of one per centum per month computed from the last +dividend, if earned, not to exceed the book value thereof, and the +reserve deposits, less any liability of such member to the federal +reserve bank: _Provided_, That no federal reserve bank shall, except by +the specific authority of the Federal Reserve Board, cancel within the +same calendar year more than 10 per cent. of its capital stock for the +purpose of effecting voluntary withdrawals during that year. All +applications, including therein any on which action may have been +deferred because in excess of the aforesaid 10 per cent. limitation, +will be dealt with in the order in which they were originally filed with +the board. + +Any State bank or trust company desiring to withdraw from membership at +the expiration of the twelve months' notice, notwithstanding the fact +that the federal reserve bank has previously cancelled 10 per cent. of +its stock during the same calendar year, may do so. In such case, +however, the federal reserve bank shall not be required to repay to the +withdrawing bank or trust company the sums due as above, until such time +as its stock would have been cancelled had it not exercised this option. +The federal reserve bank shall, however, give a receipt for the stock +surrendered. + + +VII + +EXAMINATIONS + +Every State bank or trust company, while a member of the Federal Reserve +system, shall be subject to such examinations as may be prescribed by +the Federal Reserve Board in pursuance to the provisions of the Federal +Reserve Act. + +In order to avoid duplication, the board will exercise the broad +discretion vested in it by the act in accepting examinations of State +banks and trust companies made by State authorities wherever these are +satisfactory to the board and are found to be of the same standard of +thoroughness as national bank examinations, and where in addition +satisfactory arrangements for co-operation in the matter of examination +between the designated examiners of the Board and those of the States +already exist or can be effected with State authorities. Examiners from +the staff of the board or of the federal reserve banks will, whenever +desirable, be designated by the board to act with the examination staff +of the State in order that uniformity in the standard of examination may +be assured. + + +VIII + +FUTURE REGULATIONS + +The Federal Reserve Board reserves the right to make such amendments and +adopt and issue, from time to time, such further regulations authorised +by the act as it may deem necessary, but no amendment of section VI of +these regulations, relating to voluntary withdrawals, shall take effect +until six months after its adoption and issue by the board. + +CHARLES S. HAMLIN, +Governor. + +H. PARKER WILLIS, +Secretary. + +FOOTNOTES: + +[327] Drafts and bills of exchange eligible for rediscount under section +13, other than "bankers'" acceptances, have been dealt with by +Regulation B, series of 1915. + +[328] Three per cent. has already been called from national and other +member banks, but the remainder of the subscription or any part of it +shall be subject to call if deemed necessary by the Federal Reserve +Board. + + + +***END OF THE PROJECT GUTENBERG EBOOK READINGS IN MONEY AND BANKING*** + + +******* This file should be named 35120-8.txt or 35120-8.zip ******* + + +This and all associated files of various formats will be found in: +http://www.gutenberg.org/dirs/3/5/1/2/35120 + + + +Updated editions will replace the previous one--the old editions +will be renamed. + +Creating the works from public domain print editions means that no +one owns a United States copyright in these works, so the Foundation +(and you!) can copy and distribute it in the United States without +permission and without paying copyright royalties. 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