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Readers^are asked td report al^ cases of books markecj or muti- lated. — T- [ * '- ^ ■— Do. hot deface books by mai^ks and writing.. Cornell University Library HG1813.U5 C63 1908 The bank and the treasury: 3 1924 030 182 004 olin B Cornell University fj Library The original of tliis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924030182004 THE BANK AND THE TREASURY "... About twenty-five years ago, Lord Revelstoke, at the head of the great firm [Baring Brothers], was visiting a German watering-place, where he met one of our leading American bankers. Naturally, their conversation drifted into a discussion of the financial situation, and in the course of the talk, Lord Revelstoke remarked that he intended during the next ten or fifteen years to enter extensively into modern financial banking. From that time the character of the business of the Barings began to change, and from being the greatest merchants in commercial credits, they put their resources more and more into fixed forms of investment, into speculative ventures in securities and into the promotion of financial enterprises. What was the result? In i8go the . . . world was startled by rumors reflecting upon the credit of this house, hitherto considered invincible, and its failure was only averted by the most stren- uous efforts of the Bank of England, with the aid of the strongest bankers of London. . . . "We refer to this striking chapter in financial history simply because it illustrates one of the peculiar dangers of our own times. Unques- tionably, the special temptation to which our banks are now subjected is the temptation to turn from commercial to financial banking; to change from the buying and selling of commercial credit into investments in securities and loans extended to promote financial enterprises; in short to change their business from that of commercial banks to that of finance companies. "The process of concentration in banking which is going on would possess little danger were it not accompanied in so large a degree by this change. The house of the Barings was a striking example of concen- tration in banking. Its business encircled the globe; its wealth was enormous, and so great were its transactions that even at the time of its trouble in 1890 its holdings of paper amounted to $100,000,000. But when it began to divert its interest, formerly directed almost exclusively to commercial credits, and began to throw the weight of its prestige and resources into the field of investment, speculation and promotion, then the power of its concentration of capital became a menace to the world. In the same way concentration in banking, which is going on at such rapid rate in New York, would not be open to much or any criticism if such concentration . . . was employed for the purpose of facilitating the commerce of the country instead of being used in purely financial undertakings." — The Wall Street Journal, New York, Oct. 29, 1904. THE BANK AND THE TREASURY Bank Capitalization and the Problem of Elasticity BY FREDERICK A. CLEVELAND, Ph.D. Professor of Finance in the School of Commerce, Accounts and Finance, New Tork University NEW EDITION REVISED LONGMANS, GREEN, AND CO. 91 AND 93 FIFTH AVENUE, NEW YORK LONDON, BOMBAY, AND CALCUTTA 1908 ^■0> ^-■xxxtik Copyright 190J By Longmans, Green, and Co. All rights reserved First Edition, March, 190s Second Edition, Revised, Marcli, 1908 The Plimpton Press Norwood Mass. INTRODUCTION When, in the early months of 1902, Mr. Shaw took the Treasury portfoUo, the country was passmg through a period of marvellous financial activity. Four years of commercial and industrial consolidation, four years of trading in new corporate issues, "on margin," had ab- sorbed hundreds of millions of banking capital in specu- lation. Moreover, this encumbering of current funds had taken place at a time when commercial and industrial expansion was multiplying its demands on our banks for credit accommodation. True, on May 9, 1901, an unex- pected corner in Northern Pacific had brought speculation to a temporary standstill. But the quiet which fol- lowed had been utilized by the large banking interests to get together needed financial support with which to launch United States Steel and other new gigantic promotions. From two to three thousand millions of new issues had to be digested and assimilated by the investing public be- fore our institutions of commercial credit could sufficiently relieve themselves from speculators' loans to meet the growing demands of trade. After 1898 the financial situation was at all times pregnant with danger to business. So large was the pro- portion of new flotations carried on bank credit, that in the early months of 1902 conservative financiers became alarmed J serious question was raised as to what the out- vi INTRODUCTION come would be. The fear expressed was that the bank- ing capital of the country was overloaded with credit obligations of a most dangerous sort. Within six years the national banks had increased their demand obligations to individual depositors more than $1,600,000,000, while during the same period their capital (both subscribed and earned) had increased only $135,000,000. That is to say, for every additional dollar put into the national banking business during this period, $12 of credit in the form of new deposit accounts had been issued against it. At the time that the national banks were thus extending their credit obligations, similar expansion was taking place in the deposit obligations of state banks, private banks, and loan and trust companies. They had in- creased their demand credit over $2,000,000,000, while the new capital added to the business was only $235,000,- 000, making a total expansion in deposit accounts of $3,600,000,000, with a total increase in capital of $370,- 000,000. The amount of credit expansion in bank accounts alone — i.e., expansion in the forms of cash with which business is done — was equal to about two and one-half times the total money circulation of the country outside of the reporting banks, while the total increase in banking capital was only about one-seventh of the money stock of the nation. To the end of aiding the banks to meet increasing money demands, Secretary Gage had used the customary methods of reUef. He had refunded the bonded debt on a lower investment basis; he had made numerous purchases of bonds for retirement; he had made interest payments in advance ; he had added to the relief thus given INTRODUCTION vii by loaning to the banks some $8o,ooo,cx)o in the form of revenue deposits. Such was the situation when Mr. Shaw came to the cabinet. Panics Averted by Government Loans Within the next few months pressure on the banks was extraordinary. The cHmax was reached in Sep- tember and October. Then it was that Mr. Shaw broke away from all precedents and issued his famous order that savings bank investments be received as security collateral to additional revenue deposits. This first order was soon followed by another, which relieved the banks from the necessity of holding a twenty-five per cent reserve against the secured deposits of the government. The effect of these two orders was to increase loans of the government to the banks from $113,000,000 to $166,000,- 000 — producing a temporary result in financial circles much the same as if $50,000,000 of new capital had sud- denly been added to the banking business. During 1903 the financial stress of 1902 was gradually reduced. By concerted action of banks, by the continued aid of the government, by the imposition of high interest rates on bank accommodations and by demands for added collateral to margins forcing hquidation, the over- encumbered capital of banks in financial centres was again somewhat relieved. These acts of conservatism were followed by months of wholesome trading, during which time speculation played the smaller part. The latter part of 1904 and the years 1905 and 1906 was another period of dangerous credit expansion, Dvn- viii INTRODUCTION ing 1904 clearing house transactions of the United States amounted to $102,000,000,000. The clearings for 1905 were $140,000,000,000. The following year, 1906, they reached $157,000,000,000. December, 1906, was a month of high tension at the financial centre, to relieve which call money sales were advanced to 36 per cent; the average of call rates for the month was about 14 per cent; thirty days money commanded from 9 per cent to 15 per cent. During a few days of the January following, as high as 50 per cent was paid for call money. This was followed by two months of comparative quiet. In March, 1907, however, speculative trading and holdings on margin had again reached such proportions that in efforts to pro- tect themselves, the banks were forced to call, and in a single day the market price of securities dropped from 5 to 20 points. General prosperity and prompt relief from Washington alone saved our commercial and in- dustrial institutions from distress similar to that recently experienced through the sudden contraction of bank- credit. It was during this period of rapidly increasing business activity and rapidly expanding bank-credit, and in antici- pation of a sudden need for increased support to bank- credit obUgations, that Secretary Shaw rendered another signal service to the country. He saw the approaching storm and prepared for it by getting the Treasury in con- dition to come to the rescue of the country when the banks would be unable to meet obhgations for payment without wholesale reduction of credit accommodation. In the first place, payment on the Panama Canal purchase was made by withdrawals of the deposits of the government. INTRODUCTION ix diminishing by this amount the demand loans of the Treasury to the banks, and the consequent inducement to banking extravagance. After making the Panama settlement — to provide for which a 20 per cent call had been made, — the Treasury deposits were about the same as when Mr. Shaw had been appointed to the cabinet three years before. Further than this, the Secretary gave notice to the banks that a call would be made, first for 25 per cent, and later for 50 per cent of the balance of Government deposits, and although these demands were not enforced to the letter, by November of 1905 the demand obligations of the banks to the Government were reduced to $50,000,000. Thus it was that, by the time the banks in fijiancial centres had again reached the danger point of credit expansion, Mr. Shaw was able to come to the support of the money market; and during the latter part of 1906 and the early months of 1907, $120,000,000 in the form of additional deposits were loaned to the banks without embarrassing the Treasury, enabling them to maintain their money-reserves without seriously contracting business accommodations. After the immediate need for collateral supports to the banks had passed. Secretary Cortelyou announced that he would follow the same general policy as had been pursued by his predecessor. But during the months from May to November the demand of the banks for money with which to maintain their reserves constantly increased. Protests were made against reducing the Treasury balances that had been loaned to the banks, to tide over the stress which came earlier in the year. Yielding to these importunities was a serious mistake. X INTRODUCTION Instead of calling attention to the capital weakness of the banks, the Government permitted them to continue to use the large Treasury balance without interest. The banks found that it was not necessary to increase then- own capitahzation; in fact, the Government held out an inducement not to increase their capital, since the present stockholders were able to increase their income by the amount of the credit expansion supported by the Treasury balance, without being required to share their increased profit with new stockholders. Not only were the banks themselves weakened by continuing aid, but the Govern- ment was placed in a position where it could not lend a strong helping hand in future emergencies. The October and November Panic When in October and November, 1907, panic days again were reached, the Government at Washington could not respond with the liberality required. In May $170,000,000 had been reached. August 22, this amount had been reduced to $143,000,000. August 23, the Sec- retary began increasing Treasury deposits with the banks in response to urgent demands. November 11, $70,000,000 had been added to the Treasury loans and during the following month practically the whole avail- able surplus of the Treasury was placed at the disposal of the banks. But even this did not sufi&ce to support the weight of obHgations that had been permitted to accumulate on the crumbling foundations of the credit institutions of the country. The alternative was a violent credit contraction. The INTRODUCTION xi essential weakness, a first cause of credit collapse, is found in the changed relations of credit outstanding to capital supporting it. In 1897 the proportion of National bank capital to individual deposit obligations had been as i to 2.93; in 1906 their proportions reached i to 5.03. In 1897 the proportion of capital, surplus, and undivided profits to individual deposit obligations was as i to 1.92; in 1906 this proportion reached i to 2.79; in 1897 the proportion of money-reserves held by National banks to individual deposit obligations was as i to 5.35; in 1906, even counting all the money borrowed by the banks from the Government and from State and private banks and trust companies, this proportion had reached i to 6.71. The institutions chartered by the Government to supply credit accommodations to the business pubhc had been permitted to grow top-heavy. Worse than this; not only was it permitted that they issue a dangerous proportion of demand credit to capital and money supporting it, but as has been commonly asserted and not denied that the character of commercial assets purchased by the banks by means of this credit was even more dangerous — a large part of the demand-credit having been issued in exchange for paper secured by collateral which had been purchased "on margin," the market price of which was gradually depreciating. As fast as prices depreciated the demands of bankers for additional collaterals be- came more tense. The net result was to force sales, thereby further to depress the market. In cases where speculators reached their limit, they made special pleas to the banks for "time," till the market might change. xii INTRODUCTION The Capital Weakness of Central Banks Revealed by Commercial Demands from the Interior The increasing demands from the commercial and in- dustrial constituency of the vast interior forced the issue. When the country banks began to call the loans which they had made to the reserve banks, when the reserve banks, in turn, were forced to call their loans to the great central reserve banks that had used these loans for money- reserves with which to support credit accommodations to speculators, then it was that the mutual props in the form of "legal reserves" began to give way, and the whole business constituency which depended on bank- credit for cash was thrown into a condition of distress. The resulting condition was what Mr. Ridgley has re- ferred to as the loss of confidence of banks in each other. To save themselves the central reserve city banks had to issue clearing-house certificates, which is a form of sus- pension of specie payments. This protective measure of the central reserve bank forced the banks the country over to do likewise. Mutual obligations within each community were settled by means of clearing-house paper. Relief finally came in the only way possible, through added capitalization. This capitalization, however, was only temporarily supplied. It was furnished by a syndi- cate of which the house of Morgan & Co. was the head. The government also added all of its remaining surplus available. A broader basis for credit liquidation was established through the importation of approximately $65,000,000 in gold, a large part of which was procured INTRODUCTION Xin by means of this new temporary capitalization furnished by the s)mdicate. But the reduction of the demand- credit used as "cash" in commerce and industry was far greater than either importation or money issue could supply — a contraction of the credit-circulating medium which resulted in reduction in prices, temporary receiver- ships, and wholesale stagnation of business. Never has there been a more tragic financial situation. Only the general prosperity of the commercial and industrial world saved us from the worst of business calamities. By the end of the year 1907 the credit stress was in a measure abated. This was in part due to importation and in part due to the largely decreased business de- mands resulting from receiverships and Uquidations forced on by the sudden withdrawal of hundreds of millions of dollars of banking accommodations which had been previously extended to legitimate enterprises. The remedy applied was drastic, wrecking the fortunes of thousands of persons engaged in useful employment. But the fundamental weakness of the system still remains to be dealt with. If collapse may come at a future time less prosperous than the present, failing credit may work still greater havoc. Dangers in the Present Readjustment The present readjustment is essentially a dangerous one. Not only is the added capital a temporary support, but in its method of application it is dangerous. Prac- tically the whole Treasury surplus is tied up in the settle- ment. January i, 1908, the banks were owing to the xiv INTRODUCTION United States Treasury, either in the form of direct loans or as deposits of disbursing offices, about $256,000,000. A part of this the government needs at once to meet its current expenses. By a continued poUcy of loaning the Treasury surplus to the banks, without interest, by per- mitting the banks to retain a large part of the loan as money-reserves for the support of obhgations to the de- positors during times of credit expansion, by permitting the banks to find relief in added loans from the Treasury and in a temporary syndicate, a plan of reorganization is accepted which does not take care of a large floating debt, and which does not provide adequate working capital. Another element of weakness is found in the fact that while the syndicate loans bear a high rate of interest, the loans of the Government are without interest. The syndicate loans, therefore, will be paid as rapidly as possible, while the government will be further importuned not to reduce its balances. In case it may happen that the country banks may again loan their reserves to the reserve banks, and the reserve banks may in turn loan their reserves to the central reserve banks, in sufficient amount, then the government may be able to gradually call its loans. But with the first considerable pressure brought to bear on the system, the experiences of last March and of last November may be repeated. Alternatives before the Government As a result of the present adjustment the Government is placed in a position such that one of three courses is open to it: (i) It may demand payment of loans to the INTRODUCTION XV banks with the possibility of disrupting the whole fabric of private credit based on the present reserve : (2) it may permit the banks to use its funds without interest, and borrow money at interest with which to meet its own current expenses; (3) it may, by charges of high rates of interest to the banks for loans in the form of deposits and bank notes, issued on collaterals deposited with the Government (or by other effective measures) force the banks to add sufi&cient permanent capital to their busi- ness to enable them to meet all their present emergency capital obligations, and at the same time insure the safety and stability of their own credit-accounts. In this situation President Roosevelt has appealed to Congress urging that the last of the three courses be taken. His specific recommendation, however, is confined to note issues. It remains for some one in authority to seriously propose a measure which will effectively apply the same regulative principle to the loans of the government to banks in the form of "deposits." Within the first six weeks of the present Congress sev- eral bills were introduced which provide for an interest charge on the loans. In the House, Mr. Fowler (H. R. 12,677) and Mr. Keifer (H. R. 208) proposed that banks be required to pay two per cent on government deposits. That such a measure would prove ineffective to cause banks to return government "deposits" after an emer- gency was past, is amply proved by some forty years of experience with reserve loans. At such a rate, banks have never been known to return reserve deposits until "called." In the Senate two bills have been introduced which aim to make "deposits" emergency loans, but whose xvi INTRODtrCTION defects are apparent. Senator Culberson (S. 3026) would have banks pay two per cent from August i to Novem- ber 30, four per cent from December i to March 31, and six per cent from April i to July 31 each year. This proposal assumes that money demands and credit disturbances regularly follow the seasons, an assumption which might do much to produce expansion and contrac- tion at the wrong time. The banker is in the best posi- tion to know when money demands are such that he can afford to pay six per cent for government loans, and these are times when the credit circulation should be increased or when more money is needed to support that aheady outstanding. Senator Piatt's measure (S. 108) would make the rate discretionary. This might prove effective and without public danger if a minimum of about six per cent were estabUshed to insure the use of the government loans for purposes of steadying the market in time of extraordinary demand. If the banks had the opportunity of borrowing from the government on proper security at six per cent and the government had the option of supplying funds either in the form of gold or paper money to be issued by it, the money rate could never rise far above the established minimum. In such event there would be no limit to the possibilities of expanding credit when needed, except the limits of adequate security for the loans among prospective borrowers. INTRODUCTION xvii Our Hopeless Philosophy of Panics Those who have expressed opinion concerning the cause of the recent panic used the same fataUstic philosophy as was employed centuries ago in accounting for ravages of "black death" and the scourges of smallpox and cholera. From time immemorial the same conclusions have been reached; after learned discussion, those in position to command respect for knowledge of financial situations have each time announced that sudden collapses of bank-credit have been due to an undefined, intangible, uncontrollable something called "lack of confidence." Comptroller Ridgley by a process of induction has given a new interpretation to this vague theory by asserting that the conditions which led to the panic of last October and last November were due "not to lack of confidence of the people in the banks, but more to lack of confi- dence of the banks in each other." With such a diagnosis of the malady by those who are looked to professionally for prescription of remedies, question may be raised as to whether we may ever hope to find rehef from financial ills. May we hope to correct a financial disease that is diagnosed as the result of a mental attitude of persons who may not be located and specifically treated? Congress is asked to pass remedial laws. What legislation will make business safe as against "what some people may think"? How may bankers be required to conduct their business to prevent "some people" from losing confidence? Does not such an analysis suggest that the philosophy of banking is still surrounded by the ignorance and mysticism of the dark xviii INTRODUCTION ages, and that public inquiry is still lacking in method of scientific research? Time was when a land-slide was attributed to the mental attitude of an evil one; when the breaking of a bridge or the falling of a building was considered as the inscrutable act of some great destroying force. The remedy proposed for such calamity is similar to that at present urged to relieve business, viz.; self-sacrifice and prayer as a means of restoring lost faith in an influence for good — acquiring a behef which has the power to protect the people against the intrigues of the devil. Since the days of the South Sea Bubble, this same mys- tically vague remedy has been proposed for protection against the collapse of bank-credit. Let us have con- fidence ! Restore our faith and we shall be saved ! A Plea for a Scientific Method of Determining the Charac- ter of Banking Legislation Needed to Protect the Public from Panics. In the search for causes of structural collapse, we have come to apply scientific standards to judgment. Were the tower of the Capitol building to show signs of weak- ness during a storm, the Government would not rest con- tent to set up props till the storm had abated. Were a great ofiice building of New York to fall, no one would think of the prayer of faith as protection against future evils to be suffered from collapses of similar kind, or of importuning Omnipotence for justice to those responsible for loss of life and property. Inquest would immediately go to the character of materials and workmanship used in INTRODUCTION xix construction. Neither would there be mystery or fatalistic philosophy woven about legislation proposed for future safeguards to the community; nor would it be accepted as satisfactory defence of building management that those in control had yielded to the importunities of persons wishing accommodation, and as a consequence the build- ing had been built too high or had been over-crowded, or had had a "run" on it that carried it and the tenants to destruction. If the structure had been used for pur- poses other than those approved, or if the owners had connived with officials, or officers of the law had per- mitted the superstructure to be carried beyond the point of safety, if the foundation had been overloaded and had crumbled beneath the weight, or if a superstructure had been erected of such physical parts as to endanger tenants or the public, under any and all of these circumstances tenets of scientific inquiry, premised on experience, would guide in determining responsibility for loss, as well as in the shaping of legislation for the correction of sim.ilar evils in other structures built or to be built. In engineering and architecture, as well as building ordinances, the guiding principle is: The greatest economy compatible with safety. But whatever the cost, founda- tion and materials must be of such strength and quality as to make the structure safe. In estimating the depth and breadth of foundation, or the strength of materials to be used in any part of a building, a liberal margin of safety is allowed to provide for strain greater than any that may ever be brought to bear. Should a bridge be under contemplation, then calculations as to the load or strain would depend on the character of use. After the XX INTRODUCTION bridge was completed traffic regulations would be framed to protect the public from danger of overloading, and the management would be held responsible for violations. Police control would also be exercised to prevent catas- trophe. Legislation Based on Ignorant Assumption may Increase the Danger Much of the legislation proposed to prevent collapses of bank-credit throws this kind of reasoning to the winds. The drift of opinion has been away from the theory of a coefficient of safety. The banking world is urged by public officials to make a still higher use of structural materials, i.e., to make such adjustments between them- selves as will permit the same capital to carry a larger load. No attempt has been made to calculate what burden a particular credit structure may bear without endangering the business public from credit contraction. The argument has been further to reduce the capital cost of banking. In estimating this, no account is taken of the cost to the community of the periodical wholesale demolitions and the wrecking of other business which have been induced by the banks to depend on them for current funds. The banks may be safe. Yes! But what of the many business interests that have come to rely on bank-credit for "cash"? There seems to be an utter bUndness to the public aspects of banking; no reckoning is taken of the fact that the forced con- traction of the credit of even the smallest of banks may cause greater loss and suffering to a community as a INtRODuCTlON XXI whole than would the collapse of the largest of physical structures. In the safety of a building structure the public is in- terested as a matter of physical protection to tenants and passers-by. Increased charges for rent due to capital cost required to obtain this protection is not accepted as reason for permission to build an unsafe edifice. At every cost, public safety is insisted on. In the safety of a bank it is not physical safety alone that is involved. The business, the fortunes, the life work, possibly the lives of all those who have made arrangements for their current financial needs, are directly at stake. Indirectly, a sudden contraction of bank-credit to protect the bank itself from collapse may unsettle well-founded business judgments, and produce conditions which may cause business con- cerns, not in any manner connected with the particular institution which institutes the measure, to topple to ruin. Indirectly, the business interests of a whole community or of a nation may be affected. Is it not worth our while to proceed in the determina- tion of questions of banking regulation on the theory that no capital cost is too great if it is necessary to protect the community against sudden contractions of bank-credit? May not the same principle of scientific inquiry be applied to the discovery of a margin of safety to prevent collapses of credit as has been applied to building structures? Of far greater importance to the welfare of the community is it that bank-credit shall not be constricted in time of need; of far greater importance that the capital founda- tion shall be adequate to support every dollar of credit issued by banks, so long as the credit may be needed xxii INTRODUCTION by the borrower; of far greater importance that a liberal margin of safety shall be required as against extraor- dinary strain. Would it not seem the part of wisdom for public men and public bodies to pass laws to prevent the overloading of the capital foundations of credit institutions, and over- accommodation, rather than that the Government shall be content to permit banks to extend their credit ad Ubitum? Is not legislation which requires the bank to do a safe business preferable to the administration of palliatives to the injured, or reUance upon the abiHty of the Treasury to prevent disaster by running to the sup- port of toppling credit walls as a means of relieving finan- cial institutions from the necessity of increasing the capital cost of doing business ? Elements of Certainty in the Problem of Elasticity In this relation it is suggested that banking and credit are just as susceptible to scientific analysis as are build- ings and building materials. With all the mystery that has been woven about the subject, every feature and element in the problem of elasticity of bank-credit is as capable of exact determination as are the tensile strength of iron, the crushing resistance of stone, or the wind strain on an office building. In law there is none of the mysticism about credit which is commonly assigned. Credit is an unconditional contract for the payment of money, nothing more, nothing less. So clear is the law on this point, that it has been repeatedly decided that any other form of contract or transaction is not credit. In INTRODUCTION xxiu business practice there is absolutely no uncertainty about what credit is. Every business man knows that if he be creditor he can insist on the payment of the amount and kind of money contracted for, and that nothing else may be substituted except by his consent, which amounts to a new contract. If he be debtor, he knows quite as well that he must obtain and deliver the money in the amounts and at the time contracted for, or in default of such delivery the courts may be asked to intervene and sell his entire estate if need be to procure this money. In the common parlance of the street, credit is a "short sale" of money; this sale is governed by practically the same rules as a "short sale" of bonds or a "short sale" of wheat. The only alternative to "dehvery" is "settle- ment," or the substitution of a new contract for the original credit contract. There is nothing mysterious about bank-credit. This is a contract entered into by a banker with his customer, called a depositor, or with the holder of the banker's note. The contract is one for the delivery of a definite amount of legal- tender money on demand; if the creditor of the banker be a depositor, then the evidence of the credit contract is a memorandum of account on the books of the bank and a corresponding memorandum kept by the customer in his own cash-book. It is a common credit relation — there is no uncertainty about it. It is identi- cally the same kind of a contractual relation as a demand- credit on the books of a manufacturer. In discussing the question of bank-credit therefore we may speak in exact terms, without any doubt or misunderstanding. The mysterious word "confidence" may also be re- xxiv INTRODUCTION solved into exact terms. Analyzed, to its constituent elements, what has been so vaguely spoken of as "con- fidence" may be clearly defined. In banking relations that which has been called "confidence" is a conclusion or judgment arrived at with respect to the value of a credit contract at the time that the contract is made, or a sub- sequent judgment which reflects itself in the exercise of the option under the contract to demand payment. To illustrate: A merchant takes in $i,ooo of legal- tender money over his counter. He carries this money to a nearby bank and exchanges it for a credit of $i,ooo, a memorandum of which is entered in his pass-book, as well as the customers' ledger of the bank. The merchant does this because, at the time he makes his "deposit," it is his best judgment that he would rather have the obliga- tion of the bank to pay him $i,ooo on demand than to have $i,ooo in lawful money. If this were not his best judgment he would not have made the change. "Con- fidence" in the bank means that for his own purposes he values $i,ooo of unsecured credit of this particular insti- tution more highly than he values $i,ooo of gold coin of the United States or other currency. The reason why the merchant has "confidence" in the bank is just as susceptible of analysis as is the definition of what constitutes "confidence." Why does he value the contract of the bank to deliver money at a future date more highly than money itself? The customary answer shows the inconclusiveness of the present method of approach. We are vaguely told that it is because the merchant has "confidence." That is to say, the mer- chant has "confidence" because he has "confidence," INTRODUCTION xxv and conversely, he does not have "confidence" because he does not have "confidence." Upon analysis it is found that the merchant's judgment as to the value of the bank's credit is premised in three other conclusions: (i) that "the banker is honest" — which being inter- preted means that, in the opinion of the merchant, the banker will do all in his power to meet his credit con- tracts on demand without resort being had to the court to enforce them; (2) that in the opinion of the merchant the banker is conducting his business in such manner that he will be able to fulfil every promise made by him to deliver money on demand according to the terms of his contracts; (3) that, in the opinion of the merchant, all persons with whom he currently deals have, or will have, also arrived at the same conclusions as has he with respect to the banker's honesty and paying ability. It is in facts or conditions which warrant or fail to war- rant the second of these conclusions that the chief ele- ment of public danger lies. Small loss has been suffered from mistaken judgments in arriving at the first con- clusion — the honesty of bankers. Reputation for honesty is brought to a test with each transaction. A single transaction which shows dishonesty will destroy all pos- sibihty of further sales of credit — in other words, will destroy the business of the banker. Dishonesty eliminates itself from the banking business. For protection against dishonesty little or no legislation is needed. Neither can legislation be made effective with respect to the third conclusion. Legislation cannot compel a trading public to accept the credit of any particular institution or class of institutions in exchange. It is with the second con- xxvi INTRODUCTION elusion only that laws may effectively deal, and in the character of dealing with this lies the whole problem of elasticity and the safety of our financial system. The conditions under which the banker is permitted to offer his credit for sale, the manner in which he shall conduct his business, the amount of capital required, the character of equipment in which his capital shall be invested, the amount of obhgations to depositors that he will be per- mitted to incur to each dollar of capital invested in the business, the amount of minimum cash required, the con- ditions under which he will be permitted to loan to and borrow from other banking institutions, the conditions under which he will be permitted to obtain aid from the government, the character of business to which he will be permitted to extend credit, the character of assets he will be permitted to buy in exchange for demand-credit, every phase and aspect of his business which enters into the customer's judgment as to abihty to pay, are subject to the most exacting regulation and critical current ex- amination of public officers. It is also in factors of this class that every question having reference to panics, runs, collapses of credit, credit expansion, credit contraction, and increased and de- creased demand for money relates itself. These factors are also subject of record and current report and may be classified and summarized for purposes of exact deter- mination of elements of strength and weakness, of safety and public danger. Not only may instruments of pre- cision be used in the diagnosis, but each remedial reagent may be scientifically tested in its apphcation. INTRODUCTION xxvii The True Function of a Bank Critical analysis and regulative measure must have reference to the function and purpose of the commercial bank. This factor of the problem also leaves no room for uncertainty. The business of a commercial bank is essentially the business of selling its own credit for the money and commercial paper offered in exchange for this kind of "cash." The high value set on the convenience and economy of bank-credit as "cash" for use in the making of purchases and payments has caused business men to take nearly all the money and commercial paper received by them in their own business to the bank and to offer them in exchange for the bank's credit-accounts. The check and the draft are simply the instruments by which the bank's customers demand payment, or transfer certain portions of their bank-credit to others — these transfers being accepted in Ueu of money. Selling stocks and bonds, underwriting the purchase and sale of cor- porate issues, collecting, the purchase and sale of coin and bullion, are not banking. They may be incidents or accessories to the business, but any one or all of these functions may be exercised by those who have no powers to engage in the business of banking. From the point of view of ability to pay demand obUga- tions, money is the only equipment needed by a bank. With the question of profit eliminated, the only form in which a bank need carry either capital or deposits would be legal-tender money. From the point of view of mak- ing a profit out of the business and at the same time of conserving its money-paying ability when money is de- xxviii INTRODUCTION manded, the banker seeks to keep all his capital, as well as the money received in exchange for his credit, invested in income-producing assets which are readily converted into cash when needed. If the capital of the bank alone were held as reserves for the meeting of demands for money, the business of the bank would be to exchange its own credit or the money and other cash assets, obtained in exchange for its credit, for commercial paper. Were the entire capital not currently needed as money-reserves, then the portion not currently needed may be invested in such manner that the investments may at all times be converted into money without loss, and without waiting for maturities. So considered the business of banking has two distincts sides — viz., a credit trading side and an investment side. What Amount of Capital is Required to make a Bank Safe Accepting the only logical definition of capital — viz. — funds or property contributed by shareholders or other proprietors for the purpose of providing an enterprise with the resources or equipment permanently or con- tinuously necessary to the safe and successful operation of the business, and again we are on scientific ground. Again the problem of elasticity lends itself to exact analy- sis. The profits of a bank, as such, are derived from sales of its credit. The amount of its banking profit depends on the amount of its credit it can exchange for money and other cash or income-producing assets — or, to use the parlance of bankers, on the amount of its "deposits." The equipment necessary to the highest INTRODUCTION xxix success of a bank is such an amount of money held "in reserve" as is necessary to meet demands for payment on all the credit which it is able to sell — or again, to use the parlance of bankers, a money-reserve large enough to meet the demands of depositors. The amount of capital needed by a bank, therefore, is such amount as is neces- sary to provide it with its of&ce equipment and with an adequate money-reserve. If the capital of a bank is not sufficient to do this with safety, then it is under-capi- talized. Under such circumstances, the bank would be in much the same situation as a railroad that is carrying a part of its construction on floating debt, or a manufac- turer who has supplied himself with machinery by means of demand loans. If his current loans are called he must sacrifice some of his product or current business to meet them and possibly be forced to sell his plant also. This does not mean that a bank which does not capi- talize all its equipment, including its money-reserves, is in danger of insolvency. A bank as well as a manufacturer may at all times be solvent and may so conduct its busi- ness as to meet every credit-obligation without a dollar of capital. If it rents its banking room and furnishings, if it invests its credit in money or other assets that may be quickly converted into money without loss, it may meet all obligations, provided the income on its loans is suffi- cient to pay expenses. But such a bank is in a position at any time to lose its business by being forced into liquida- tion. In other words, it cannot fall back on a capital fund to protect its deposit obhgations, and, therefore, as was the case with many institutions in the recent panic, it may lose its depositors while other institutions that are XXX INTRODUCTION able to protect all credit-obligations without forcing loans will get them. What is the Public Interest in Bank Capitalization! The bank is not the only one to suffer from lack of capitalization. The customer is vitally interested, so vitally interested that the bank always makes a point of advertising the amount of its capital as an inducement to the customer to buy. The public as a whole is in- terested for the further reason that banking capitaUzation is one of the prime factors in elasticity both of the volume of money and of credit. PubUc interest in the capital equipment, therefore, may be said to be twofold: 1. Each individual is interested in the lank as an in- stitution chartered to provide a convenient form of "cash." The one who sells his note or his money to a bank in exchange for its deposit obligations does so by reason of his desire to provide himself with current funds in con- venient form, needed for his immediate uses. In estab- hshing a banking relation, therefore, he desires to deal with an institution that can safely sell sufficient credit to meet his current financial wants. For the same reason, it is his desire also to deal with a bank that at all times is able to maintain the account which he has contracted for without caUing his loan or diminishing his accommoda- tion, so long as accommodation is needed, provided he has good commercial paper to offer in exchange 2. The public at large is interested in the manner in which banks are managed on account of the effect which a rapidly increasing and decreasing volume of available INTRODUCTION xxxi cash has on prices. By reason of the medium of exchange being so largely in the form of bank-credit, instead of money, the country at large or the combined business interests of the community and of the nation demand that there shall not be an expansion of bank-credit which can- not be supported so long as the current funding need which created the credit is present; and conversely, that there shall not be sudden contractions in the medium of exchange brought about by efiforts of banks endeavoring to convert needed business accommodations into money to enable them to make deliveries on deposit obligations. It is such a condition as this that prevails in time of panic, and these are the conditions that should be met by adequate and safe capitalization. By application of methods of research, it is entirely possible to know whether the past emergencies could have been met if the banks of the United States had been required by law to capitalize their equipment, including their legal reserves. We would also be able to reach a scientific conclusion as to whether much of the present danger might be avoided if banking reserves were not tied up in loans to speculators "on margin." Conclusions that Have Been Reached as a Result of Experience As a result of the experience of the last few decades, and of reflection on the numerous collapses suffered in institutional credit, certain conclusions have been reached that may be said to be generally accepted. These are as follows : xxxii INTRODUCTION 1. That the dominant demand in time of credit strain is a demand for money which the banks are unable to supply except at the expense of a very great contraction of commercial credit; 2. That the present law which permits the issue of bank-notes was framed for the purpose of stimulating a favorable market for government bonds; that at the time of the formulation of the National Bank Act no thought was given to making either the currency or the bank- credit circulation elastic, and that some provision should be made for increasing the elasticity of the cur- rency as well as for increasing the elasticity of bank- credit; 3. That the means employed by the Government for encouraging the banks to invest in Government bonds (viz., permitting them to hypothecate the bonds purchased for their par value in notes, without the payment of in- terest on such notes sufficient to keep them out of circula- tion in times when they are not needed) encourages the banks to encumber their capital to such an extent that they are unable to obtain notes from the Government when needed except by borrowing government bonds from savings banks and other investment institutions; and that under the operation of the present law the only effective relief which may be given by the Government to relieve money-demands on the banks is through Treasury "deposits," this being made possible only by permitting new forms of security to be used as collateral. 4. That the National Bank Act is defective in that it permits all the banks outside of the central reserve cities to loan their legal reserves, and still count these loans as iNTRODtJCTION Xxxlii reserves for meeting obligations to pay depositors; in operation the reserve law only makes the banks inter- dependent, but also makes a large part of the money and credit of reserve institutions available for speculation only, thus encouraging "margin trading" during periods of low interest rates, unsettUng the investment markets and endangering the whole credit system for the protec- tion of which the reserves are created. Neglected Aspects of the Currency and Banking Question While there is practical unanimity of opinion with respect to the need for elasticity and some of the condi- tions present which have produced inelasticity, experience, especially our recent experience, points to essential con- siderations that have been entirely overlooked or seldom referred to in discussion. The considerations referred to are suggested by the following questions: I. What amount of elasticity must be provided for? The question has a double bearing; it suggests inquiry, with respect to two aspects of the financial situation; {a) what is the variation in the business demand for money, and (6) what is the amount of elasticity in bank- credit required to meet legitimate business demands ? That no serious attempt has been made by legislators even to approximate a scientific conclusion appears from the bills now pending. The limits to be placed on issue powers of banks range from $250,000,000 to not less than $2,000,000,000. xxxiv INTRODUCTION 2. What kind of protection is needed? A large number of bills have been brought forward at Washington to the end that the deposit obhgations of banks may be insured. That this element of pro- tection is seriously contemplated is shown by the large proportion of all the banking bills containing such provisions and the broad representation and high standing of their authors. Among them may be named Senators Raynor, Culberson, Brown, Nelson, Curtis, Gore, Scott, and Owen, and Representative Fowler. Deposit insurance will doubtless be forced by state legislation, if not by the federal law. But as- suming that the deposit obhgations of banks had been fully insured, would this have materially relieved busi- ness distress during the recent panic? Assuming the average time of bank-credit accommodation to be sixty days, the actuarial risk of loss amounts to about -^^ of one per cent. Do stability of business and sane judg- ment require legal protection against loss from insol- vency of banks, so much as legal protection against the violent and dangerous expansions and contractions of bank- credit? Are not the direct losses to depos- itors neghgibly small as compared with the disasters which foUow the efforts of banks to obtain money with which to protect themselves from insolvency, or from inability to maintain their own credit-accounts when demand is made by other banks for settlement of balances. INTRODUCTION xxxv 3. What are the influences which bring about dangerous expansions in credit? From 1904 to 1906 the expansion in deposit obli- gations of commercial banks of the United States amounted to about $2,000,000,000. This was the amount by which this form of cash was increased with- in the two years immediately before the present stress for money became seriously felt. It is not suggested that any danger lies in the mere fact of expansion, but it is now a matter of experience that this particular ex- pansion was dangerous. It is also a matter of history that the havoc wrought by every panic that has oc- curred during the last half century has been the result of the contraction of a dangerous expansion of bank- credit. Looking toward a proper appreciation of the influences which bring about expansion the fol- lowing questions seem pertinent. In time of finan- cial ease, has it not been the constant effort of banks to increase their demand obligations to depositors without any regard whatever to their own capitaliza- tion? As a means to this end, and at the same time keeping within the money-reserve requirements, have not the national banks in reserve cities offered inter- est and every known inducement to other institutions for money loans which might be carried as reserves to support a credit expansion that ultimately became dangerous ? 4. What are the incidents to credit contraction? Without adverting to the results of contraction of XXXVl INTRODUCTION credit so disastrously felt and heroically met by the business community, the recent panic suggests the following specific inquiry: Is the financial problem which confronts the community in time of panic pri- marily a currency question, or is it essentially one of the inability of banks to maintain a volume of credit which they had previously issued to merchants and manufacturers for use as cash in their current busi- ness? Is not the purpose of these issues of credit to increase the profits of the bank? Have not a large part of the reserves which have been held by banks to support these increased credit issues been borrowed from other banks, instead of being provided for by cap- italization? Have not money stringencies been largely due to demands created by these banks for the pay- ment of reserve loans as a means of protecting their own customer's accounts? In these several relations the following statement of facts taken from the report of the comptroller is illuminating: Banks Individual Deposits Money Reserves Percentage of money reserves to deposit Money borrowed from other banks and the 0. S. Treasury (millions) 13.495 2,061 3,068 4,319 151 (millions) $ 28 104 254 701 8 .008 .050 .083 .162 .058 (millions) $ 8 Loan and Trust Companies State Banks 167 211 1,738 2 Private Banks $i3,°9S $1,097 .084 $2,128 There are now two bills before Congress which make a clean breast of the reserve loan practice. Senator INTRODUCTION xxxvii Culberson (S. 3027) would have "every national bank . . . keep on hand in its own vaults the reserve of lawful money provided by law." Senator Heyburn (S. 3044) would require that when a bank shall permit its money reserve to fall below twenty per cent it "shall not increase its liabilities by making new loans other than by discoimting or purchasing bills of exchange payable at sight," and would also during such period forbid the payment of dividends. These measures would seem to be weak at two important points, viz., (i) they do not provide for the investment of reserves and the use of these investments as security for govern- ment loans or issues; (2) they do not attempt to co- ordinate reserves with capitalization, i.e., under either measure the money-reserves may be borrowed money. 5. Whai would be the effect of the capitalization of legal reserve requirements? To know what amount of capital would be required to provide for redemption equipment equal to the amount of the legal reserves required of banks (after taking out of the capital and surplus such unavailable assets as the cost of banking houses, real estate, and the margins on securities deposited as collateral for issues, govern- ment deposits, bonds borrowed and other secured loans, and also after providing for the necessary work- ing balances to provide for exchanges in other cities) would require a special inquiry on the part of the comp- troller of the currency. As nearly as may be approxi- mated without an official inquiry, such a provision of xxxviu INTRODUCTION law would add not far from $500,000,000 to the cap- ital of national banks, as a prerequisite to incurring their present deposit obUgations, and, if applied to state institutions as well, would add not far from $1,000,000- 000 to the total bank capital of the country. What- ever might be the amount, would not this added capital contribute materially to give increased stability to business and increased elasticity to bank-credit? Even though it add to the capital cost of bank-credit, would it not be an economy to the business world ? Presumably some such result was in the mind of Senator Owen when he introduced his bill (S. 3987) by which he would forbid a national bank from incur- ring deposit obligations in excess of ten times its capital and surplus. He would also limit speculative loans to the amount of a bank's capital and surplus (S. 3986). In view, however, of the known facts, these measures would be of no practical effect. The ratio of capitalization to deposit obligations has been re- duced two-fifths since 1896. Should not immediate steps be taken to make the foundation of our credit safe, and provide for adequate expansion without en- dangering the public? 6. Is it either safe or expedient to have a large volume of hank-notes permanently outstanding? For two decades the banking interests fought against the continued use of greenbacks. The result of the agitation was a compromise limiting the form of credit- money to $346,000,000. During the last few years the INTRODUCTION xxxix bank-note circulation permanently outstanding has been increased over $400,000,000. In this relation the ques- tion may be raised as to whether Gresham's law does not operate on permanent issues' of bank-notes as well as on greenbacks. Have we not in recent legislation and practice, with respect to bank-notes, employed a form of money that is cheaper to the banks than greenbacks? Have we not in the volume of bank- notes permanently outstanding a monetary device more dangerous than greenbacks, for the reason that they not only drive gold and silver out of the country but at the same time encumber the banking capital by means of which gold and silver might be brought into the country when such a need is felt. In the legisla- tion now before Congress few measures have any re- gard for this situtation. The bills of Senators Knox (S. i239),Raynor(S. 2954), Aldrich (S. 3023), and Owen (S. 3988), follow the recommendation of the President, viz., that the bank-note currency should be taxed suffi- ciently to make it an emergency currency. Senator Knox would tax all issues secured by United States bonds five per cent, and all issues having other col- lateral security 7 per cent. This is subject to the criticism that such a tax imposed, without refimding the national debt, would at once operate to reduce the price of United States bonds, and therefore would amount to confiscation of the premium. Senator Aldrich has met this moral question by providing that the tax on issues against United States bonds remain practically as at present, but would impose a tax of 6 per cent on all other issues. His measure, however, xl INTRODUCTION becomes practically ineffective in that it makes no provision for reducing the permanent bank-note circu- lation; in fact, by the terms of his bill, the permanent note circulation might be increased, and it specifically provides that all banks may thus encumber 50 per cent, of their capital and surplus. Senators Raynor and Owen would impose 6 per cent during the first four months of issue and 8 per cent thereafter, per- mitting any security to be accepted that may be ap- proved by the Secretary of the Treasury. 7. Should government funds he used to give more than temporary relief? In this relation it is to be conceded that bank-notes are nothing more nor less than loans of government money to the banks without interest. The govern- ment loans unsigned notes to the bank for issue in exchange for a collaterally secured obligation of like amount to the government. Unquestionably govern- ment "deposits" stand in the category of collateral loans without interest. Having this fact in mind, these questions are fairly presented : When business interests are endangered by reason of the inability of banks to maintain the volume of credit needed, should govern- ment loans be looked to to give more than temporary relief? Do not loans by the government without in- terest, or at a low interest rate, cause the banks to rely on "deposits" instead of their own capital? Will not such a practice cause the banks to retain these loans when not needed, unless the government arbitrarily INTRODUCTION xli enforces payment against their wishes? Do not de- posits, without a rate of interest which will cause the banks to repay the loans as soon as an emergency is passed, leave the whole situation subject to the discretion of public officials, instead of making regula- tion automatic? Does not a large volume of govern- ment deposits or loans without interest to the banks, weaken instead of strengthen the credit situation, and leave the banks without the possibiUty of obtaining collateral aid when a new emergency arises? 8. Is a "great central bank" a better institution to give collateral support to our banks than the Treasury? The large bank idea has taken two distinct forms, one as expressed in Senator Hansbrough's bill (S. 547) giving to an institution controlled by other banks the widest banking powers, both of loan and deposit; and the other as expressed in Congressman Fornes' bill (H. R. 13845) giving to a government controlled insti- tution, with capital of $100,000,000, powers of issue only — all issues over $100,000,000 to be taxed on a graduated scale of from 6 per cent to 10 per cent per an- num, thus making the issues in excess of capital an emergency circulation. Assuming that a large perma- nent issue of bank notes is not a good business expedi- ent, and narrowing this part of the problem down to a choice between a great bank and the United States Treasury, in case the funds of the United States Treas- ury were not permanently loaned to banks may not the United States Treasury do all that it would be safe xlii INTRODUCTION for a great central bank to do? In case the funds of the government were loaned or deposited with a cen- tral bank would they not operate on the financial system in the same manner as if loaned to other banks ? Having in mind the arguments of prominent bankers, the further question may be asked: Does the cumula- tion of a treasury surplus operate to deprive the busi- ness of the country of the use of money held by the government, or is this surplus drawn from the money stock of the world, thus increasing the money stock of the United States? If the conclusion is reached that it does operate to increase the money stock of the United States, with adequate money-reserves main- tained by the banks may not a treasury surplus be held with advantage as an emergency fund for any use to which it might be applied, thus placing the United States in a stronger position financially than any other nation, — a situation which might go far to relieve this country from the incidents of falling markets and faihng credit abroad? Would not legis- lation which would permanently encumber or tend to encumber the government surplus or lower the capital strength of the banks, operate to make this country still more dependent on foreign states, and to relin- quish a financial advantage which by nature and trade position it enjoys? INTRODUCTION xliii Evolution not Revolution Needed to Make Business Credit Secure In recent discussion of currency and banking, it has seemed that a too narrow view has been taken: By one class the assumption is made that "issues" of Government are capable of affording the "elasticity" desired; another has attempted to demonstrate that in an "assets-bank- currency" is to be found the nostrum for financial ills. Both classes have failed to recognize the fact that fully ninety-five per cent of the "cash" used in business other than banking is made up of bank accounts. Both have failed to see that the great credit structure by means of which business is transacted rests on two distinct and widely separated pillars — the Independent Treasury, and the Commercial Bank; that each has its own burden and responsibilities; that the one is an institution of pub- lic-money-issue, the other an institution of private-credit; that the one supports a large issue of credit-money upon a "gold reserve" for its foundation, the other a still larger issue of bank-credit upon a "lawful money-reserve." Upon these two pillars is rested a superstructure of private- credit incalculable in amount — a magnificent pile, to the building of which nearly every business transaction of the immediate past has contributed and which in its long- time credit-obUgations projects itself into the future, in- volving to a greater or less extent the prospective business of the next fifty years. It is this towering superstructure of credit, sensitive to the last degree, and the contempla- tion of the perils of a shock to so delicate and compre- hensive an organization, that makes a matter of currency xliv INTRODUCTION or banking reform a dangerous undertaking — one that should be carefully considered and not entered upon lightly from motives of political expediency. During the last two decades currency and banking questions have been prominent in the councils of the nation, and many radical changes have been proposed. Every sudden institutional or social change must of necessity be accompanied by disturbances due to break- ing bonds of custom and to the introduction of certain elements of the unknown as premises for judgments con- cerning the future. This fact, together with the known sensitiveness of the credit structure, suggests that what- ever the financial reforms to be undertaken, we break with the present no further than is necessary to accommo- date immediate needs. Sweeping changes would amount to financial revolution, and proposals of this kind should be peremptorily dismissed. The suggestion that we should at once abolish one of the pillars upon which the national-credit superstructure rests (the United States Sub-Treasury) brings with it nothing but a picture of national distress. No change of this kind could safely be undertaken till the present burden of credit-money had been removed from the capital; there must first have been a complete revision of the monetary system — a system that we have labored a century to bring to its present state of "soundness" and which in its architectural plan is yet scarcely completed. The proposition to throw the whole financial burden on the commercial bank, and to strengthen this by a scheme of centralization, carries with it the same certainty of disaster, unless the change be gradual, and unless also INTRODUCTION xlv every shift of stress be made after a careful calculation of probable results. And this calculation should be something more than philosophical conjecture. It should be based on ex- perience. In the preparation of this work it has been the constant endeavor to measure carefully every salient point of the present financial structure, to take into account the monetary and banking experience of the past, and, having in view this experience, to suggest certain results that may be attained in the direction of increased sound- ness and elasticity by slight changes in the organic rela- tions of the system with which we are now working and which in all its details we may understand. Making these suggestions it has been the underlying belief that experi- ence is the only safe guide to judgment — that evolution and not revolution should be the principle of financial reform. New York, January 15, 1908. CONTENTS CHAPTEK pjVOE I. Commercial Banking and Speculation . . i II. The Use of Commercial Bank-Credit in Lieu of Industrial Capitalization . . 13 III. The American System of Currency and Banking 29^ IV. Credit-Money and the National Bank . . 41 V. The Demand for a " Sound " and " Elastic" System of Bank-Credit 54 VI. The Relation of Bank Capitalization to the Problem of Elasticity 67 VII. The Public Control of Commercial Banks 77 VIII. An Element of Control not Adequately Provided by the National Bank Act . 99 IX. Character of Assets that May Be Safely Held by Banks as "Invested-Reserves" 113 X. Public Dangers in the Present Equipment OF National Banks .... . . 127 xlvii xlviii CONTENTS CHAPTEE PAGE XI. Why the "Unencumbered Securities" of National Banks are not Readily Con- vertible INTO Cash 146 XII. False Assumptions made by the Govern- ment WITH Respect to Currency and Banking .... .... 157 XIII. Advantages of National Banks over State AND Private Banks under the Present Practice ... 171 XIV. The Amount of Money and Credit for WHICH Elasticity should be Provided . 180 XV. Possibilities of Elasticity under Our Present National Banking System . . 193 XVI. Possibilities of Increasing Elasticity by Simple Modifications of the Present Law 208 XVII. Superior Possibilities of the American Financial System for Adapting Current Funds to Current Needs . . XVIII. Recent Efforts to Adapt Our Currency and Banking System to the Nation's Business Needs 237 259 Appendix of Documents: "The Baltimore Plan" of Currency Reform, 1896 . 291 "The Carlisle Plan," 1896 293 Fowler Bill of March 15, 1897 . . . . 296 Indianapolis Monetary Commission Bill, January 6, 1898 303 CONTENTS xlix Appendix — Continued: McCleary Bill, May ii, 1898 . . Aldrich Bill, December 19, 1899 . Secretary Gage's Bill . Gold Standard Act, March 14, 1900 Fowler Bill, April 4, 1902 . . . Payne Bill, February 26, 1903 Fowler Bill, February. 26, 1903 Culberson Bill, Januajry 7, 1908 (S. 3027) Heyburn Bill, January 7, 1908 Rayner Bill, December 21, 1907 Brown Bill, Januajy 7, 1908 . Culberson Bill, Ja,nuary 7, 1908 (S. 3028) Gore Bill, January 13, 1908 . Scott Bill, January 14, 1908 . Curtis Bill, January 14, 1908 . Knox Bill, December 5, 1907 . Aldrich Bill, January 7, 1908 . Culberson Bill, January 7, 1908 (S. 3026) Bulkeley Bill, January 9, 1908 Clay Bill, January 9, '1908 Owen Bill, January 15, 1908 . Piatt Bill, December 4, 1907 Hansbrough Bill, December 4, 1907 Fornes Bill, January 15, igo8 306 3" 312 316 319 325 327 327 329 33^ 33^ 335 335 337 338 342 348 350 352 353 355 364 368 FACING PAGE List of Charts: I. Showing fluctuations in credit compared with capitalization . - - 4 n. Showing commercial assets compared with capitalization . - 8 m. Showing periods of increased and decreased business activity 18 1 CONTENTS List of Charts — Continued: ^*^™° IV. Showing correspondence of credit fluctuations with business activity. . ... 24 V. Showing fluctuations in money-demand ... 60 VI. Showing eSect of national money-demand in New York . 70 vn. Showing how money-demands reach New York through the reserve system 134 vm. Showing amount of money borrowed by New York banks for use as reserves 152 rx. Showing how bank-credit is affected by specu- lation . . . ... 160 X. Showing how fluctuating demands are met in Cotton States 176 XT. Showing varying conditions of credit in different sections of the country .... . . 184 xn. Credit conditions in Com States compared with Cotton States . . 202 xm. Showing money-reserve, securities -held, credit accounts and commercial assets of National Banks ..... 244 Tabular Inserts: I. Consolidated Statement of Capital Accounts of all National Banks in the State of Iowa . . 94 re. Classified and consolidated balance sheet of all National Banks in the United States . . . 130 THE BANK AND THE TREASURY Chapter I COMMERCIAL BANKING AND SPECULATION December, 1890, the announced embarrassment of Baring Brothers called the credit institutions of Europe to a halt. A period of promotion and specu- lation in new industrials, in railways. Periods of credit j ■ ,t_ -. • r o ^i a ' fluctuation ^nd m the securities of South Amer- ica, Australia, and South Africa was suddenly ended. The movement preceding the failure had been one of expansion — a struggle for increasing profits; the movement following the fail- ure was marked by credit retraction and trade depression — by efforts to recoup and prevent fur- ther loss. Although for two years after 1890 we had tremendous forces working in our favor (with un- precedented yields of grain and higher prices of food stuffs, due to crop failure abroad), the detracting in- fluences of foreign depression and foreign financial reorganization brought home to the United States the fact of over-speculation; in 1893 our credit institu- tions collapsed and we followed the wake of Europe through a period of depression. Our experiences of 1893, following 1890, was similar to our financial [1] 2 THE BANK AND THE TREASURY collapse in 1884, following foreign failures in 1881. September, 1902, brought us again to face the pos- sibility of another credit reaction. About two years before, another period of specu- lation abroad had come to an abrupt end; since that time Germany and England had been passing through financial readjustment and reorganization. Here in the United States, as in the two years fol- lowing 1890, we had forces at work to keep the wheels of industry moving at an increasing atumf^^^ ^^ '■^*^' ^^^ trade journals looked upon this growing activity as evidence of national thrift — an era of unprecedented prosperity based on safe business methods. Those represent- ing manufacture, merchandising, and transportation enterprise saw ahead nothing but increasing activity. But the experience of the last four months of 1902 caused men in financial circles to regard the situation with feelings of apprehension. Months of strain on our commercial credit institutions, months of adverse trade balances, months of increased speculation had put those in control of financial interests on their guard. Causes of Credit Fluctuations After September, 1902, the financial situation was the general topic of discussion among bankers, and these deliberations found strong expression in ap- peals to the National Government for measures of relief. Among those who early sounded notes of BANKING AND SPECXILATION 3 warning was the vice-president of the National City Bank of New York. Commenting on the financial outlook in November, 1902, Mr. explnsim"^"^''^ Vanderlip showed that from 1896 to 1902 the increase in business activity of every kind had been accompanied by a like increase in the credit-accounts (so-called deposits) sold by banks to their customers; and that along with so- called prosperity had been purchases of commercial paper by the banks by means of these increased book-credits or "deposits." He called attention to the dangers of expansion in the credit-accounts (de- posits) of the National banks. He pointed to the even greater extension of credit by State banks and trust companies. From the most reliable data available the increase in demand obligations to depositors was placed at $3,600,000,000; within six years there had been an increase of credit-funds in the form of bank accounts, amounting to almost double the entire money stock of the country both in circulation and in the Treasury. What had been the increase in banking equip- ment ? What provision had been made by the banks for maintaining these increased burdens on the credit structure? After showing that during the three years following 1899 the credit accommoda- tions of National banks alone had increased $1,300- 000,000, Mr. Vanderlip further commented as follows: "With that increase in liabihties of Na- 4 THE BANK AND THE TREASURY tional banks in mind, let us look at the assets representing the reserve basis. The CredU weakness ^^^^^ ^f -^ ^^^ legal-tenders held due to tnjiation ^ ° by National banks last month [Octo- ber, 1902] was $508,000,000. The total at the begin- ning of 1899 was $509,000,000. Here we have an expansion of $1,300,000,000 in deposits [demand obligations of the banks used in the community as funds], while the basis of gold and legal-tenders upon which that inverted pyramid stands is actually slightly smaller than it was at the beginning of the period. Now, in that same time, the deposits of the other banks — State banks, trust companies, savings banks, and private banks — have probably increased not far from three billion dollars, and there is little likelihood that their gold and legal- tender reserve is materially larger than — if it is as large as — at the beginning of 1899. We have had, then, in less than four years, an increase in the bank deposits [bank credit-accounts] of the country of over four billion dollars accompanied by no increase in the specie or legal- tender holdings of these banks." Causes of Credit Contraction The data relied on for this conclusion were taken from the report of the Comptroller, an official compilation made from the returns of the banks themselves. The evidence presented in the report of the Comptroller, however, went further; it showed o8 § 8 i 21UU 1800 1500 ^ 3300 3000 2700 W CJ SCALE ^5 Q IN MILLIONS OF DOLLARS t 1 , , I INDIVIDUAL DEPOSITS, DEPOSITS OF UNITED STATES DISBURSING OFFICES, AND AMOUNTS DUE TO BA^ (C) NET OUTSTANDING DEMAND OBLIGATIONS -\.B\ lesS AMOUNTS DUE FROM BANKS, AND CURRENT EXCHANGES. CB J TOTAL CAPITALIZATION -SHARE CAPITAL, SURPLUS AND UNDIVIDED PROFITS. (A) TOTAL SHARE CAPITAL. y- CO jV ^ :^ \o g > S 00 \ ' V ^^ S i \ [ CO ^ t ^ g 1 1 \ 00 1 I CO \ ca CO I ) § i [ > 8 < -j5 ^^ ; [0 < _> ) ) i'; 0^ 3 > DO V \., v5 ^ ^ 00 I > v,0 1 '\ V 8 \ \ d \ N > S c5 CO t> »o fo 08888 I ' 00 "^ 3 8 g 3300 3000 2700 W U SCALE S^ >^ IN MILLIONS OFDOLLAFS BANKING AND SPECULATION 5 that, during the period under discussion by Mr. Vanderlip, the capital of these institutions had not been proportionately increased. We may take a still longer period: May, 4, 1893 (before the de- pression began), the capital, surplus, and undivided . , , . , profits of National banks amounted Lack of capital , * „ , ^ r, o i support to 11,041,807,066.87; September 15, 1902, immediately before the Octo- ber money and credit stringency of that year began to be felt, the total of capital, surplus, and undivided profits was only $1,201,145,882.69, a decrease of nearly $1 1,000 per bank doing business. There had been an increase of $1,561,335,896.44 in obligations to depositors, while the gross increase in capitaliza- tion available to support this increase in demand liabilities was only $159,338,815.82, about ten per cent. The average net increase in deposit liabilities was $282,418; the net decrease of capital was $10,951 per bank doing business. The banking equipment of 1893 had proved too weak to support outstanding credit obligations. In September, 1902, the current credit-accounts out- standing were vastly larger than in 1893. Without, therefore, materially increasing the capital employed in the business, in fact actually de- Comparison of • ^i. v i t_ i 1893 and 1902 creasmg the average capital per bank doing business, the banks had been offering to the public, and actually selling, an increase in accounts-payable over those outstanding in 1893 6 THE BANK AND THE TREASURY amounting to $1,567,000,000; in 1902 they had sold an amount of demand-credit for use in the busi- ness community as funds equal to about double the amount of deposit liabilities outstanding in 1893. The experience of 1902 was a repetition of the ex- perience of 1893, and this in turn was a repetition of 1884 and 1873. In each of the previous cases disas- ter had followed close on the heels of an inflation of credit-accounts. Methods Employed for Expanding Commercial Credit But in his address of warning Mr. Vanderlip did not stop with showing the weakness of the reserve basis. He proceeded to a second conclusion: "What," he asks, "has brought about this remark- able development of bank-credit?" The answer must at once come to the mind of any observer of finance that the principal reason for the expansion of deposits (bank credit-accounts) The flotation of ■, ,^ . . . new companies ^^d the accompanymg expansion of loans (commercial paper held by banks) is to be found in the great movement which has been the significant feature in financial affairs of the last half dozen years — the movement to aggre- gate industrial establishments into single great cor- porate units and to convert the evidence of ownership into corporate securities which have entered actively into the stream of financial operations. Vast amounts BANKING AND SPECULATION 7 of new securities have been created in these half- dozen years, based in a large measure upon proper- ties which were before held as fixed investments by individuals, or, if standing in the form of corporate property, the securities of these corporations were more closely held, and in but small measure entered into the financial operations of the day. This move- The use of new ^lent — tending to convert the evi- issues as col- dences of ownership of a great amount * ^'^'^ ^ of fixed property into a form which has been considered a bank collateral, and which has been made the basis of loans and of corresponding increases or deposits — is undoubtedly the most im- portant single cause for the increase of more than four billion dollars in bank deposits [bank accounts] and bank loans [commercial paper] of the country in the space of three or four years. A False Notion of "National Prosperity" We would not shut our eyes to industrial progress — to the fact of augmented capital and increasing production. We would not deny the benefit of thrift, nor the prosperity which comes from mating industry with economy. But such are not the phe- nomena which have stirred national pride, carried The imaginative it beyond the rule of reason, and un- quality in busi- settled the judgment of our industrial ^^^^ leaders. Periodically we become psy- chologically drunk. That which has inebriated has 8 THE BANK AND THE TREASURY not been the wine at the feast, but a distorted imagi- nation that lives in dream-pictures of opulence. Not the actual increase in wealth, but an increase in the estimates of value given to our possessions swells us with a vanity of hope which marks us for destruction. The basis for criticism for every "note of caution" addressed to the public during such a crucial period is found in the exuberant feeling then current, ex- pressed in the oft-repeated phrase "national pros- perity." If we accept the reasoning of Mr. Vander- lip and others, the ancestral lineage of this wonderful prosperity is not hard to trace. At- i&QT.-iS^^^ ' tention may be called to the fact that the depression from 1893 to 1896 was, as were other similar periods, one of financial reor- ganization — one of new economies introduced into our industrial establishment. During this period of depression the water had been gradually squeezed out of previously inflated capitalizations; again the nation had come to rely, for its "cash" as well as for its income, on profits from legitimate business. With such an equipment we were able to sell pig iron at a profit of $10 to $12 per ton; steel rails were sold with a liberal return to capital at $17.50 per ton; and bar iron entered a profitable market at 95 cents per hundred. After business had been reorganized on a lower base of capital liabilities, thousands of commodities were produced with profit at prices such that they CT.SjSSf=SSg SCALE IN gggggggS MILLION ooooocDoo DOLLARS 1 1 • H 00 0) 00 ! \ 1 M • M 00 to 1 1 ] ' 2 1 i ir 1 1 2 5 \ 1 H s 1 ^ 1 "" 5 o ° o H 03 J, -< 1 1 CO I t 'l' If f < i 1 c H 00 B i 1. K \ S g I 1 'J. '\ > > r M 00 1 1 1 S H CD 1 l' 1 1 s > - 1 > r 00 J I M (10 CO 00 1 I \ £" r- H ■0 ■0 1 V M t \ V H 2 f t \ H CD to j \ M 4000 3600 3000 2000 1600 1000 eoo BANKING AND SPECULATION 9 began to find their way into foreign marts and, in competition with foreign made goods, undersold them. Europe was startled at our commercial strength developed. Our appearance with shiploads ^, , . of products that others could not / ke business re- . vival oj 1897 manuiacture at competitive rates made the world realize that in the Western continent were resources and an industrial development that in free competition might bid de- fiance to all Europe. Under such circumstances bills of exchange drawn against the sale of these goods formed a true basis for commercial bank loans, and bank-credits were supported by capital-resources ade- quate to protect them — a banking equipment that included a thirty-three per cent money-reserve for the redemption of demand obligations. And as our foreign trade increased, instead of allowing this banking equipment to become impaired, we at that time imported gold for new banking reserves, to support new credits, and new current funds were again at hand for the support of still larger commer- cial accommodations in the purchase of bills and commercial paper based on actual sales of produce. What was the result, however, when the commer- cial bank extended its support to the capitalization of new promotions and became the chief factor in the "industrial speculation" that grew out of this sudden national awakening? Instead of limiting the com- mercial banking business to the service of a com- 10 THE BANK AND THE TREASURY mercial constituency, instead of devoting the energies and the funds of commercial banks to the accommo- So-called pros- Nation of producers and merchants, perity and specu- a system of underwriting new flota- lative excesses ^^^^^ ^^^ inaugurated. This was not a novel experience. Similar practice is recalled by the ex-Assistant Secretary of the Treasury, by reference to the "real-estate" restriction in the Na- tional Bank Act. Back of the law forbidding banks to loan on real-estate securities may be seen the long periods of industrial depression and financial reor- ganization following the panics of 1825, 1837, and 1847. Each period of prosperity immediately preceding these crises had been one of capitalization of new promotions. At that time, however, speculation was based on the possibilities of increasing profits to be derived from the development of agricultural re- sources. Westward migration had appropriated for use large areas — a new empire — of grain lands for which new transportation develop- False attitude of , , , , , the banks ^^'^^^ "^^ opened a market to the seaboard. New cotton, tobacco, and hemp lands enlarged this area to such an extent that the territory appropriated but still undeveloped was larger than the old Atlantic slope to which capital had before confined its investments. In these new areas all other demands gave way to the clamor for new capital, and the commercial banks attempted to supply this demand. BANKING AND SPECULATION 11 The failure of some eight or nine hundred com- mercial banking institutions during 1837 and 1838 was the result of this kind of bank-credit employ- ment; the failure of nearly fifteen hundred banks during the next three decades of State banking on investment securities brought to the mind of prac- tical bankers the character and purpose of the com- mercial bank. In 1903 and 1904, while Europe was going through the throes of financial reorgan- ization, our farmers were blessed with large crops and high prices; a kind and bountiful Providence Need for re- filled the granaries and the storehouses medial legisla- of the great West and South, per- ^^"^ mitting us to levy tribute on a dis- tressed world. Temporarily judgment on our financial folly was suspended, but the instruments of self-destruction were still in the hands of an un- thinking speculative public. These instruments of destruction were placed in the hands of speculators by commercial banks in the great financial centres. They were used not alone in self-destruction, but merchant and manufacturer have suffered such violence that we are now threatened with a general depression from closed shops and unsold merchant stocks. Organized and capitalized for the purpose of rendering service to a business community in fur- nishing "current funds," or "cash" for current use, the equipment of the commercial bank is nee- 12 THE BANK AND THE TREASURY essarily ill-adapted to the work of "permanent capitalization." To employ the funds of a com- mercial bank for long-time real-estate investment has ever been found unsafe, and following 1837 legislation was invoked to protect the public against loss. The same need for restrictive and protective legislation is now upon us. And such legislation should be as welcome to the conservative banker as to the community. The public requires protection against ruinous disturbances to commercial credit; the conservative banker would be protected against the competition of short-sighted officers and specu- lative managers of financial institutions who, posing as bankers, are responsible for these disturbances. Chapter II THE USE OF COMMERCIAL BANK-CREDIT IN LIEU OF INDUSTRIAL CAPITALIZATION In business, there are two distinct classes of obli- gations for the future payment of money which are made subjects of investment. These two classes are commonly known as (i) "capital liabilities," and (2) current credit liabilities, or "floating debt." The cap- ital liabilities are those obligations (shares or bonds) incurred by a concern which are sold to obtain funds or properties for permanent equipment or for con- tinuous use in the business. The current credit liabilities are those obligations which are sold to obtain funds for some temporary or current need. These differing purposes give char- Meihods of capi- . ^ ^^. 1. ^ r 2. 2. talization acter to the two classes of contracts as investments. The need for capital being a continuing one, the contracts representing capital liabilities are long-time contracts. Share contracts are interminable and consequently are not due or payable during the life of the concern ex- cept by proprietary resolution reducing the amount of capital employed. Even the current income pay- ment on share contracts are made contingent on [13] 14 THE BANK AND THE TREASURY profits and the declaration of dividends; there is no obligation for payment of money which will in any way embarrass the concern or threaten its capital. The "credit" capital liabilities are those contracts for the future delivery of money, such as bonds and mortgages, the principal of which is made payable after such a time that the company may make ample provision by payment out of profits or by occasional refunding. A company which has not been ade- quately capitalized may, however, procure equip- ment and properties for continuous use with funds obtained by temporary loans or on floating debt. This bespeaks a condition of under capitalization, is unusual, and is dangerous to the last degree. The capitalization of a business by means of long- time obligations should be large enough to cover all of the continuous financial needs. That is, the cap- ital thus contributed must be large enough to provide the properties and equipment permanently or con- tinuously used. To provide, by the sale of long-time obligations, more funds than are needed to carry the stock and to obtain the property and equipment continuously needed, would be to encumber the busi- ness with an unnecessary capital burden. To pro- ^ . , . vide, by sale of long-time contracts, Capital reqmre- c ^ ^ • , i ments funds less m amount than the per- manent or continuous needs, would be to handicap the management by putting it under the necessity of constantly refunding capital needs BANK-CREDIT IN LIEU OF CAPITALIZATION 15 and to prejudice success by carrying a floating debt, at an increased current cost, for the payment of which there are no assets available other than those which, if taken for liquidation, would impair the equipment in use. The distinction between capital liabilities and cur- rent liabilities for the present purpose is this, that the former should be, and usually are, the subject of direct capital investment, while the second usually are the subject of commercial bank-credit invest- ment. The commercial bank is not organized for Capitalization of direct capital mvestment. It is cap- permanent finan- italized for the purpose of supporting cia nee s -^.^ ^^^ credit obligations; and these credit obligations in turn are used as a means of purchasing the current liabilities of other business concerns. This is the business of banking. One wish- ing capital-funds ordinarily must apply to some one having funds for long-time investment. Capitaliza- tion depends on the ^ong-time investment powers of a community. The permanent equipment of com- merce and industry can safely increase only so fast as investment capital increases. Investment capital is increased by importation as a result of foreign investment, or by net income in the form of returns on prior investments. The demand-credits (or de- posits) of banks are neither of these, and therefore are not proper funds for use in purchasing permanent equipment. 16 THE BANK AND THE TREASURY In the recent period of inflation, as in other periods of speculation, it was not found necessary to await the tardy development of capital-funds for purchases of this kind; promoters did not find it necessary to appeal to such an investing constituency. They Funding perma- ^und that by incorporating industrial nent needs by means enterprises and consolidating corpo- of bank-credit ^^^^ control into still larger corporate syndicates, these new securities or "industrials" so created could be listed on the market and could be made the subject of general quotation. This step taken, the speculation induced by the sudden realiza- tion of our commercial greatness as a world power was converted into an agency for marketing the new securities to banks. An active buying having been "stimulated," it was not necessary to wait for the investing public to absorb the flotation ; the margin speculator was utilized to obtain capital-funds from our commercial credit institutions, using the securi- ties so created as "collaterals." One syndicated issue having been introduced into the speculative pool and floated on margins (the promoters having realized) a new consolidation was undertaken and in like manner funds were again procured from the commercial banks. The infection spread from in- dustrials to railroads, to mines, and to every form of undertaking. It was on this character of banking resources — loans, secured by newly created collaterals — that BANK-CREDIT IN LIEU OF CAPITALIZATION 17 a large part of the increase in our credit-funds (the deposits of commercial banks) was based. It is to credit obligations of this kind — those used by banks as a means of purchasing collateral notes of brokers and promoters secured by new flotations — that many of the disturbances to commercial credit are The character of attributable. Investments of bank- bank-credit so credit are not capital investments. ^^^'^ ^ So to use them is, by sudden credit expansion and then by a subsequent credit con- traction, to threaten industry with loss of equipment, or, by inability to contract, to threaten the bank with insolvency. Before such insolvency will be admitted, however, the increased credit burden will be shifted on the commercial constituency of the bank. The bank — the provider of current funds for current use — is forced to sacrifice the ends of its creation; being allured into this kind of investment by a pros- pect of large gains from speculation, it is converted into an instrument of business uncertainty and of wholesale financial debauchery. Expansion of Bank-Credit and False Estimates of Future Earning Power That a temporary increase in industrial activity results from these practices cannot be denied. Such has ever been the result of speculative promotions and credit inflations. The cause of this increased activity, however, is quite apparent. In each so- 18 THE BANK AND THE TREASURY called "period of prosperity" the immense amount of new funds made available for the andlisZTpH^es purchase of properties and equipment through the flotation of securities and the expansion of bank-credit has increased the de- mand for every kind of material — of construction, of maintenance, and of subsistence. From 1898 to 1903 manufacturers of pig iron could not fill do- mestic orders, and prices advanced from "$12 per ton in October, 1898, to $25 at the beginning of 1900; steel raUs doubled in the same period, the price going from $17.50 to $35; bar iron scored even a greater percentage of gain within a shorter time, the price advancing from 95 cents a hundred in July, 1897, to $2.60 in October, 1899. The quotations of clear pine boards advanced from $45 to $73 a thousand; for brick, from $4. 50 to $6; rope, from 5^cents toi3 cents, and salt, from 21 cents to $1." Prices were advanced all along the line, in cases doubled and quadrupled. An increase from four to six billions in the credit- funds within five years — billions, not millions — made available to the country as a means of pur- chasing new materials and new services, by a simple process of "flotation," operated to put the conduct of enterprise into the hands of pro- False estimates oj . , , , , ,.^^, ^, , ^ valuation moters who have had little thought for the future. Of what interest was it to the promoter that he was offering prices for materials twice or three times their cost when the funds OSoOOOOOOoC ooooooooooog M w w \ i i 1 i 1 55 1 1 i 1 1 1 1 II w \ 11 n II 1/ III 1 11 1 II \ l^ I \ \ 1 \\\ V N \ 1 > .\ \ \ \1 \/ \ 111 \ \ // / i ' • — 1 II * 1 Will - s i s n. E" " 3. i i 8 - \\\ w \ \\ \ V \ \/l i \ \\\ ^ \ \\\ \ \ \\\ \i \ III N V \ III II /// ,^ > / III w \ 111 \\ \ 111 I 1 \\\ \ \ w 1 \ \ \ \ \ \ s ^1 \ s \ \ \S \ \ \ w \ . K s & g i § i O o o o o o o < 3 g 8 § ^i I BAKK-CREDIT IN LIEU OF CAPITALIZATION 19 With which to pay for them were so easily obtained ? Why should he be concerned with cost of production when his profits were to come from promotion and equipment instead of coming from operations or permanent income on investment ? Of what interest is it to merchants and manufacturers that prices are higher when they might sell at advances which would yield increased net profits? These new trade de- mands and the consequent higher prices of products, based on credit-funds obtained from speculative flo- tations, temporarily increased the profits of produc- tive enterprise, and these new margins of profit carried speculation in capital shares to a still higher mark; again new market quotations made a new basis for estimates of value of the securities offered as collaterals; these in turn increased the amount of bank-credit made available for higher spendthrift prices; and again there came larger returns in the form of immediate net earnings to plants set in motion at a higher speed with larger equipment for supplying customers' demands. As has been re- peatedly demonstrated, this is not prosperity, but the result of a debauched popular judgment recording new increments of wealth by a process of increasing valuation of goods. No other explanation is needed for the reverse of the foreign trade balance. When American prices are high, instead of having a trade balance to be settled in Europe, exportation becomes so far reduced and 20 THE BANK AND THE TREASURY importation so far increased that for months at a time we are forced to borrow from abroad on "finance bills" — or other devices — some form of floating debt incurred by our bankers as a means of meeting the demands of a commercial con- joreign trade stituency. After 1898, instead of im- porting gold, "there has, in spite of the theoretical trade balance, been no significant shipment of gold in our direction," except when forced by temporary loans. More than this, our financial institutions have not had the strength to keep gold on this side. Before the end of 1902 we had begun to lose our gold. At that time conserva- tive bankers pertinently asked: "What of the fu- ture?" "If a hundred million dollars' importation of gold can serve as a basis for an expansion of so many millions of dollars of deposits and loans, what will an exportation of $100,000,000 mean?" It might have been added, that in all probability the adverse balances against our financial centres would have resulted in a complete overthrow of our inflated credit system had not the United States Treasury come to the relief of commercial banking institutions with deposits (loans of the Government to the banks) amounting to over $100,000,000; and within four months Government aid to the banks was increased to more than $160,000,000. BANK-CREDIT IN LIEU OF CAPITALIZATION 21 Banking Crises Due to Credit Inflation But even with the support given by the Treasury, as events subsequently proved, the credit problem was not solved. The question of the ability of the commercial banks of the country to ^ serve their constituency with current funds (the problem of adjusting the speculative situation and forcing liquidation of spec- ulative loans to such an extent as not to compel them to restrict accommodations to commercial enter- prise) kept the New York banker in a quandary by day and, for two years, hung over him like a spectre by night. With all effort bent toward the common cause; with united action on the part of the commercial banking fraternity acting on the best counsel and combining their united resources with those fur- The cooperation wished to the banks by the Treasury, of banks for pro- they managed to maintain their finan- tecHon ^^^]^ integrity, although this was ac- companied by a long line of forced liquidations. To a large extent the "capitalization" of these new pro- motions fell on the banks and trust companies and weakened their equipment for the support of com- mercial credit accommodations. During the first weeks of January, 1903, with the customary New Year's commercial settlements and payments, there was a relaxation of nervous tension 22 THE BANK AND THE TREASURY induced by what had come to be speculative neces- sity. But the far-seeing read the handwriting on the wall. Summer demands must be provided for; the "finance bills" were coming due and Forced liquida- ^-^^^^ contributed to an adverse inter- national balance which set up expor- tation of gold; the character of securities held by American banking houses was not attractive to for- eign investors and sales of these could not be utilized as a set-off against foreign balances; moreover, spec- ulative syndicates found it necessary to "buy in" securities offered on the other side below the market here. It is much to the credit of our leading banking institutions that in 1902 a campaign of liquidation was inaugurated in time to allow them gradually to "convert" speculative loans, in anticipation of de- mands — to make available those forms of holdings Circumstances ^hich in time of financial strain are favoring the absolutely unavailable, but which may hanks i^g realized on without loss to the banks if pressure is brought on the borrower in such moderation as not to induce panic. By making this pressure a gradual one, all the resources of the spec- ulative public in the market were utilized. But the effect was deadly. First the margins and accounts of the small speculators were wiped out; then the more resourceful "outsider" was driven to the limit of his means and was forced to suspend BANK-CREDIT IN LIEU OF CAPITALIZATION 23 operations; later the contest was carried on between "insiders" and "professionals," the stronger utiliz- ing profits gained from those less able to manipulate the market; but in the end all contributed (through demands to maintain margins on a Hon falling market by sale of stock and by reduction of loans) to keep up the reserves of the banks and protect the credit of New York institutions against exportation demands and against "calls" on reserve loans from the interior. For two years this liquidation continued. Those banks which had confined their operations to a com- mercial banking business were able to protect them- selves and their customers against serious losses. By fortuitous circumstances, by aid of the Government, and by cooperative action, through their ability to utilize the profits and resources massed by specula- tors during the five years preceding, those into whose fostering care the national funding system has been given were not driven to measures which seriously interfered with commerce. The dangerous expan- sion of 1905 and 1906 with the violent contraction of 1907 proved beyond a doubt that these resources are incidental, and speculative profits are not lim- itless. In 1904 as well as in 1907 it was the boun- teous return of a wide expanse of fertile soil and a partial failure of supplies abroad, with correspond- ing profitable returns to the South and the West and the continued high prices obtainable for the 24 THE BANK AND THE TREASmiY products of both farm and factory, that saved the day for American financial institutions. Falling Prices and Industrial Depression That the financial situation is still a dangerous one is apparent. And the danger lies not so much in a present or in an approaching crisis as in the continued use of a dangerous instrument of commerce. This danger is always present and will be so long as present practices continue. The recurring necessity for adjustments of credit to a lower The scaling of ■, ■, ■, , .1 1 ■ r r valuations ^evel has been the chief source of financial disturbances in the past. This has been brought about by the repetition of speculative expansion and subsequent forced credit liquidation. Forced credit liquidations have re- sulted in declining valuation of assets and a lessening ability to meet credit obligations outstanding. The basis of credit judgment is estimated ability to pay. This estimate is arrived at by the use of that financial device known as a "balance-sheet," on one side of which are placed "liabilities" and on the other "estimated valuation of assets." The liabili- ties of a business concern are the "weights" used in adjusting the balances; they are fixed in amount. In arriving at financial condition, judgment^^ * "liabihties" are placed on the right- hand side of the scales. Then on the other side of the accounting balance is placed "ap- H^ I-. ^- (0 N> to C* 1 W CJ o8§8§§§88§88§ ^ IN MILUONS g OF DOLLARS ^ s < il i IIP s K 00 Q \ rn H -< V V\ "^\ 00 %\ v o^ 1 O 1 > CO %\ . v\ -z S CD l\ \ 2 -z. a III g "-1 c ^ s 7. \ ?5? s v6 O °\ \, s '"' 5 % P S/ m i^. _ .'/ ^K r' S Ui " o; o °\ B :g O ■z ?i vf) O C/l .- 2 "•V a* 1 >< ^N \ .ft -» \ \ \ IN > NO m \ \ \ < > m o NO \ s^ i 8 \ \ o > o K M ^ — — NJ M 1 ^ c A^ CO CO o88 8§8_i88S ^ \ \ 8 § >9 rN MILLIONS Q OF DOLLApa BANK-CREDIT IN LIEU 01" CAPITALIZATION 25 praisement" or "the valuation of assets." If the amount of the "valuation" exceeds the amount of the "liabilities," then there is recorded a "surplus." If the scales swing in the other direction there is re- corded a "deficit." This "surplus" (or "deficit") of value of assets over liabilities is the basis for judg- ment as to the value of securities and as to ultimate ability to liquidate credit. The basis for judgment of short-time demand-credit, however, is estimated value of "available" or readily "convertible assets;" these are weighed against "current liabilities." The depreciation or reduction in estimates of value placed on "industrials" alone during the first year after September, 1902, has been calculated to exceed three thousand million dollars. If other securities are included, the most conservative estimate of the amount of depreciation is beyond comprehension. The depreciation of securities in 1907 was even Contraction of grater than in 1902. With this credit-funds to level continuous scaling of estimates of of capital support ii^^^^^ of assets," some business concerns have not been able to make the nec- essary adjustment. Several of the so-called "trusts" have become insolvent, and a number of others have admitted the speculative character of judgments on which their "prospectus" profits and prospective dividends were based by passing divi- dends. And, as in former periods of readjustments, depreciation {i.e., the scaling of estimates of value) 26 THE BANK AND THE TREASURY of securities must continue until the earning capacity of the joint stock institutions has been demonstrated to be adequate to justify investment at a level of valuation which may be maintained. The greatest public danger to be feared from this sort of credit expansion and contraction is that spec- ulative gains may not be adequate or available to meet demands for credit liquidation when readjust- ment of the credit load becomes necessary. When the financial balance cannot longer be kept in ad- justment by exchange of "securities" owned against liabilities {i.e., by process of cancellation of liabilities of one concern against the liabilities of another), and the weight of liquidation falls on pro- The daneer to be j , r • j . • .1 , feared ducts of mdustry, m other words, when liquidation is forced into the market where "goods" are disposed of, then it may become necessary to readjust the whole industrial machinery to such a level of capitalization that net profits may give ample return on the capital liabilities represented in the balance-sheet. If this readjust- ment falls on a period of low productive returns (poor crops and low prices), as in 1893-96, then the reaction and reorganization becomes far-reaching. A period of financial readjustments is what we know as an era of commercial and industrial depression. It was such a condition that we had to face in 1893, after the speculative collapse of December, 1890, and the re- organization continued until 1897. Similar to this BANK-CREDIT IN LIEU OF CAPITALIZATION 27 was the period of readjustment from 1884 to 1886, after the excesses of 1879 to 1883; and still further back may be found the long depression of 1873 to 1878, after the speculative activities following the close of the War. And although every favoring cir- cumstance has been with us to support the inflated capitalization used as collateral to bank loans, we cannot say that we are yet on a safe and sure financial foundation. Demands for Greater Elasticity It is during such periods of credit contraction, and industrial depression that demands for "elasticity" may be found Avritten on the editorial pages of news- papers and financial periodicals. At such time, "elasticity" is the term most often heard in public councils and in private financial dis- SSr "^ cussion. Though frequently used it is a term accepted without definition, and understood by each to mean something that will afford him financial relief. Each person puts into the word a different content : to the man in commer- cial pursuit "elasticity" means ability to obtain funds for current use in the form of bank accommodation; to the banker it signifies ability to expand and con- tract his supply of money according to his own needs for payment; others take it to mean the ability of the Government to increase or decrease the general circulation. It is this failure to agree on the meaning 28 THE BANK AND THE TREASURY of the first premise of their reasoning that makes agreement on a conclusion so difl&cult to reach. A proper understanding of the problem of elas- ticity must take into account the dangers of unwar- ranted and ill-supported expansion of bank-credit as well as the more obvious fact of contraction; those with whom lies the duty to pass remedial laws must seriously consider the interrelation of both forms of current funds, viz.: bank credit-accounts (the form of funds used by the business man), and money (the form of current funds necessary to the payment of balances by the banker). To the individual busi- ness man or to the individual banker, the problem resolves itself into one of the relation of "available Whatisneces- assets" {i.e., assets readily convert- saryto a proper ible into cash) to "current Habilities," consi era ion current demands for payment of cash. The exercise of sound discretion, with refer- ence to proposed measures of reform looking toward elasticity, however, requires that we know, not only the character of the demand, but also the financial machinery with which we are at present working and in which the readjustment is to be made. Chapter III THE AMERICAN SYSTEM OF CURRENCY AND BANKING For years the National Bank Act has been a sub- ject of general condemnation. The system of com- mercial banking operating under it has been pointed to as a patchwork — as an impotent device that has outgrown its original usefulness; it has been referred to as a financial crutch that from force of habit the country has been leaning on after convalescence. These critics have observed that our system differs from banking systems of Europe and, Syltem " ^^ analogy, the conclusion is reached that our financial calamities are due to these differences. The champions of the National banking system, however, contend that in the same sense every institution is a "patchwork"; that the Bank of England is founded on and constructed of "patches" of legislation and administration, having grown out of the exigencies of war quite as truly as our own; that the Bank of France has been "patched" till little or none of the original fabric is left; that the Bank of Russia, and, in fact, if cause for criticism be found in this, the financial systems of all coun- tries are to be brought under the same condemnation. [29] 30 THE BANK AND THE TREASURY What the critics of the system have failed to see, and that which is most important, is that each of the great financial systems has been evolved from con- ditions quite different from our own; that it is from these differences of environment (if a biological figure may be used) that variety has been produced in financial concerns as well as in other forms of busi- ness life. Arising out of conditions peculiar to our- An evolution selves we have a distinctly American from American institution — an institution that has conditions ^^^^ gradually adjusted to our busi- ness needs. We have a banking system as distinctly our own as is our factory system, our railroad system, our school system, our Government. In so far as there is demand for change, it is in the nature of a further development of the institution — a further adaptation to meet the growing needs of a fast de- veloping and rapidly shifting business organization. With this statement of differing point of view in mind, it may be well to trace the distinctive fea- tures of the American system, then from the van- tage ground of the institution and its environment again to take up the thread of discussion as to the new adaptations proposed or that may be thought necessary. The Development of American Banking Ideals At the time that the American colonies became embroiled in revolution with the mother country they THE AMERICAN CURRENT FUNDING SYSTEM 31 had no commercial banks; they had no agencies of government adequate to financing the necessities of war, and none to meet the demands of a fast growing commerce. As a means of meeting the exigencies of military operations, resort was had to issues of colonial and continental public scrip and to foreign loans. When public credit failed, funds were raised by lottery and by temporary funding devices. Com- mercial and industrial paralysis left no occasion for organization in aid of private business till after the close of the struggle for independence. The country emerged from the revolutionary con- flict politically independent, but without money or credit at home or abroad. The people were without a currency other than that imported in the form of foreign coin; their paper currency had depreciated to a point that forbade other than speculative trading or barter; they were practically without adequate funds for public or private use. The welfare of the commercial classes on the seaboard The First Bank oj J j j ^i. ^ lt -l ,. c the United States demanded the establishment of agen- cies of commercial credit ; the country at large demanded a money that would pass current throughout the bounds of the nation. These two demands were met by the organization of a great central commercial bank — the first Bank of the United States. The circumstances of the time re- quired (i) that the obligations of State and Nation which had been incurred during the war be refunded 32 THE BANK AND THE TREASURY (2) an institution of national scope which would give to the people a sound currency; (3) a bank with powers of discount equal to the volume of commer- cial credit used. With the expiration of the Charter of the first Bank of the United States, however, these situations had entirely changed. In the first place, the National debt had been refunded and the Government had been placed beyond necessity other than that which Why the First might be met by its current revenues. Bank was not re- In the second place, the controlling chartered interests of the people had shifted; from foreign trade to domestic commerce, from support of shipping to the development of land transportation, from merchandising raw materials and foreign products to the capitalization of home industry, from town building on the coast to the development of the resources of the interior the commanding interests of the nation were turned. The mint was supplying a uniform coinage for bank reserves; local banks were supporting local interior development. The first Bank fell with the party with which it was identified — the party of foreign trade, the party that drew its principal support from the seaboard commercial interests. The War of 18 12 was a war directed against the New England coast towns. It was a war of the in- terior against the East. As against England, it was a failure; as against the East, the interior won a de- THE AMERICAN CURRENT FUNDING SYSTEM 33 cisive victory; the enormous foreign trade interests of the North Atlantic seaboard were ruined. The The Second Bank National financial system was reor- of the United ganized with the party of internal im- provements and home markets in power. As a means of permanently turning away from shipping interests and encouraging the up- building of home industry, the tariff of 1816 was passed. War had served either to destroy or had proved a temporary barrier to foreign commerce. The tariff of 181 6 was enacted as a permanent barrier to investment in international trade — a barrier that was raised higher and higher through several suc- cessive enactments. Party measures were pushed forfthe opening of interior transportation routes, and as a means of further strengthening the hands of the administration, the second Bank of the United States was established. The only banks that had remained on a specie-paying basis during the War of 18 12 were the banks of New England. The commercial rela- tions of the interior were in a chaotic condition; the Central Government was struggling under a new load of debt; the currency was disorganized and un- satisfactory; Treasury bills were at a discount. A National financial agency was again created, with a capital of thirty-five million dollars, to perform the double function of refunding the National debt and providing a sound commercial currency for the interior. 34 THE BANK AND THE TREASURY As the Charter of the second Bank neared its close the scene again shifted. Before the Federal Government was in a position to lend adequate aid to the enormous demands from the interior for trans- portation and internal improvement New York had successfully financed the Erie Canal. With this event begins a new chapter in our financial history. Reasons for wind- No longer did local communities look ing up the Second to the National Government as the "'^ only agency adequate to carry on the internal improvements demanded. Besides, with the development of the resources of the interior, a new alignment took place which detracted still fur- ther from support of National as opposed to State enterprise. The industrial systems of the North ^nd South worked to cross purposes. As soon as the uplands were utilized and cotton was made king the constituency of the cotton and tobacco belt was thrown against the tariff, while the industrial organi- zation of the North and West demanded its con- tinuance. The tariff contest finally resulted in compromise. Both sections, however, weakened in their support of "National" as opposed to "State" institutions and "State" activities. Internal improvements in each section were promoted from a State or local financial base ; the support of a National agency was not needed. The South demanded "States-Rights" a a measure of protection to its industrial and social THE AMERICAN CURRENT FUNDING SYSTEM 35 system; the North and West Ukewise organized their internal poHtics around State functioning, State im- Internal improve- provements, State banking, but held ments_ and State to tariff legislation for protection of an mg home-industry as against foreign competition and as a means of inducing invest- ment of capital in the development of interior re- sources. In all but tariff issues, therefore, ideals of local self-government carried the day as against the party representing National activities. Jackson rode to power in 1828 as the popular representative of the compromised "local" ideal, while Adams and Clay, representing centralized National functions, failed to retain political support. As a logical sequence, the second Bank — the instrument created to support centralized National activities, the federal institution — perished, and the whole financial system went over to a State basis. But evil days were ahead. The panic of 1837 and the depression following carried down local enter- prises. State banks and State flotation schemes of all kinds were brushed away like the paper issues which had preceded them. From Ji^SSi. the ruins of their own fortunes the people looked out on bankrupt cities, bankrupt towns, bankrupt counties, bankrupt States. Over eight hundred State banks were complete fail- ures, while all commercial credit institutions that survived within the area of the new development 36 THE BANK AND THE TREASTIRY went over to a non-specie-paying basis; their issues passed for what they would bring. At the same time, the National party (the Whigs), by fusion with malcontents and with the "Ultra- States-Righters" — the "nuUifiers" of the South — again gained control of the Central Government. Attempt to incor- Another measure was proposed by porate a third leaders for a third Bank to bring Federal hank ^^^^^ ^^ National finance, to cur- rency and to commerce. But Harrison's death threw the administration into the hands of the "Ultra- States-Righters," the extreme advocates of localism; Congress, representing National functions, was powerless; the way was blocked till again local in- terests had readjusted themselves, till strong local institutional life reasserted itself in the election of President Pierce. It was in the midst of this chaos, following the panic of 1837, that the Independent Treasury was established as an institution designed to protect the finances of the Government against becoming in- volved in transactions and institutions of private- credit. It was out of this same chaos that our new "independent" institutions of private-credit arose. From the working of these two independent systems side by side, from experiment, and from adaptations made to current necessity and to business need, American banking ideals were developed. Before the Civil War had again thrown us into the turmoils THE AMERICAN CTJRJRENT FUNDING SYSTEM 37 of military contest we had passed through two more financial crises; two industrial depressions brought American banking ideals to the test, The local institu- i . , i , , ■ , , i Hon retained ^"^^ ^he adaptations then made, as a result, were again along distinctively American lines. With no purpose of reverting to a system of National commercial credit — with ideals of "local" internal improvement and "local" need for capital uppermost, with "local" interests, as op- posed to "National" necessity, the force present to give shape to enterprise and form to legislation — "local," "independent" banking in the various States was gradually reduced to a basis of safety and economy. The Suffolk system of New England had proved itself adequate to keep bank issues on a specie- Measuresto Paying basis during times of severe strengthen capi- strain — had sustained commercial credits when in all other sections they had failed. This was a system devised to protect "local" institutions when the forces of the country and of the Central Government were arrayed against them. From the Suffolk system was adopted the salutary principle of prompt redemption of current demand-credit obligations. The Free-Bank system of New York was distinctly the product of "local" and State as opposed to "National" financial in- terests; this was the result of the adaptation of "in- dependent" commercial credit institutions to the 38 THE BANK AND THE TREASURY demands for internal improvement and for the de- velopment of the latent resources of a politically organized "locality." By experience, and the application of the test of business necessity and convenience to each new de- vice, the States came to distinguish between the forms of credit used as "money" (forms which were Credit-money dis-i<^ pass from hand to hand without tinguished from question) and "bank credits-of-ac- credii-account, ^^^^^„ (c^edit-funds provided for private use, created by direct contract with the bank). The "independent" Free-Bank system was adopted by nearly all the States. The safety-fund, and the idea of collaterally secured circulation, was directed toward the correction of the "unsoundness" of the "money" system under a practice of "independent" commercial bank issues; collateral security for notes was introduced to serve the double purpose of giving a market to "local-improvement" stocks and bonds, and at the same time of avoiding the necessity for holding coin reserves against notes outstanding; the safety-fund came to be a marginal coin reserve to insure payment in full in case of failure and on forced sale of securities. The business importance of the distinction between "money issues" and bank "credit- Importance of ihe . ,, ■, i- i r i distinction accounts used as funds found expres- sion in the distinctly different provision for the payment of each of the two forms of demand THE AMERICAN CURRENT FUNDING SYSTEM 39 obligations of the banks. The "safety-fund" and "collateral security" were devoted entirely to the support of "credit-money," or notes of the banks; a first lien on general assets was also added for further security of bank "money issues." But such provision for the security of the "money-funds" left the bank free to provide or not to provide for the redemption of its " credits-of-account." As a means of protection to book-credits, a "money-reserve" re- quirement was introduced and a system of inspection was established to protect the people against financial impotence and fraud. The necessity for capital (the necessity for invested funds as equipment for a busi- ness institution offering credit-funds to a community) came to be recognized and laws were passed to pre- vent banking without capital-resources, or what was known as "wild-cat" banking. In all of these adap- tations, however, in all of the legislation and provis- ions for administrative control the leading idea was one of local need, local service, local development, as opposed to "National" necessity or "paternalistic" enterprise. The Separation 0} the Institution 0} Money Issue from that 0} Credit-Account Fortunate it was for our financial system that the Civil War occurred at a time when banking ideals had come to be so well crystallized and when the necessity for a common currency had come to be so 40 THE BANK AND THE TREASURY generally felt. We were quite ready to have a uniform practice, a common law, a central administration along Establishment oj lines of previously proved experience a strictly Amen- — a system that would preserve all can system ^j ^^i^ salutary principles worked out under American business conditions, and one which, by uniformity, was adapted to a wider commercial activity. The complete taking over of the money functions by the Treasury, under necessities of war, and the reorganization of our independent com- mercial-banking institutions under the National Bank Act, were the last steps in the final establishment of the American system of currency and banking. Chapter IV CREDIT-MONEY AND THE NATIONAL BANK Again attention is called to the fact that banking ideals in America had developed from strictly Amer- ican conditions; that as a result we had worked out a system unique ; also that intelligent banking opinion was fairly well settled at the time the nation found itself in the throes of civil strife. We were still suffering from the results of the panic of 1857, and there was engraved on the memories of older bankers the record of failures in 1837 and 1847. The nation also realized, as a matter of experience, that these years of financial failure each had been followed by an era of industrial depression and financial reor- ganization. It was commonly believed that lack of uniformity in laws, conflicts of systems, and rival advantages offered to incorporators by one State bidding against another, under conditions favoring loose banking practice, had contributed to this con- fusion. Before the greenback came to take a prom- inent part in our circulation, the credit-money of the nation, in the form of "notes-of-hand" (issues of State banks), were in such condition that one doing [413 42 THE BANK AND THE TREASURY business was required to keep constantly before him a current list of quotations as to prices of "bills," and then he ran the risk of loss in exchange. Still, Confusion in the advantages found in the local in- credit-money at be- dependent institution for fostering ginning of War u^^^^^„ interests were so great that all this confusion and loss could be suffered with scarcely a suggestion of return to central banking — to a central "Federal" institution with its large capi- tal, its branches, and its uniform currency. Even during the War, when Federal ideals were strong, there was no large business interest ready to advocate or even listen to proposals for a central Federal bank. In fact, it was the fear that such might be the out- come of a Federal law which stood for a long time in the way of establishing a uniform National system in conformity with existing ideals. Conversion of the Treasury into an Exclusive Agency of Credit-Money-Issue When the Government found itself confronted by the necessity of supporting armies in the field, when it became necessary to maintain an armament with a fighting force of half a million, when its expendi- Issues of Govern- t^res amounted to millions per day, ment credit for it found itself equipped for such an currency undertaking with an independent (but empty) Treasury, and with a commercial-credit sys- tem entirely divorced from the Federal State; the NATIONAL CREDIT-MONEY AND THE BANK 43 finances of the country were organized on independ- ent commercial lines rather than on those intended for Government service. The conversion of this empty independent Treasury into an active financial agency to provide current funds for the Government became a matter of necessity, and as the easiest and most expeditious way of providing such funds the Treasury assumed issue functions. The notes (demand-credit obligations) of the Treasury entered into circulation in competition with the mixed and inefficient system of bank-note cur- rency. At first (as demand obligations for the pay- Government credit ment of gold and silver) they passed becomes money at par. Later, being valued at less standard ^^^ specie-paying bank-notes, they were made legal-tender to give them currency. Be- fore the Legal-Tender Act, the commercial-credit system passed over to a Government "paper stand- ard." The banks, failing to provide a "coin-reserve " for the redemption of their demand obligations, im- mediately accepted the situation. They provided themselves with a cheaper form of money for re- serves and sold their coin, using instead issues of the Treasury for the redemption of notes.* At first, from National necessity, Treasury-notes * This practice became general with banks in every section except the Pacific Coast. The practice was systematized in the East by action of the principal Clearing-House Associations; Boston was the last of the large cities to adopt the United States note as a standard for payment. August 27, 1861, that Association voted that any bank which might conform to the agreement entered into by the banks in New York and Philadelphia, 44 THE BANK AND THE TREASURY were issued in settlement of demands against the Government; after the issues of the Treasury had been accepted by the banks as a standard for pay- ment of their own credit-accounts the notes of the Displacement of Government were found preferable to the State bank- the diversified issues of banks. Gov- '"'°^^ ernment issues at least provided a uniform, and therefore more acceptable form of credit-money. This preferment on the part of the banks, this decision to accept United States notes as reserves, this better service rendered by the Treasury as an agent of money-issue, paved the way to the tax which eliminated the credit-issues of banks from our money circulation.* From that time to the present all our "credit-money" has been issued by the Cen- tral Government, the banks confining their credit activities entirely to commercial functions, using the credit-money-issues of the Government for their re- serves. From that day to this the American money question has been an entirely separate and distinct with reference to the National loan, could deposit with the Clearing- House Committee "Treasury-notes" of that loan and receive in exchange certificates of the "loan committee" to an amount not exceeding ninety per cent of the par value of such Treasury-notes. These certificates were to be received at the Clearing-House in settlement of balances. The notes were later adopted as a basis for payment in lieu of "coin." *True, the ten per cent tax imposed on State bank-notes was the im- mediate cause of the retirement of State bank-notes. But if the green- back and the National banking system had not been considered more advantageous, the opposition of banks would not have been lessened, and, furthermore, existing institutions would not have voluntarily ac- cepted the change. There can be no doubt that the uniform system of greenbacks and " Government " bank-notes was in every way more acceptable and more serviceable to the people than the complicated, hazardous, and uncertain system of independent bank issues. NATIONAL CREDIT-MONEY AND THE BANK 45 one from the American commercial banking problem, and every attempt to treat the two questions without distinction has led to confusion of thought. The Creation of a Unijorm System of Commercial-Credit In the reduction of our "commercial-credit" to a uniform system the same National necessity was the immediate cause. It was the need of the Govern- ment for current funds that reduced credit-money- issues of the country to a uniform basis in the Treas- ury-notes; it was the continuing public need for A national bank- current funds that finally gave us ing system from uniform institutions of commercial- public necessity ^^^^^^ Secretary Chase saw in the commercial bank the possibility of an enlarged mar- ket for bonds. The practice among the States under the Free-Bank system suggested a practical method for utilizing this market. Before this could be done, however, it was neces- sary to incorporate the many "local" banking sys- tems under National law. But to make such a National system a success would require voluntary consent on the part of both banks and bank patrons. Incorporated the General respect and voluntary con- best American sent must be gained through devising experience ^ National law that would serve the commercial purpose better than had the mixed and uncertain State-bank systems. The inducement to 46 THE BANK AND THE TREASTTRY voluntary consent which Secretary Chase and his advisors offered was a National Banking Law, into which were incorporated all of the most wholesome measures — the best banking ideals that had been evolved during nearly half a century of independent commercial banking experience. These ideals were brought together and welded into a consistent plan — one that commended itself both to bankers and to established business interests. The manner in which this law represented and still represents the "local" ideal is caught from the language of ex-Comptroller Dawes, in a recent speech before the Kansas Bankers' Association: "It has been built up, not from some central institution com- bined with numerous branches which discourage the banks in small towns, but has been built up from Organized fifteen thousand differentiated banking around local, units, until in banking, as in other banking needs ^^^^ industries of these United States of ours, is coming a day of commercial domination of the world. It is the little men whom we have protected in this Government. ' ' The National bank- ing system is a part of that National policy evolved "to let the little men get on in the country, in order to let the little bank get into operation, in order to let the little manufacturer get into operation, and to not cut off from their credit those people who, start- ing from small beginnings, have brought us into this great prosperity which we all enjoy and which is so NATIONAL CREDIT-MONEY AND THE BANK 47 widely and evenly distributed throughout this great country of ours." The American System of Sound Money The American credit-money-system; in its final evo- lution, is essentially a system of Government obliga- tions for the payment of gold on demand. In the effort of the American people through the last cen- tury to obtain a "uniform" currency, the Independ- ent Treasury has been maintained, and has finally become the only institution of credit-money-issue. Uniformity of valuation of all our money-issues is secured through this central institution by a process of immediate redemption. In the interest of "sound money," and as a provision directed toward meeting the demands for gold payment arising out of these credit-money-issues, a gold-reserve is set aside in a special department of the Treasury known as the Department of Issue and Redemption. Here is kept the $150,000,000 gold-reserve; here all demands for gold obligations arising out of credit-money-issues may be presented and honored ; here, in fact, and in practice, all forms of money are made interchange- Credit-moneys able. If the holder of silver wishes issued and re- i_ 1 1 1 -i deemedhytheNa- greenbacks he may exchange silver tional Treasury for notes ; if he has gold, and for con- venience wishes silver certificates, these may be had ; if he has any form of money other than gold, and wishes standard money, he may obtain this in ex- 48 THE BANK AND THE TREASURY change, at par, without discrimination. Thus every form of money is issued by the Treasury, and all forms other than gold are made demand obliga- tions for gold payment. Furthermore, the means of meeting these obligations are at hand: first, in the form of a "reserve" large enough to meet current demands, and, second, by making the credit-money- issues redeemed a first lien on the general resources and revenue powers of the Government. These credit-money-issues of the Treasury are made legal- tender for the payment of commercial-credits. The American System of Banking The American banking system, on the other hand, is essentially an independent institution of commer- cial-credit. It has for forty years been entirely di- vorced from money-issue functions, except as an agent of the Government for the conversion of bonds An independent i^^^o demand notes. The service that system o) com- it renders is one of furnishing com- mercial-credU ^^^^^^^ credit-funds to its business constituency in the form of book-credit accounts. The legal- tender "credit-money- issues" of the Government are contracts to pay gold coin; the Comparison of " commercial-credit-accounts " offered money and bank- to the public by the banks are con- tng systems ^^^^^^ ^^ ^^^ legal-tender money. The Independent Treasury protects the "credit-money" system by maintaining a "reserve" of gold. As NATIONAL CREDIT-MONEY AND THE bANK 4d all the reserves and the revenue power of the Treasury are organized for and directed toward the maintenance of a convenient form of legal-tender money in its integrity, so it is intended that the com- mercial bank shall protect its " demand-credit- ac- counts" by keeping a money-reserve adequate to meet current demands, fortified by all the capital- resources of the bank. It has come to be recognized that the bank's service to the country is not one of "money-issue." When money is needed, a customer cares not whether it is in bank-notes, greenbacks, gold certificates, or notes of 1890, so long as it is "sound;" i.e., so long as he knows that he may obtain gold or something as valuable on demand. He may obtain "money" as cheaply from a Treasury office as from a bank. The chief service of the bank is one of purchasing good, sound, commercial paper offered for sale in the community as a means of obtaining funds to meet the current needs of enterprise, and (as the most convenient form of funds) to be able to give "good, sound, commercial bank-credit" in return. Under a system which permits the banks to The public ser- . ^ r 1 i j.i ^i /. vice of the bank i^sue notes-of-hand, the reason that the bank gives to its customers funds in this form is that it is to the bank's advantage to do so, and not because the customer prefers the bank-note to Government issues. But the American business public has found that, in over ninety per 50 THE BANK AND THE TREASURY cent of its business, funds in the form of a "bank- account" are more convenient to the customer, and they have seen fit to take away from the bank the power of money-issue in the interest of public safety. Under our system, the commercial bank, being de- prived of credit-money-issue privileges, renders two services: (i) It furnishes a market for commercial paper; (2) it furnishes a form of credit- funds more convenient for use than money itself. But the public is quite as much interested in know- ing that the credit-accounts of banks will remain "sound" — i.e., will be paid on demand in "sound" legal-tender money of the Government — as it is that the Government shall furnish "sound" legal- tender money, for under the law of greater economy, over nine-tenths of the business is done on this form of obligation when protection is given against "un- sound" banking. The method employed under this Need for sound- Unique American system of independ- ness in bank- ent commercial banking is to require '''^^ * banks to makitain their capital-re- sources unimpaired, and to keep a "reserve" of legal-tender currency sufficient to protect the accounts which they have sold to the public for business use. When thus protected we have a system of credit thrice compounded: (i) a system of Government "legal-tender credit-money-issues" based upon the gold standard; (2) a system of "commercial bank- credit-funds" (book-accounts) based on legal-tender NATIONAL CREDIT-MONEY AND THE BANK 51 money; (3) a system of "business-credit" looking to the bank-account for means of payment. It is the current opinion that under the American system, through the Independent Treasury, we have already secured to ourselves a "sound money"; the problem now before us is one of securing for ourselves " sound commercial bank-credit." The So-called "Issues" of National Banks To this conclusion and summary one objection will be urged, viz., that the banks called National banks have retained issue functions. This conten- tion will not be admitted, and in this lies one of the minor financial fallacies of the time. As an institu- tion of commercial-credit, our National bank is not a bank of issue. It would be as logical to call banks, which deposit gold and receive in return gold- Clearing-House-certificates, banks of issue ; it would be as justifiable to so regard a State bank or private bank that has deposited gold, silver, or currency in the Treasury and received certificates to represent them. Bank-notes, it is true, are at present a form of money, but, for the issue of these, the bank occu- pies a position of agency of the Government for the Banks an agency 0} conversion of bonds into notes. The the Government for note-issue power was not intended bond conversion ^^ ^ ^^^^^ ^f meeting a commercial demand; it was given purely as an accommoda- tion to the Government for its own ends. As a 52 THE BANK AND THE TREASURY means of creating a bond-market when the Treasury was in need of coin the bank was allowed to buy coin bonds, i.e., to exchange gold, or gold market equivalents, for bonds; then (on depositing the bond thus purchased with the Government as security to a promise to deliver a definite amount of money to the Treasury) the bank obtained a form of paper money, called "National currency" or bank-notes, for use in its business, receiving the interest on the bond as an inducement for the exchange. The Government issues the bank-note in the same sense that the Clearing-House issues Clearing-House loan-certificates. These notes are not bank-credits issued in the course of a commercial banking busi- ness. The value of the note does not rest on the credit-contract of the bank, but on a contract with the Government which in turn rests on the collateral securities deposited with the Treasurer, i.e., on Gov- ernment credit. The notes were not "issued" by the bank, but were purchased or borrowed from the Government, and as a form of money the immediate Government ^^st to the bank is more than that of issues notes to any Other form of money obtainable. the banks j^ j^ therefore thoroughly misleading and tends to involve the subject of currency and banking in mystery to speak of this form of currency as bank-money. It is quite as misleading to attempt to align this practice with any experience under other systems of banking in discussion of "elastic bank- NATIONAL CREDIT-MONEY AND THE BANK 53 issues." Under the American system the National "bank-note" is a form of money issued by the Gov- ernment to and through the bank as a corporate agent of the Government. Chapter V SYSTEM OF BANK-CREDIT The solution which we have given to the problem of "sound money" has been by taking our money- issues entirely out of the hands of private concerns and putting them under a department of Govern- ment. By so doing, however, we have left our Opinion as to " commercial-credit " entirely in the need for greater hands of private individuals and cor- easicty porations. That greater elasticity is needed and that some change should be made in the National Bank Act to this end, all are agreed. Opinion differs only as to what the character of this change should be. And this difference grows out of a differ- ence of view as to the method by which elasticity in credit obligations may be attained without restricting business accommodations. Two Schools of Banking Opinion as to Method of Obtaining Elasticity and Sound Banking Proceeding from the assumption that greater elas- ticity is needed as a common point of departure, argument has gone out on two distinct lines; bankers [54] have divided into two schools of opinion diametri- cally opposed. The one has reached the conclusion that "branch-banking" and "cur- Poinls of differ- u j • i it) g^^g ' ' rency based on commercial assets" will secure the desired end ; the other has as zealously urged "independent banking" and "credit-accounts" (deposits) based on independent and adequate capitalization. On examination of the arguments used by these two schools there ap- pears not only the fundamental difference in their appreciation of the relation of the problem of "elas- ticity" to financial "soundness," but the reasons for this divergence in conclusions as to the remedies to be applied are also apparent. Taking premises for argument there has been a wide difference in their conception of the "system" to be modified, and also a lack of agreement as to the form of "bank-credit" to which elasticity is to be given. The "Commercial Assets" Banking School Mr. Eckels, representing the ideas of the "branch- bank", "commercial assets banking" constituency, has refused absolutely to take into account the fact that we have in America a system that has grown out of American conditions, and therefore one that must be considered from the standpoint of further adap- tation to American financial and industrial interests. He and his followers show that branch-banking has produced good results in other fields, and conclude 56 THE BANK AND THE TREASURY that it would also produce equally good results if grafted upon our own industrial plant. They show that the bank-note circulation of Eng- Character of their i j r' j.i j t i ^ r^ claims land, Scotland, Ireland, Germany, Canada, etc., has adjusted itself to in- creased and decreased business demands for current funds ; it is therefore assumed that the English or the Scotch or the German branch-bank would work here better than our own system of decentralized, inde- pendently capitalized banks. This reasoning from analogy might have been put with convincing force if they had first shown that the American business demand and the American bank- ing system were the same sort of demand and a system similar to those from which their analogies are taken. Their fundamental error lies in failure to appreciate that there are no par- discussion is not with reference to an English system of banking, a Scotch system or a German system; what we have to do with is an American system. In the second place, the form of "bank-credit" demanded by the American business man is not a bank-note, but a "credit-account" for the use of the customer of the bank. To show by direct quotation Mr. Eckels' line of departure : " Com- merce wants (i) a note-issue which is sound, and (2) one which from day to day in its volume meets, not only in the cities of great commercial undertaking. "sound" and "elastic" banking 57 but upon the frontier and in sparsely populated places, the needs of the people in their transactions, . . . in their transferring of property from one to another." This is the first premise in the reasoning of the "commercial assets banking" school. All admit, and our whole past history supports the conclusion, that the American people wish a "sound" credit-money when they wish credit-money at all; but it is affirmed by Mr. Eckels' opponents that his assumption is wrong when he further says that the American people wish a "note-issue upon the part of the bank." This, it is urged, is what the Ameri- can people have been drifting away from since 1837, Note-issues jor ^^^ what they completely abandoned the use oj the forty years ago. The American peo- hanks pjg j^^yg j^Q^ gggj^ ^^ "issue" of a bank — using the word in the same sense that Mr. Eckels uses it in his analogies drawn from Canadian and European practice — since the Civil War. The school which he represents fail to appreciate the fact that the American people have completely di- vorced their system of "credit-money-issue" from their system of "commercial-bank-credit." The "Capital Assets" Banking School The other school is ably represented by Mr. Dawes. While in a measure this school has failed to appreciate the full import of the institutional dis- tinction between the American and other systems, 58 THE BANK AND THE TREASXXRY in their reasoning about "elasticity" they have pro- ceeded from a proper appreciation of the form of Bank-accounts circulating medium demanded. Quot- used by business ing from Mr. Dawes for a statement community ^f ^j^jg ^j^^. "^hat is the most im- portant function of a bank? It is not the note- issuing function . . . the most important function which banks exercise in any community is that of producing purchasing power [credit-accounts of cus- tomers] in that community. ... By that method through those simple operations of banking [the purchasing of commercial paper and giving to the customers, in exchange, accounts on the books of the bank], there has been built up in this country to-day a purchasing power of something over nine billion dollars, whereas the total amount of Govern- ment money in circulation — gold, silver, and paper — is about $2,250,000,000. It is the check and draft circulation against that tremendous credit balance which furnishes the currency [current funds] with which over ninety per centum of our total trans- actions are done. . . . We have in this country the most elastic currency which the world has ever known, in this check and draft cur- Elasticity in t>> • j .^ • ^ ^ credit-accounts '"^^cy. ... Did you ever thmk how elastic the check and draft currency of the United States is? Why in the year 1900 the clearances of the city of New York alone were thirty- one billions of dollars — not millions — thirty-one 'SOUND' billions of dollars greater than they were in 1897, and they were five billions of dollars less in 1900 than they were in 1899. Just think of the elasticity of that magnificent currency which has been built up in this country by this system of differentiating bank- ing among the fifteen thousand banks scattered over these United States." Recognizing that the chief service rendered by the commercial bank is one of providing its customers with credit-accounts (deposits) for business use, this second school of banking opinion have strongly im- pressed on their faith, that there is at present no limit to the elasticity of the form of funds in current use except that imposed by the bank itself; elasticity is limited only by the amount of capital support given to accounts outstanding. They strongly advo- Limit to elasticity cate increased financial "soundness" imposed by banks as a remedy for inelasticity, and as a themselves means to this end they further advo- cate the principle of banking on the "capital re- sources" of the bank instead of doing business with "issues" based on "commercial assets." Since the exchange of credit-accounts for com- mercial paper is the chief business of the bank, and The limitation since these credit-accounts (deposits) one 0} " sound- are the chief form of funds used in "'^^^ the community, the underlying pre- mise of their belief is that the first duty of the bank is to make these credit-accounts "sound." Soundness 60 THE BANK AND THE TREAStTRY is here used in the same sense that it was understood to mean in the recent money controversy. The bank- account is sold to the customer (or exchanged for his note) to be used as current cash in his business. What the customer wants to know is that it is as good as gold. And what the bank must do to insure this result is to be able to redeem its credit-contract on demand. The "Soundness" of a Bank's Credit There are two ways in which credit-contracts may be met; viz., by "payment" and by "settlement." Payment is the satisfaction of a credit obligation by delivery of the amount of money contracted for. Two methods of Settlement is the satisfaction of a con- satisfying a credit tract for future delivery by a new tga ton contract or acceptance, in lieu of de- livery or payment. Ability to pay depends on the ownership or possession of money, or something which can be converted into cash, for delivery when the credit-contract is due and demand is made; ability to settle depends on the power of the one obligated to offer something which will be acceptable to the creditor in lieu of legal-tender money. In campaigns for currency and banking reform, these two methods of satisfaction of credit-demands have been the first premises of the two opposing schools of financial thinking. Recurring periods of relapse from speculative excess, cycles of decreasing t i I M %/ 1 (JO ' L I ■n \ s f ^ V, M ^ < A. 01 H 5 o z > ^ 00 zj 2/ i^ ■?■ > "^^ i> <~. CD to M u ^V r \ ^^. ^ n >^ i / ^^§ H CO -*«• ""^ s 73 f f^ A ? < V ^ M X V^ -<'" r-^ r- iJO CO ^> r ro 01 ?', l> > -< > r o \ L r CO ^~~^ i* ^^2: ffl rn T ci j H ^ J> J* "t- T o <=C i.( ^^^''*- to 03 \. ■5 ;• ^"^"^^ "j M T' ->J I" 0^ IP % <^ • \ f > z ID TT\ >y^ ^^ CO ^^ ^. k <^ m CD % X '^ '^ -f- \ < ^ r V"^ o ^ > ^ ^r, u ■^ < *• -i ^ \ / / 1 H ( CO \ •t \ I H )_» CO >^ 01 SCALE o MILLIONS o OF DOLLARS "sound" and "elastic" banking 61 assets and proportionately increasing liabilities, have caused issue to be joined between them. The school The dividing line in which have pleaded for reform based campaigns for finan- on ability to pay, have styled their ar- cial soundness ^^^^^ ^ ^^^^ f^^ financial "sound- ness." The school which have urged measures for settlement, without being required to fulfil their con- tracts for future delivery of money, have been char- acterized by their opponents as "inflationists." But, whatever may be chosen as terms properly to repre- sent these two financial creeds, it must be recognized that each is an attempt to solve the problem of liqui- dation — the one, by the introduction of methods which will insure a larger proportion of assets to credit issued, the other, by a provision for new issues of credit liabilities to meet those already outstanding. It may be further observed that, in all of these con- tests, the one school have stood for the strict fulfil- ment of existing contracts, and have sought to protect business against the evil of future excesses of credit- issue, while the other school have sought to obtain re- lief from a present emergency, arising out of demands for the delivery of money on existing contracts of credit. In 1893-96, attempt was made to solve the prob- lem of liquidation by establishing 371.5 grains of silver as the standard of payment of existing liabili- ties and for the valuation of assets. With the price of silver as it then stood, this device would at once 62 THE BANK AND THE TREASURY have doubled the proportion of assets to credit Habili- ties, and would have made liquidation easy. Two successive political campaigns re- The sound money jj-j. r ^^. Uijj controversy corded victory for the gold standard; and all future doubt as to the ability of the Government to liquidate its credit-money obliga- tions, by payment according to the standard, was set at rest by increasing the assets of the Government available to meet gold demands. These questions are now considered settled, but a new period of liqui- dation brings with it a similar controversy with re- spect to the credit-accounts of commercial banks. On questions of public policy, opinion is again di- vided between the same schools, representing the same ideals that have contested for supremacy throughout the last two centuries. The Demands of the Two Schools of Banking Reform A re-statement of their respective demands may lend clearness to the presentation of contending faiths. To give greater facility to the liquidation of bank-credit liabilities, the one school argue: (i) for authority to issue new promissory notes in settlement Demands of the ^^ credit-accounts outstanding; (2) for "commercial as- a first lien on the general assets of the sets "banking bank to secure the ultimate payment of schiOoL these notes; (3) for the abolition of the Sub-Treasury; (4) for the "deposit" of all revenues of the Government in the commercial banks, without "sound" and "elastic" banking 63 collateral security; (5) for the right of banks to es- tablish branches, without requiring a proportionate increase of capital-resources to liabilities. The arguments offered in support of these several demands are in brief as follows: (i) That authority to issue notes will relieve the banks from the necessity of obtaining legal-tender money for delivery in time Arguments sup- ^f unusual demand for liquidation of porting these de- bank-credit, and will thus relieve ex- traordmary pressure on the money market; (2) that a first lien on the general assets of the bank, to secure the ultimate payment of notes issued in settlement of outstanding credit-accounts, will keep the bank-note as "sound" as the issues of the Government, and will protect it as well as if secured by a deposit of Government bonds; (3) that the abolition of the Sub-Treasury system will prevent money being abstracted from the regular channels of trade when there is a surplus of Government revenue over expenditure; (4) that by "depositing" the reve- nues of the Government with the commercial banks, these "deposits" may be used to support still larger volumes of credit-accounts, and increase the available funds of the community; (5) that by a system of branch-banking, capital wUl be given greater "fluid- ity," — i.e., the money of the bank may flow from one part of the country to another as it may be needed. Answering these contentions, the other school of 64 tHE BAisfk And The treasury banking opinion urge that all this is a plea directed towards weakening the capital-resources of the banks on the one hand, and for permission to avoid payment of credit-accounts outstanding on the other. Further enlarging on these views, they argue that authoriza- tion to issue new notes in settlement of demands for Arguments for delivery of money made on-account "capital assets" is a means of avoiding payment, and an %ng j^ j^.^ ggg^,^ j^q^ Qj^jy prevents such a readjustment of assets to liabilities as is necessary to "sound banking," but tends toward a still larger inflation of credit, at the very time when assets are being scaled by the exercise of more conservative judgments of valuation — i.e., when ability to con- vert assets into cash for delivery on credit-demands is being reduced. It is also pointed out that the security offered for note-issues, in the form of a lien on the general assets, not only decreases the need of capital-resources, but at the same time tends to weaken stUl further the support to bank-credit-ac- counts — the kind of funds in most general use — and to weaken public confidence in the whole bank- ing system; the immediate effect of this weakened confidence is to lessen the opportunities of the bank to render a service in the community out of which it obtains its revenue. They urge that the Sub-Treas- ury, instead of being an element of weakness, is an element of strength in two ways: -first, by segregating the pubHc funds, the necessity for larger bank capi- "sound" and "elastic" banking 65 talization is increased ; and, second, by storing up an independent reserve in time of low money-demand, an independent money-reserve is at hand which may be made available to the banks in time of monetary strain. In support of this last contention, they point to the wholesome influence of the Sub-Treasury in the recent disturbances, such as the Baltimore and St. Louis panics, at which times the bank situation might have proved disastrous to the business of the whole country, had it not been for the aid of the Government. As to the so-called "deposits" of Government- moneys in the banks, they show that these are noth- ing more or less than loans to the banks without interest. In this relation, it is further urged that the only reason why the Government or anyone else should purchase a bank-account is to obtain funds for current use in a form more convenient than money; that the only need of the Government for such funds is represented in the accounts of disburs- ing ofi&cers — about $6,000,000. They hold, there- fore, that the ever-increasing loans of the Govern- ment to the banks (in the early part of 1904 amount- ing to about $170,000,000) put a premium on their Increased "tlas- relying on the paternal support of the ticity" through m • 4. j r j j- increased capital Treasury, mstead of dependmg on strength their own capital-resources for the cash needed in the liquidation of their own accounts — i.e., for money-reserves. Again, it is urged that 66 THE BANK AND THE TREASURY the demand for branch-banking is inspired by this same motive — the desire for still further lessening the capital cost of doing business, which, if accom- plished, would result in again weakening the need for capital contributions by the stockholding pro- prietors of banking corporations. This second school would secure elasticity in quite another way. Their underlying principle is ex- pressed by Mr. James G. Cannon: "Bankers some- times plead for more elastic currency, but what is needed is more elasticity of the assets of the bank; what is wanted are assets that are readily convertible into cash in time of panic, which will pay depositors, and at the same time permit new loans." This Adequate capital- statement sets out in strong relief the resources the so- irreconcilable premises of the two lutton classes of thinkers; the one urging a right to increase liabilities stUl further when their assets are already inadequate to support outstanding demand-credit; the other urging an increase in capi- tal-assets — those assets readily convertible into cash without curtailing loans. Chapter VI THE RELATION OF BANK CAPITALIZATION TO THE PROBLEM OF ELASTICITY Although the relation of capitalization to the problem of elasticity is an indirect one, its importance has been overlooked by those who have had remedies to propose. As before observed, "elasticity of credit-accounts" and of banking accommodations is Distinction be- the desideratum ; and elasticity of tween" wild-cat'" j., i. j j j and "sound" credit-accounts depends on an ade- hanking quate equipment of the bank with "available" or "convertible" capital-resources. The assets, which are available without "forcing" or curtailing loans, are those that are obtained by capi- tal expenditure ; in fact it may be said that this is the chief end for which the capital of a banking institu- tion is obtained. The provision of "capital-assets" instead of "commercial-assets" as a basis for bank- credit (whether in the form of notes-of-hand or bank- credit-accounts) is the essential distinction between the "wild-cat banking" of the past and "sound banking." This is another way of stating the controversy be- tween the two schools of banking opinion represented [67] 68 THE BANX AND THE TREASTIRY by Mr. Eckels and Mr. Dawes. While it may not be said that Mr. Eckels favors "wild-cat" banking (i.e., banking without capital), the conclusion reached by his critics seems warranted that all of his proposals are in the direction of weakening the capital support given to asset liabilities outstanding. An application of his proposals, therefore, would be in the direction of wild-cat banking. Mr. Eckels argues for bank- ing on "commercial-assets," i.e., making the current credit obligations of the bank depend on the converti- bility of loans and discounts, which in turn would depend on the convertible assets of customers. The Banking on the school represented by ' Mr. Dawes capital of the contend that the current money-de- '^*^ mands arising out of the credit-ac- counts used by the bank to purchase commercial paper should be met by the bank itself out of its own capital; i.e., the second school referred to argue for banking on the capital-resources of the hank instead of banking on the convertible assets of the community, to which the bank has sold its credit to be used as current funds. Principles of Banking with Respect to Capitalization The reasoning of this second school is based on the assumption that the purpose of bank capitalization, as in all business enterprise, is to provide funds with which to procure permanent equipment. This BANK CAPITALIZATION AND ELASTICITY 69 assumption cannot be denied; it must be accepted as axiomatic . The financial process called capitalization Capitalization of is the creation of a permanent fund permanent needs for a permanent use. The reason for "' °'^ ^ obtaining funds for permanent equip- ment by capitalization is to avoid the necessity of constantly refunding — a need which is a continuing one. This being generally accepted, the only ques- tion that remains is: What are the permanent needs — what is the equipment necessary to safe banking? Their second premise is that the business of bank- ing is one of furnishing "current funds" to its cus- tomers in the form of non-interest-bearing credit. This must also be accepted. The customer obtains these credit-funds by selhng to the bank his own interest-bearing note, or some other form of bankable asset. The earnings of a bank are derived from exchanging these non-interest-bearing credit obliga- tions, which are used in the community as current Needs determined funds, 'for good commercial paper hy nature of purchased at a discount or with in- ustness terest accruements.* The amount of earnings depends in large measure on the amount of good commercial paper the bank is able to buy with its credit-accounts — i.e., profits depend on the amount of credit-accounts (so-called deposits) pur- *Tliis fomi of statement is not entirely in accord with the more recent practice whereby the banks are paying interest on their own accounts (deposits). But in such event, the rate must necessarily be lower than that paid by the customers for loans. In any event the result is the ?ame, 70 THE BANK AND THE TREASURY chased by customers by means of their own interest- bearing obHgations and bankable assets. The permanent need of a commercial banking institution is a need for money and for assets readily convertible into money; this equipment is necessary as a means of supporting outstanding credit-accounts sold to customers. And if a bank has in mind the principle of elasticity in providing accommodation to the community which it attempts to serve, the amount The amount of ^f capitalization of a bank should be capital needed hy sufficient to support and protect its '^ credit-purchases of all good commer- cial paper offered by those who wish to use credit- accounts. The bank holding itself ready at all times to purchase all good paper offered by those who carry so-called "deposits" should have "capital-resources" large enough to meet all demands for money on the credit-accounts created and issued to customers in exchange for commercial paper, without calling or re-discounting its loans. Or, to state the conclusion of the second school categorically: Capitalization should he sufficient to meet every money-demand on the amount of hanking {credit-account) business done. If there were no variations in the amount of credit used, then a money equipment large Fluctuations in i. i. ^ 11 credit-demand enough to meet money-demands on this constant volume of credit-issues, pending voluntary liquidation, would be the only equipment needed. But the fluctuations of de- _j ro 4^ g SCALE g ~— <=> C3 C3 O O , ^ O oIN MILLIONS o J -n < c H V r ^ 00 < < <5is y CO ^ ^~-->A H ?-" %- J. f£ 2i M / % • — "^^n / c / ^^ to A -^ J o Pl < •o-~ ■2. ''^^ IP » o-^t — Tl Y >"V»^ M 00 1^ f— > ? / (^ I -/ / ± / O 4 m <^ 2 H > m r' 3> 01 Ul I ? ~/ 5 > 5 M V tn f o 00 <. 01 '-^ § >!^ r^^vi^ v '^ r% H > ^ 00 (^^ ^ c "^ (0 Xq^^ CP ^^ 4 «j ■p- ^"■* '>> ^**s. ^■^ ^---, / I ^ / I V \ a \ H ^ y ^ f < 1 \ J. i ^ "^ w. C3 C3 C3 s g SCALE g C3IN MILLIONS o BANK CAPITALIZATION AND ELASTICITY 71 mands for current bank-credit are continuous; the pro- portion of money-demands to credit outstanding is also variable. These fluctuations come from the shifting prosperity of customers; they come also from the fluctuating demands of a business community from season to season. It is found by experience, however, that the de- mand for current funds (i.e., the amount of good commercial paper and other bankable assets offered to the bank in exchange for accounts) varies with considerable regularity. The money-demand may likewise be closely approximated. In highly mer- cantile communities the experience of a bank may show a recurring ebb and flow of credit four times a year — the largest demands coming semi-annually; in certain agricultural communities there is a rise Abiliiy to capital- and fall twice per year; in others, the ize fluctiMting loans and accounts cumulate and are demands reduced by voluntary liquidation only once in twelve months. The amount of capital needed under such circumstances, unless the bank intends regularly to shift the burden by re-discount, is an amount that will provide a safe money-reserve for the support of the largest volume of credit-ac- counts (so-called deposits) carried during the year. No greater fallacy existed in banking circles than the one so often stated — that a certain percentage of "cash" to deposits is the only equipment necessary to sound banking. This form of reasoning has led 72 THE BANK AND THE TREASURY to strange results. In time of minimum demand, the money-reserves are allowed to run low in propor- Equipment tion. By assuming that this is the needed to meet only form of equipment needed, the fluctuations -^^^^ -^q,^ ^^ resources from which more money may be realized, when demands are larger, without calling loans or restricting credit accommo- dations. Again, in attempting to determine the amount of money-reserve needed, it may be found that in one institution less than ten per cent is actually used. The bank having such an experience recog- nizes that it is not good business to carry a money- reserve of twenty or thirty per cent. This would be as foolish as for a coke company to build twice or three times as many ovens as it may ever hope to use. The clause of the National Bank Act which allows the banks to "deposit" their surplus money-reserve is a contradiction in itself and a recognition of this folly. But those who are responsible for this law engaged in two other fallacies, viz.: (i) that the so- called "deposit" is not a sale of money; and (2) that the asset obtained on sale of surplus money is a readily convertible "in vested-reserve." The wide variations of demands for money from "Money-reserve" t™6 to time on the accounts of cus- and "invested- tomers make two forms of equipment reserve advantageous, viz. : (i) a legal-tender "cash-reserve" of such amount as will protect the bank against all current demands, including de- BANK CAPITALIZATION AND ELASTICITY 73 mands of customers for money and demands of banks on exchanges; (2) an "invested capital-re- serve" w^hich will produce an investment income when money-demands are small, but which may readily be converted into "cash"* in time of need, without forcing the bank to sell its commercial paper or call in its loans. The Kind of Capital Equipment Necessary to Elasticity As a basis for further discussion of the relation of capitalization to the problem of elasticity, the follow- ing illustration is given. A bank with a share-capi- tal of $100,000 and a surplus of $25,000 may provide equipment for itself, as follows: Capital-Resotirces Banking house $S,ooo Redemption equipment: 1. Cash-reserves: (a) Exchange balance $10,000 (6) Money-reserve 60,000 2. Invested-reserve .50,000 120,000 Total equipment $125,000 Capital Liabilities Capital stock $100,000 Surplus 25>°°° Total capitalization $125,000 *"Cash" ishereused to mean legal-tender "money" and "accounts" with banks for purposes of redeeming exchanges, but not to include "loans" to banks at interest even when these loans are in the form of open accounts not used for the redemption of credit obligations. See subsequent treatment of "loans to reserve agents," etc, 74 THE BANK AND THE TREASURY With these capital-resources and with this redemp- tion equipment of $120,000 the bank may purchase commercial paper and other bankable assets with its own credit-accounts as follows: Commercial Assets Loans and discounts, etc.* $466,666.66 Commercial Liabilities Accounts of customers {i.e., deposits) $466,666.66 From the above it wUl be seen that the bank in question has used all its capital in the purchase of equipment, that is to say: (i) $5,000 was used to provide a banking-house, furnishings, etc.; (2) a redemption equipment made up of a "cash-reserve" of $70,000 and an " invested-reserve " of $50,000 — i.e., capital-resources amounting to $120,000 were set aside for the protection of the credit transactions of the bank with its customers. In the above showing, $466,666.66 of "demand-accounts" are represented as outstanding; these have been used to purchase $466,666.66 of commercial paper.* It thus appears that there is a "cash-reserve" amounting to fifteen per cent of the outstanding customers' accounts *It is not to be presumed that all accounts are created by the purchase of commercial paper. Much of the accounts are created by "deposits" (sales) of money, checks, and drafts, etc., but generally speaking the money, checks, and drafts deposited with (sold to) a bank will be used as set-offs against withdrawals, and the customers' accounts (deposits) will very nearly equal commercial paper held — i.e., loans and discounts. If the capital funds are kept separate and apart and the investments to be used as capital-equipment clearly distinguished and unimpaired, the "commercial assets" account and the "commercial liabilities" account will be very nearly equal. BANK CAPITALIZATION AND ELASTICITY 75 (so-called "deposits") and that there is an added "in vested-reserve" of ten and seven-tenths per cent. Let us assume that this bank is located in a Western cattle country, and that the demands of customers for current funds fluctuate from $300,000 to $700,000 during a year — also that a fifteen per cent money- reserve (a much larger money-reserve than is usually necessary) is found adequate at all times to satisfy current demands for money. During Capital adjust- . , i^i i. • • ^i 1 ments to demands the cattle shippmg season the loans would, by voluntary liquidation, be reduced to $300,000; at such times only $45,000 in "cash-reserve" would be needed for safety. With the capitalization above represented, therefore, $65,- 000 of the redemption equipment of the bank might be invested in some kind of readily convertible asset that would produce an income. Gradually, as the season progressed, the ranchers would bring in new cattle-notes to exchange with the bank for accounts. Safety would then demand an increase in the "cash- reserve"; this (the cash-reserve) might then be re- couped out of the "in vested-reserve" — i.e., out of the unencumbered capital-resources. When the commercial-paper-assets and current-accounts-pay- able rise to $700,000 the "money-reserve" (by sale or by h)^othecation of "in vested-reserves") would be increased to ^105,000 (fifteen per cent of out- standing accounts-payable) and still leave a liberal margin of "in vested-reserve." If the banks were to 76 THE BANK AND THE TREASURY operate under some such measure as that proposed by Senator Knox, December 4, 1907 (S. 1239), or by Senator Aldrich, January 7, 1908 (S. 3023), the invested-reserve might be used as collateral to note issues, or, under the Payne- Aldrich law of 1903, the invested-reserve might be deposited as collateral to government deposits. Thus without in any man- ner increasing the market demand for money as a means of increasing the banker's reserves, the credit accommodations of the bank might be increased two and one-half times its available capital. The capital- resources of the bank in the form of "in vested- reserves" might be hypothecated with a ten per cent margin in collaterals without sale of the invested capital-reserves (or they might be sold) in any mar- ElasHcUy a result ^^^ "^^^^^ money might be had on 0/ capital adjust- favorable terms, and the amount of ^^^^ the money so purchased might be transferred as an exchange balance to the Western bank. With such an equipment, operating under laws of the character referred to, the national banks alone would enjoy an elasticity of credit fully supported by capitalization ecjual to $2,500,000,000. Add to this the ability to safely expand which would come through other banks operating under favor- able State laws, and the elasticity adaptable to business of legitimate character would exceed any emergency demand that has to this time been felt. Chapter VII THE PUBLIC CONTROL OF COMMERCIAL BANKS One of the principal functions of government, so far as it undertakes to control banks, is to protect the customer against an impairment of banking capital; to this end periodical reports are required. Question is raised as to the efficiency of present methods of control and as to the degree of pro- tection given to purchasers of credit-accounts of banks. Preliminary to this inquiry three questions must be answered before any proper appreciation may be had of the possibilities of public control as a means of protecting the public against an "un- sound" and "inelastic" circulating medium, viz., (i) what are the powers of control given by the Na- tional Bank Act? (2) Under the Act, what are the purposes for which control is to be exercised? and (3) in the exercise of powers granted, what devices or means may be employed by the Comptroller to reach these ends ? These preliminary questions having been disposed of we then will be fairly abreast of our topic. Powers 0} Control Given by the National Bank Act The first of these inquiries may be answered by direct appeal to the language of the Act. Section [77] 78 THE BANK AND THE TREASURY No. 87 of the National Banking Law (Section 5211, R. S.) contains this specific mandatory declaration: "Every association [i.e., National bank] shall make to the Comptroller of the Currency not less than five reports during the year, according to the form which may be prescribed by him." This general provision is supplemented by grants of specific power to the Comptroller, which enable him to call for other re- ports as often as he may desire, and to obtain such information as he "in his own judgment" thinks necessary "to a full and complete knowledge" of financial condition; a bank failing or refusing to comply with such request is liable to a penalty of $100 per day (Section 5213, R. S.). It would appear, therefore, that the Comptroller is not lacking in authority to obtain any and all information which may be necessary to administrative supervision. A further reading of the National Bank Act quite as concisely forces the conclusion that the Comptroller has all the power necessary to a complete control over National banks and their operations, as to all subjects which are properly within the range of official dis- cretion; this power extends even to the taking posses- sion of the bank itself and winding up its affairs for failure to comply with his demands. The Purposes for which Control is to be Exercised This brings us to consider the second question raised, viz.: the subjects of official discretion imder PUBLIC CONTROL OF COMMERCIAL BANKS 79 the Act, or the purposes for which official control is to be exercised. It has repeatedly been affirmed that the prime purpose of the National Bank Act was to create a better market for Government bonds when the National credit needed support. In the midst of civil strife when the financial resources of the nation were strained almost to the point of bankruptcy, it was conceived that a very large part of the capital employed in commercial banking enterprise in the United States might be utilized to support the Gov- ernment. The plan proposed was an old one — one in which the banks (being induced to use their capital to purchase Government bonds receiving the high rate of interest then paid on National loans) would be permitted to use "notes" with which to carry on their banking business. By this device it was thought that the financial strength of the banks might be brought to the support of the Government, i.e., that the State banks might be induced to bring over their capital into a new National system where it might be utilized in the manner indicated. To make such a scheme acceptable, however, two conditions must be met: The first result of such a plan of support to the bond market would be a large Conditions neces- increase in the money circulation of sary to the adop- the country and this note would not tion oj the Bank ^^ j-eceived unless it be made as sound (i.e., as valuable) as the money then in current use — the greenback. But this is not the only condition 80 THE BANK AND THE TREASURY that the Government must reckon with. In the experience of the past, business had suffered quite as much from unsound bank-credit in the form of customers' accounts (or deposits) as it had from an unsound currency. National reaction against "wild- cat" banking had but recently forced the several State systems over to a basis of capitalization and official inspection to protect the people against wholesale fraud and bankruptcy. If these State institutions were to be brought into a National bank- ing system — if the Government was to utUize their capital-resources to fund its own necessities — the new National system must carry with it all the pro- visions for safety and for the protection of the public against the speculative devices of the unscrupulous that three decades of the legislative reaction had evolved. Wild-cat banking was banking on "com- mercial assets" without adequate capitalization. From 1837 to the time of the Civil War the whole trend in banking ideals and in banking legislation was toward the strengthening of banking equipment. It had been found from bitter experience that a bank which was not properly capitalized (and which, therefore, did not have capital-resources sufficient to support its credit transactions) was as dangerous to those coming into business contact with it as was a mine or a factory whose construction was faulty and whose machinery was overcrowded. To the public, the poorly equipped bank was much more PUBLIC CONTROL OF COMMERCIAL BANKS 81 dangerous than the mine or factory by reason of the fact that, in case of collapse, a much larger number of people were constantly within the danger line. After two years of agitation and amendment and compromise an acceptable law was enacted. Under the Act the note was to be secured by a collateral deposit of the bonds purchased; and those Guarantees jor holding the credit-accounts of the '^ sound currency" ■, ^ ^ i. i. i. j i_ and "sound bank were to be protected by pro- hanking" visions which required what was thought to be adequate capitalization before busi- ness should be begun, and the exercise of official supervision to prevent "impairment of capital" during the period that business should continue. It was for the purpose of enforcing these two pro- visions of safety and security that the Bureau of the Currency was created and a Comptroller was ap- pointed. Means by Which Control May Be Exercised and the Ends of the Act Reached The functions of the Comptroller have a direct relation to the conditions above described. The first, or, as it was then viewed, the prime purpose for which public control was to be ex- otcontroT'^"''' ercised was to guarantee the sound- ness of the new National currency. This is clearly expressed in the first clause of the Bank Act which recites: "There shall be in the 8g THE BANK AND THE TREAStJRY Department of the Treasury a bureau charged with the execution of all the laws passed by Congress relating to the issue and regulation of a National cur- rency secured by United States bonds; the chief ofl&cer of which bureau shall be called the Comp- troller of the Currency. ..." The second purpose of the appointment of a Comptroller is set out in various subsequent portions of the Bank Act, viz.: to insure adequate capitalization — (i) adequate capitalization as a condition precedent to commenc- ing business, and (2) adequate capitalization at aU times to secure customers against loss through "impairment." That the "National Currency" which was to be issued through the agency of the banks might be as sound as the standard money (i.e., that all forms of money-issues might have a common valuation) pro- vision was made that the bonds purchased by the banks might be hypothecated with the Treasurer as collateral security for final payment and redemption of notes outstanding. According to the provisions of the Act the Government was made a trustee for the benefit of note-holders. For each Control to insure ^v r . . ■, , ,1 i 1 sound currency ^9°° of notes turned over to the bank by the Government for issue, the Treasurer was to hold a non-interest-bearing account with the bank secured by a $1,000 bond. The obli- gation of the bank to the Government was for the repayment of $900 in bank-notes or legal-tender * At present the bank may obtain par on bank notes under this Act. PUBLIC CONTROL OP COMMERCIAL BANKS 83 money at its own option. The Government as trus- tee was the legal owner of the bond. The benefi- ciaries were (i) the note-holders to the amount of notes held, and (2) the bank for the amount of the current income on the bond and for its equity of redemption. This plan of National currency having been adopted, when a bank issued a note the cus- tomer took it, as before observed, not on the credit of the bank, but as a beneficiary in the trust-security held by the Government. The note-holder never inquired as to the credit of the bank through which the note was issued, but relied entirely on his claim against the security held in trust by the Treasurer. Since both bond and greenback were Government credit the National currency secured by Government bonds was taken by the public to be as good as a greenback. Later, when both greenbacks and bonds were redeemed in gold, this National currency came to be considered as good as gold. As a means of control (to secure the soundness of the circulation or National currency so issued), therefore, the function of the newly created bureau was to see that the trust account of fhlsJiZtZ" "^ th^ bank with the Treasurer was kept amply secured, and that the bonds held as collateral security were sufficient for this purpose. But all the data was at hand for deter- mining this fact, and the bonds themselves being in custody, the services of the Comptroller in his capac- 84 THE BANK AND THE TREASURY ity as guardian of the currency became merely nomi- nal and perfunctory. Moreover, for this service no report was necessary to control. Not so with the second function exercised by the bureau — the protection of those who held open accounts (or deposits) of the bank; its importance was correspondingly increased, but not in its bearing Importance of on original capitalization. As at the control to protect beginning, the method of ascertaining depositors whether the bank had the requisite capital-resources to commence banking operations has remained one of inspection and not one of finan- cial report. The Comptroller must know that at least fifty per cent of the amount of the authorized capital-stock is actually in hand in money, and that the balance of the stock subscription is good, so that it may be realized in ten per cent monthly instal- ments. The most difficult duty which the Comptroller has to perform, and the one of increasing importance to the financial world, is that which pertains to the security of the public against the "impairment of Capital as a sup- capital-resources " during the period port to "de- that the bank continues in operation. posits Ejiowledge as to this feature of the work must come largely from the reports made by the banks themselves, as the number of examiners is grossly inadequate to report more than a check on some of the main items of account. It is from PUBLIC CONTROL OF COMMERCIAL BANKS 85 this duty that the present inquiry takes its chief bearing. Protection of the Public Against Impairment of Capital To state more specifically some of the questions that the Comptroller must have in mind in asking for reports with respect to capitalization: Section 5202, R. S., provides that "No association at any time shall be indebted, or in any way liable, to an amount exceeding the amount of its capital-stock [capital- resources] at such time actually paid in, and remain- ing undiminished by loss or otherwise, except on accounts of the nature following: (i) Notes of circu- lation; (2) Moneys deposited with or collected by the association; (3) Bills of exchange or drafts drawn against money actually on deposit to the credit of the association, or due thereto; (4) Liabilities to the stockholders of the association for dividends and reserve profits." Section 5203, R. S., specifies that Specific assign- "No association shall, either directly menis oj duty to or indirectly, pledge or h)rpothecate Comptroller ^^^ ^j j^^ ^^^^^ ^f circulation for the purpose of procuring money to be paid in on its capital-stock, or to be used in its banking operations or otherwise; nor shall any association use its circu- lation notes or any part thereof in any manner or form to create or increase its capital-stock [capital- resources]." Section No. 5204 recites that "No 86 THE BANK AND THE TREASURY association or any member thereof shall, during the period it shall continue its banking operation, with- draw or permit to be withdrawn, either in the form of dividends or otherwise, any portion of its capital [capital-resources]." Again, in Section No. 5205, R. S., the law requires that "Every association which shaU have failed to pay up its capital-stock, as re- quired by law, and every association whose capital- stock [capital-resources] shall have become impaired by loss or otherwise, shall, within three months after receiving notice thereof from the Comptroller of the Currency, pay the deficiency in capital-stock [capital- resources] by assessment upon the stockholders pro rata for the amount of capital-stock [capital-liability] held by each." All of these, and other assignments of duty with respect to the protection of customers against im- pairment of capital, make necessary official inquiry into the relation of capital-resources to capital-lia- bilities — they require a special in- Need for an • ,. .^ •, ^ analytical report ^^^^ ^^ *« ^^e capital-resources at hand. For the purpose of determin- ing whether or not the capital equipment of the bank has become impaired through "loss" on account of banking operations or "otherwise," a keenly ana- lytical report is necessary. To properly execute this function of control it is necessary to distinguish the capital-resources and liabilities from the other assets and obligations of business. PUBLIC CONTROL OF COMMERCIAL BANKS 87 The Present Value of the Report to the Comptroller as a Means of Control In taking up the "form" of report made by the banks to the Comptroller, attention will be confined to the question of determining whether or not the No attempt made capital-resources have become im- to distinguish paired. An examination of financial capital-resources statements, as at present made, will disclose the fact that no attempt is made to distin- guish "capital "-resources and liabilities from the assets and obligations "current" to the business. An Analysis of Banking Resources For the purpose of determining the financial con- dition of a going concern, it has become an established principle of analysis that capital-resources are all those properties and assets which are intended for permanent or continuous use in the business. Two Equipment to be principles of administration are well provided by capi- settled: (i) to prosecute an enter- tal investment ^^^^^ successfully it is necessary to provide the management with equipment adapted to its purposes; and (2) whatever property, equipment and stock or working assets are permanently or con- stantly needed, should be provided out of capital investment. As before suggested, this is the purpose for which capital is needed. The proper equipment 88 THE BANK AND THE TREASXIRY of a business is necessary to success. As a matter both of financial advantage and of financial safety, this equipment should be provided out of capital. To attempt to provide permanent equipment out of temporary loans, or floating debt, is to hold the enter- prise in constant jeopardy. This is as true of a bank as it is of a railroad or of a mine, and this is the under- lying thought of the law. Again, to restate a currently accepted definition, the current assets of an enterprise are those which are acquired, not for equipment or continuous use in the business, but those which are acquired in its current transactions — i.e., in the course of current operation for profit. The purpose of current assets is realiza- tion, or conversion. Current liabilities are those in- curred in current transactions. It is to fund the temporary needs — to meet the current expenses — to provide funds to carry these current assets and current transactions — that a floating debt is con- The " commercial tracted. If the principles of financial assets" obtained analysis commonly employed in ac- oncurrentaccount counting are applied to the assets and liabilities of National banks, conclusion may be reached as to whether or not the capital-resources have been impaired; also, whether or not the permanent equipment is adequate to support its operations with safety to those who may be in business contact with the institutions under ex- amination. PUBLIC CONTROL OF COMMERCIAL BANKS 89 What Are the Capital-Resources of National Banks The reports, as at present made to the Comptroller, are not based on such a system of analysis, and, therefore, any attempt at rearrangement to this end must in a measure be unreliable. But taking the various items of resource exhibited as a basis for present discussion, a fair approximation may be reached: (i) "Banking-house and fixtures" are un- questionably capital-resources. (2) "Real-estate," in contemplation of law and from every point of business reasoning, should be charged against capital. (3) The bank invests its capital in Analysis of capi- ^ ■, , • i i- ^ tal outlay bonds to secure circulation, and re- ceives on the collaterals deposited notes which may be used in the business — the "mar- gin" of capital invested in these collaterals should be considered a capital charge; the same is true of the "margins" invested in the collaterals deposited to secure Government deposits. (4) The "money- reserve" is essentially a capital-reserve; it is the principal redemption equipment necessary to support the current credit-accounts (deposits) outstanding — the resource necessary to meet the floating debt of a business, whose chief transactions are the purchase of current assets by use of its own current credit- accounts. There can be no doubt that the "money- reserve" held by a bank should be a direct charge against capitaHzation, and is made so by legal enact- 90 THE BANK AND THE TREASURY merit — the only question with reference to this class of items pertains to the interpretation to be given as to what properly constitutes "money-reserves." (5) The accounts which it is necessary for a bank to maintain to provide for its out-of-town "exchanges" are likewise assets permanently needed and in con- tinuous use; it should therefore be counted as a part of the necessary redemption equipment. (6) Finally, the unencumbered securities and other direct invest- ments of capital owned and held by a bank as a means of strengthening its cash-reserve should be regarded a part of its redemption equipment and a charge against capital-resource. These must be so considered for the reason that the direct applica- tion of capital to the purchase of "securities," or for that matter even to the purchase of commercial paper, is not banking. There can be one purpose only for making such purchases, viz.: to keep the capital which is needed to support credit transactions in- vested in income-producing assets when not needed in the form of "cash." "Securities" must be con- sidered either as redemption equipment held in reserve or as an investment which is a charge on capital and therefore a deduction from capitalization for banking. The same is true of all other direct investments of capital. A bank which engages in buying and selling "securities," in "underwriting flotation," or in other business not in the nature of banking, needs to have a larger capital than an insti- PUBLIC CONTROL OF COMMERCIAL BANKS 91 tution which does not so engage itself. Whether the capital investment be in banking equipment, or in other assets and business ventures, the amount of funds thus engaged by the banks should be set up as capital-resources or charges against the capital pro- vided for doing business, the protection of which is the chief end of control. These several classes of assets being in the nature of charges against capital, the duty of the Comptroller (under the National Bank Act) requires : (i) that an examination of the assets be made to ascertain what may fairly be counted as capital outlay for banking Examination to equipment, and that this be compared ascertain capital with the amount of capital provided tmpatrmen j^^. ^g^ ^^ ^j^^ institution under exam- ination; and (2) that an examination of current assets be made to ascertain whether there have been any losses suffered in the prosecution of the business, since all "bad loans," etc., must be charged against capital. The accounts exhibiting capital put into the busi- ness are found on the liability side of the balance- Accounts exhibit- sheet. The capital provided for use ing capital pro- in the business is represented in three ^ controlling accounts, viz.: "Capital- stock," "surplus," and "undivided profits." Of these, the first two items are to be a permanent reserve or liability in the business, and the third must remain in it so long as there is any question as to the impairment of capital-resources. 92 THE BANK AND THE TREASURY Before any comparison may be made for the pur- pose of determining what character of investments have been made of capital put into the business, the statement of assets reported by the banks must be Provisions made assumed to be based on a proper jor appraisement valuation, or a critical examination oj assets ^^^^ t^^ j^^^_ ^qt this purpose the Comptroller may supplement the report made by the bank itself with the report of his examiners in whose field the bank lies, or may detail a special examiner if the case seems to warrant such an assignment. In any case, however, a distinction must be made be- tween the current-accounts and the capital-accounts. Classification of Balance-Sheet to Show Financial Condition Intelligent judgment as to the character of equip- ment provided by a bank by capital investment requires a classification of resources. The exercise of official discretion with reference to the integrity of capital-resources, which proceeds from the examina- tion of financial reports, makes a classified balance- ConsoUdated sheet a necessity. To the end of statement jor establishing a basis for the further dis- aeo) owa cussion of "the financial report as a means of control," and at the same time of showing some of the difficulties which stand in the way of the exercise of effective control under the present form of report, an analysis of the consolidated statement PUBLIC CONTROL OF COMMERCIAL BANKS 93 of all the National banks of the State of Iowa for September 9, 1903, is here exhibited. The classifi- cation submitted is not offered as a model in the arrangement of items. Neither is the assignment of inadequacy of the present set form intended to reflect on Comptrollers past or present. The form now used is, in effect, that which has been employed by officers of banks for a century; it has been engaged by comptroUing officers of Government since public examination first began. To suggest that a change might be made to advantage is not therefore to be considered as offered in the spirit of reflection on official conduct, more than a proposed amendment of law would imply legislative incapacity. Not engaging any spirit of personal criticism, and holding in mind the difficulty of doing more than to suggest that a classified balance-sheet is essential to a consideration of the topic assigned, the statement of capital-accounts opposite page 94 is modestly offered as a tentative arrangement. Attempting to show the amount of capital put into the business, and to account for its investment, in the exhibit below it is assumed that the valuation of assets represented in the reports of the Comptroller is conservatively made, and that there are no "bad loans" to be written off. But even with this assump- tion, and for this purpose, the form of report made by the banks to the Comptroller renders many of the items doubtful: (i) In the statement of "premium on 94 THE BANK AND THE TREASURY bonds" as one element in the computation of the amount of capital locked up in "margins" there is Doubtful items no way of distinguishing this from dm to form 0} premium on "bonds on hand"; (2) statement ^ ^^^ u^^^-^ j^ems" it is of frequent occurrence for banks to include expense vouchers which are to be held till the end of the month; in so far as these were included, the statement of the amount of "cash-reserve" is too large. (3) The amount stated as "balance kept with banks for ex- change" must be roughly approximated, as no spe- cific inquiry is made in the present form submitted by the Comptroller to determine this fact. The amount of Clearing-House exchanges held are $141,- 000; assuming that the amount of exchanges out- standing against the banks under consideration aver- ages$i 75,000, and further that the average exchanges against "outside" banks are not greater than those against clearing-house banks, and this would seem conservative; assuming further that on an average it requires three days for outside exchanges to be presented and paid, the average balance needed to be kept for the redemption of exchanges would be $525,000. Again assuming that the "outside" money demands for exchange were not more than one-tenth of the local demands for money, and taking this as a basis for estimate, the exchange account necessary would be $548,799; this is taken as the amount of the account with "reserve agents" which Missing Page PUBLIC CONTROL OF eOMMERClAL BANKS 95 is carried for redemption of outside exchanges. The remainder of the "reserve agent" account is con- sidered as "loans" to other banks at interest and is included in the "in vested-reserve." These amounts are arbitrarily set up, but as they are both in the nature of capital charges the arbitrary division is not important. (4) Under the head of "encumbrances" on "securities owned" it is assumed that the "bills payable" and "other liabilities" stand as encum- brances on stocks, bonds, etc. This is true to the extent only that these liabilities are based on stocks and bonds hypothecated as collaterals, and in so far as this is not true the account would be varied by an exact return such as might be obtained from the bank. (5) The amount exhibited as "loans to re- serve agents" is stated on the assumption that the purpose of such investment is to have a quickly convertible asset by means of which cash may be obtained when the money-reserve runs low — a bank making a statement to the Comptroller under a form calling for these specific items of capital-resource might set up some other form of asset as a "direct capital investment." In each and all of the items above mentioned there are elements of doubt — elements which require questions to be raised, but each of which might be made certain by a different form of inquiry submitted to the banks by the Comp- troller in seeking for a classified statement of capital investments. 96 THE BANK AND THE TREASURY But assuming for the purposes of present discus- sion that the above analysis of capital investment were true to the facts, let us see what use might be made of such form of report. In the first place we may seek to eliminate those investments which are not in the nature of redemption or banking equip- ment. The building in which the bank is housed need not be owned by the bank itself. The banking business is a credit business; primarily it consists of the exchange of bank-credit for commercial-credit at a profit. Investment in a building does not strengthen the concern in its current-credit relations. Many of the largest banking institutions do not own a building. The prime purpose of capitalization being to provide equipment with which to supply funds to the community in the form capital outlays ^^ demand-credit, any use of capital to purchase a building must be con- sidered as an extraneous investment not available for the support of the credit of a going concern. "Real-estate" belongs to the same class of invest- ments. This has been so often said that it has be- come axiomatic in commercial banking circles. The "margin" invested in the securities hypothecated with the Government are also not available to the business as a going concern. All of the above classes of assets are important as assets for final liquidation on "winding up," but to a "going con- cern" they are purely voluntary and ornamental and PUBLIC CONTROL OF COMMERCIAL BANKS 97 bear much the same relation to the business of bank- ing that the gilded dome on the Congressional Li- brary does to the value of its literary stores within. Whether or not in contemplation of law this amounts to an impairment of capital, the fact remains that $3,297,053 of capital invested in this way has weak- ened the banks of Iowa as "going concerns" to that extent. Another class of considerations attaches to the remaining classes of capital investments — those re- sources used to support the banking transactions themselves by redemption of credit obligations on demand. Assuming that the banks had made re- turn of redemption equipment as above exhibited, the Comptroller as an agent of the Government Outlays for re- should know whether this equipment demption equip- is adapted to the use for which it is "**"' intended. The unencumbered secu- rities, for example, being intended for an invested- reserve to strengthen the cash-reserve held to support demand-accounts (deposits outstanding), the ques- tion pertinent to this use is: Are these securities im- mediately convertible by sale or hypothecation with- out loss of principal ? If, again, any of these are held as the result of underwriting, this fact would suggest that a portion of the bank's capital was being em- ployed in business other than banking and there would be an impairment in use if not in valuation. Such part of the bank's capital as is used for under- 98 THE BANK AND THE TREASTJHY writing should be placed among the unavailable assets. Further than the specific inquiries made as to the character of redemption equipment, compari- son may be made of total capital outlay with capital liabilities, to ascertain whether the equipment had been provided by means of capital or on floating debt. By some such classification increased facility would be given to many other official inquiries directed toward the protection of the people against the impairment of the capital-resources needed by a going banking concern. Chapter VIII AN ELEMENT OF CONTROL NOT ADEQUATELY PRO- VIDED BY THE NATIONAL BANK ACT While the National Bank Act is very specific as to powers of control directed against the "impair- ment of capital" there is another element of banking strength or weakness quite as important that has been neglected; viz., the protection of the customer against overburdening the equipment used. Judg- ment as to safety must be made not alone with re- spect to the absolute strength of material used in construction and equipment, but this having been Need for deter- determined it then must be compared mining the with the weight or strain that it is to ^^^ * " support. To be more concrete, every facility is given to such inquiry as the Comptroller may desire to make to protect the capital put into the business against deterioration, but almost no provision is made for official inquiry as to whether the credit burden imposed by the bank officers on this equipment in the prosecution of the business is greater than it can safely bear. [99] loo THE SANK AND THE TREASURY There is no provision made for correlation of capi- tal equipment with the credit liabilities incurred in the course of its business. These must be met on demand, and safety requires that they should be met by capitalization. This is an essential to sound banking as contemplated in the National Bank Act. Banking activities are represented in its current assets acquired and the current liabilities incurred in banking operation. To concretely exhibit this class of financial results, reference will again be made to the summary for the State of Iowa above used in the statement of capital accounts. Current Assets (Less $000,00) — Acquired in the Course oj Banking Operations I. — Due from Banks and Bankers: (i) Due from National Banks $2,698,877 (2) Due from State Banks... 1,058,726 (3) Clearing-House exchanges 141,352 13,898,955 II. — Commercial assets : (i) Loans and discount $62,159,426 (2) Overdrafts 1,121,025 Total $63,280,451 Less notes rediscounted.. 105,267 Net commercial assets 63,175,184 III. — Miscellaneous : (i) Revenue stamps 1,020 Total current assets $67,075,159 A POINT NOT COVERED BY THE BANK ACT 101 Accounts Representing Banking Operations Current Liabilities {Less $000,00) — Incurred in Banking Operations I. — Due to Banks and Bankers : (i) Due to National Banks.. $2,362,481 (2) Due to State Banks 4,257,426 (3) Due to Trust Companies, etc 3,258,966 l9,878>873 Less amount incurred for equipment purposes . . 1,465,537 8.413,336 II. — Commercial Credit Accounts: (i) Individual deposits $58,606,777 (2) Deposits of U. S. disburs- ing oiEcers 42,586 58,649,363 III. — Miscellaneous : (i) Dividends unpaid 12,460 Total current liabilities $67,075,159 From the two summaries exhibited, — the one of "capital accounts" (p. 94), and the other of "banking transactions" (above), — it appears that by means of a capital investment of $20,501,114 a banking business of $67,075,159 was carried on. With these results in mind let us determine, in so far as we may, what Means of deter- strain was brought on capital equip- mining equip- ment. In the first place, on what ment strength ^^^^ ^^ ^^^ equipment does the bank- ing strain come? As before observed, it is at once apparent that no part of the credit strain falls on the first three classes of equipment enumer- 102 THE BANK AND THE TREASURY ated, viz.: (i) "Banking-house and fixtures." (2) "Real-estate" and (3) "Margins." From the point of view of the demands of commercial banking these are purely a gratuitous use of capital. Ownership of a house and furnishing is unnecessary — this para- phernalia may be leased and the rent charged to current expenses, and when a building is owned it is in the nature of a real-estate investment; "real- estate" owned is an encumbrance on banking capital and not banking equipment; the "margins" invested in bonds used as collaterals for notes and deposits are incidental to the system devised by the Government to strengthen its own credit, and as such are not banking equipment — they are a further encum- brance on banking capital. The equipment necessary to banking transactions is the "cash-reserves" or "such invested capital- reserves as may readily be converted into cash" and which may be used to meet demands on outstanding credit-accounts without curtailing commercial ac- commodation. As a means of carrying on a business which consists in the exchange of bank "credit-ac- counts" for "income-producing assets in the nature of commercial-credit," the bank must estabHsh and Three classes of maintain a reputation for meeting its redemption credit-accounts on demand. The eqmpmen ^^^^ ^^^ ^^^^ ^j^j^ ^^^ ^^ ^^^^ ^^^-^ safety to its customers is by having capital-resources in the form of "cash" when demands are made. A POINT NOT COVERED BY THE BANK ACT 103 The real test of banking strength, therefore, is to be found in the redemption equipment: (i) in the "cash-reserve" — cash in hand and exchange-bal- ances — and (2) in "in vested-reserve" — "unencum- bered securities" and "other capital investments" readily convertible into cash. Again assuming the valuation of these capital-assets to be conservative, the strength of banking equipment of the State of Iowa by this method of analysis, at the time stated, was $17,104,061. But a comparison of strength of equipment with the credit strain upon it must be arrived at by bring- ing the two results together. The total demand obligations for the payment of money were in round numbers $68,500,000. That is, the redemption equipment (after deducting reserve loans uncapital- ized) being $17,100,000, and the total amount of demand-credit to be supported $68,500,000, the inverted pyramid would be $68,500,- The test of credit ^ _ -n i. • ^^^ tension 000 — $17,100,000. But m gettmg at the amount of the strain that will fall on the capital-resources this gross amount must be reduced. Eliminating by set-off the current institutional assets and liabilities, the relation of credit outstanding to capital-assets would be $62,- 500,000 — $17,100,000. In other words, $17,100,- 000 invested in banking or redemption equipment has permitted the banks of Iowa to purchase about $62,500,000 of interest-bearing commercial assets by 104 THE BANK AND THE TREASURY means of about $62,500,000 of their own credit- accounts supported by this equipment. Through banking operation, the corporations have a gross income about four times as large as they would have by direct investment of their capital in commercial paper, and have furnished to the community credit- funds which do the work of money of equal amount. The purpose of control is to make such a business safe, and the differential of safety must be drawn from experience, leaving an adequate margin of pro- tection to the public against contraction of the circu- Need for control luting medium as well as to protect as a means of customers against immediate loss from ^^"'^ ^ non-payment. The need for a better correlation of capitalization with equipment and banking operations carried on may appear the more vividly by comparison of the several classes of banks reported. {See next page.) Assuming that for the purpose of accounting for capital investment in redemption equipment the cash on hand is to be a first charge against capital (this not being an income-producing asset and of first importance in the support of credit), in so far as may be determined from published bank returns, the foregoing summary shows the disposition of cap- ital invested in the banking business in the various classes of banks represented. From this it would appear that while in a single agricultural State like Iowa the banks by their own capitalization have A POINT NOT COVERED BY THE BANK ACT 105 Exhibit of Capital Investments by Classes of National Banks, September g, 1903 (Stated in Millions of Dollars.) Classes of Items All National Banks 3D CO S ■ass £■3 S8, II UU1 D» Unavailable Capital : Investments (Banking-Houses, real- estate and margins) Redemption Equipment : Cash-Reserve: (i) Money (2) Exchange account Invested Reserve: (i) Securities (2) Other reserve investments Total Capitalization* $186 605 61 446 $101 183 18 237 159 $42 147 14 116 S43 248 $38 177 H.310 $698 $321 $291 $215 * The amount stated as capitalization includes capital stock, surplus, and undivided pro&ts. provided the funds to procure a large part of the resources used as redemption equipment to support their outstanding credit, taking all of the banks of the Inadequacy of United States this is not true; they capital invest- have provided capital enough for ^^^^ "cash-reserves" and for "securities" actually held, but they have provided almost no capital for direct investment in "loans to reserve agents." The banks in reserve cities (of the second class) are in about the same relative con- dition 9,s those of the country at large, in so f9,r as 106 THE BANK AND THE TREASURY these items are concerned ; absolutely they are in a much weaker position on account of the importance of their "reserve loans" not capitalized. The banks of the central reserve cities (the "cities of the first class"), however, have not sufficient capital to pro- vide themselves with the current "cash-reserves" used in the business, and which are required of them by statute, to say nothing of securities owned; the amount of "cash" which such banks are able to provide through capitalization is only 24.2 per cent of their net banking liabilities. Assuming that all of their capital were retained in the form of cash, there would not be enough to provide the amount actually on hand by $27,000,000 — this part of the redemption equipment, together with the funds neces- sary to provide all other forms of equipment carried, had been borrowed. Assuming that the equipment actually carried is needed, then the banks of reserve cities have obtained $292,000,000 of their equipment on floating debt. If we take the judgment of bankers as to what equipment is necessary to the safe conduct of their business, an interesting result will be obtained. For this purpose it may be assumed that a banker will keep no more "cash" on hand than safety to his business requires ; if he does he is violating good busi- ness judgment. The same may be said of "exchange accounts" and of investments made in low income- producing assets from which "cash" may be realized A POINT NOT COVERED BY THE BANK ACT 107 by quick returns to support credit-accounts. Assum- ing further that the principle is a sound one, that such Capital weakness assets as are permanently employed, admitted by or such as are continuously needed an ers ^^ ^^iq business, should be procured by direct investment of capital (i.e., that a busi- ness concern, especially a bank, should not obtain its equipment on a "floating debt"), then the in- adequacy of capital increases as we proceed from periphery of the National banking system towards this centre. To exhibit this in tabular form, the result of failure of the Law to require such control as will prevent the overtaxing of capital-resources, and such as will insure that our commercial banks do business on their own capital, would appear something as follows: (See next page.) In this question is raised as to several classes of items. Without specific inquiry as to the amount a bank carries for "exchange account" this must be approximated. The approximation here given, how- ever, is a deduction from "loans to reserve agents" (another account which is carried as an invested- reserve for the purpose of supporting the cash-re- serve) and therefore one which should be capitalized. As to the securities held, in so far as they are not held as reserve equipment, they are not a banking re- source, and like "real-estate" are in the nature of an encumbrance on banking capital. Such assets must be either for support to bank-credit or for direct 108 THE BANK AND THE TREASURY Statement of Equipment Actually Used by the Several Classes Compared with Capital Provided (Stated in Millions of Dollars) Classes of Capital Iteus Unavailable Capital Outlays : " Banking-house," " real-estate," and " margins " Redemption Equipment Used : Cash-reserves Exchange account Securities Loans to reserve agents Total equipment carried Actual capitalization provided Equipment carried on floating debt. . Percentage of floating debt $3-4 S-S ■5 2.4 lO.I $21.9 $20.5 1.4 7% So $101 183 18 237 221 $760 $698 62 9% •a $186 606 61 446 365 $1 ,664 .1,310 354 27% pi-z US" $42 147 15 116 I4S S465 144 44% $43 27s 27 94 $439 $291 148 51% $38 208 21 79 $346 $215 131 60% investment. In either case the bank should not buy bonds on credit. Taking the charges against capital Amount of in- as they stand and the redemption crease in capital equipment actually used, we find that needed ^^^ ^^^ United States, in the judgment of bankers themselves as reflected in practice, the banks should have provided $354,000,000 more of capital to support their business. That is, to prop- erly support $4,363,000,000 of credit used in the course of bank operations to purchase $4,363,000,000 of income-producing assets, the equipment which was actually used should have been provided by the A POINT NOT COVERED BY THE BANK ACT 109 proprietors of the business. Such a provision would require an increase of twenty-seven per cent in total bank capitalization. But further inquiry would show that all but about five per cent of this gross amount of capital to make up the shortage would be required from the reserve city banks, and that nearly one-half of the entire increase is needed in the City of New York. Such would be the inevitable con- clusion if we accept the business judgment of bankers themselves as to the needs for banking equipment. The Inadequacy of the Bank Act Again the position before taken is affirmed, — that this is not proposed as a true method of analysis to get at the relation of intensity of credit strain to equipment used. Attention is directed only to the fact that such an element should be taken into ac- count in reports, the purpose of which is to furnish the data for ofiicial control as a means of protecting the country against "unsound" banking and an "inelastic" currency. Further, it is suggested that no provision is made in the present form of report for ascertaining these data; and only one provision of law is made to protect the public against any The only protec- overtaxing of capital equipment. This tion against in- one provision referred to is the clause fiation which imposes a minimum limit in money-reserve to be kept. This limitation imposed does, in fact, operate to prevent some of the least 110 THE BANK AND THE TREASURY provident bankers from bringing their house down on the heads of customers, and precipitating a panic in the business community. Nevertheless, the pro- vision is entirely inadequate to prevent an overtaxing of equipment. To illustrate one of the methods used for complying with the law, and at the same time for carrying a load that keeps the institution on the verge of credit collapse : — From the published reports it appears that a number of banks have indi- vidual deposits outstanding amounting to from ten to twelve times their capitalization. Some of these banks continuously carry a cash fund larger than their capital-stock, surplus and undivided profits. They also carry large holdings of stocks, bonds, and other securities. Where did they obtain this money ? Undoubtedly they borrowed it. Where did they get their other redemption equipment? Undoubtedly by means of a floating debt. In several instances, only about one-third of the redemption equipment constantly used by these banks is provided by means of capitalization ; the balance is obtained on demand loans. Imagine another enterprise being financed in this manner. With methods of capitalization ad- mittedly unsafe if applied to another business, is it to be presumed that our system of commercial credit will be "sound" and capable of rendering the highest service to the business community so long as these methods are permitted ? This is not to be considered as imputing fault to a A POINT NOT COVERED BY THE BANK ACT 111 banker for doing business in this way. If a banker finds that he may obtain capital from others with which to do business, and that, when a sudden de- The individual mand comes for payment, he can force hanker primarily his commercial customers to find the not at fault , ^ ,i . ' means necessary to replace the tempo- rary foundations withdrawn, if by such methods the banker maybe able to keep his own house from falling on the heads of managers and stockholders, he maybe exonerated on the principle that he has availed him- self of a business advantage which has brought a large return in profits. The method may be excused in the case of the individual bank. But what is the result of this character of banking to the commercial com- munity? And what of a general law and adminis- tration which permits such an individual practice? As a National system this is another form of "wild- cat" banking, and it is in this very practice that we find much of the trouble that heretofore has been ascribed to inelasticity of the currency. The prime fault is in a law which permits bank capitalization inadequate to maintain the volume of bank-credit offered by banks to the community as a circulating medium with which to do business and of which customers have availed themselves. This form of bank-credit being suddenly withdrawn to protect the bank from its own weakness, the community and the individual customers of the bank are left in a crippled condition, to struggle against financial loss. 112 THE BANK AND THE TREASURY One of the purposes of control should be to secure a better coordination between the volume of credit- Additional eh- accounts sold and capital equipment ments of control provided as a means of support ; to needed ^j^jg ^^^ ^j^^ National Bank Act needs revision. But having been revised so as to give the Comptroller power to exercise supervision, to prevent the overstraining, as well as the "impairment" of capital, the present power to compel reports is suffi- cient to make the supervision effective. One of the principal purposes of the Bank Act is to guard integ- rity of our financial system and to protect the public against loss on account of inadequate bank capital- ization. To effect the full purpose of the Act, to vouchsafe a system of control which will secure "sound banking" as well as "sound currency," there should be added to the present powers which are intended to protect against an impairment of capital, inquisitory powers directed against an overloading of equipment. As a means of executing this author- ity, classified schedules should be devised which will furnish the information necessary to intelligent offi- cial discretion, and classified financial statements of results should be published, that the public may the more intelligently deal with the banks. Chapter IX CHARACTER OF ASSETS THAT MAY BE SAPELY HELD BY BANKS AS " INVESTED-RESERVES " To restate conclusions: If we define capital-re- sources as those assets which represent capital outlay (assets purchased by means of capital-funds or which are to be charged against capital-account), then it is in financial statements of capital-resources that the capital outlays of a business are to be accounted for. In a banking business, there are two general classes of capital-assets, viz., (i) those in the nature of physi- cal equipment, and investments not A restatement of m 1,1 i. ^ -u i • i. conclusions available to support bankmg trans- actions, and (2) the banking or re- demption equipment — resources which have been provided or which are being held to support current banking operations. Investments in assets of the first class referred to (not being a necessary part of the business) may be treated simply as an encum- brance on capital; outlays for assets of the second class (or what we may term "redemption equip- ment") are essential to the business of banking. Again, under present business conditions the "re- demption equipment" of a bank is necessarily made [113] 114 THE BANK AND THE TREASURY up of two general classes of resources, viz., (i) the "cash," which is made up of the "money-reserve" on hand retained as a means of protecting the bank against default on current or ordinary local money- demands on credit-accounts, and exchange-balances kept with correspondents to meet foreign demands for money on credit-accounts, and (2) those assets which are held as an "invested-reserve" as a means of obtaining "cash" to meet extraordinary demands on credit-accounts outstanding. The purpose of a legal requirement for adequate capital equipment is to insure the "soundness" of credit-accounts of banks sold to customers for their use, without forcing a sudden contraction of the circulating me- dium and a consequent credit collapse. The reason for carrying a part of the equipment as "invested- reserves" is to decrease the capital cost to the bank. From such a view of the capital-resources of commer- cial banks, and such a statement of the uses of the two kinds of redemption equipment (viz., "cash" and "invested-reserves" or capital investments read- ily convertible into cash), inquiry may be made as to the character of assets which a bank may hold as an "invested-reserve." What character of "invested capital reserves" will contribute best to the purposes (public and private) for which they are held? Generally speaking, there are three kinds of in- vestments in which a bank may employ capital-re- sources not needed in the form of "cash," but which ASSETS TO BE HELD AS "RESERVES" 115 are necessary to the equipment of the bank for the support of outstanding accounts. These may be described as follows: (i) Loans to other commercial institutions; (2) stocks, bonds, and other securities; Classes 0} re- and (3) the commercial paper pur- sers capital in- chased from those who are not de- vestments positors. That is to say, the "loans to other commercial institutions," the "stocks, bonds, and other securities," and the "commercial paper" which are chargeable to "capital-account" are assets which have not been purchased by means of credit-accounts of the bank. And in making finan- cial statements of "capital-resources" and "capital- liabilities" the bank should clearly indicate what paper or assets are to be considered as chargeable to capital-account. These three classes of invest- ments will be separately considered. Demand Loans to Other Banks as Reserve- Capital Investments It is the common practice among banks to loan a portion of their capital-resources to other banks. The reason for this is not a public one, but to de- crease the capital cost to the bank. Such loans are set up in published summaries under two heads; viz., (i) amounts "due from reserve agents," and (2) amounts "due from other banks." Regarding the practice from the point of view of public interest, these loan accounts have been considered as assets 116 THE BANK AND THE TREASURY immediately available for procuring cash to meet money-demands. So general and so plausible is Loans called" de- this assumption, that it was made a posits with re- part of the National Bank Act, under serve agents" ^j^-^j^ ^^^j^ classes of items are ac- counted as cash. The general acceptance of this conclusion rests on fallacy. The conclusion has been supported by reasoning from analogy. In mercan- tile business a bank-account is properly considered "cash"; the primary purpose of a merchant's bank- account is to provide the means necessary for meeting current commercial demands. While, however, this is true of the merchant, it does not necessarily follow as to the banker. It may not be assumed that a credit-account of one bank against another bank should be considered as cash- capital equipment. For the purposes of the bank, this assumption goes afield at four points: (i) Since the business of the bank is one of purchasing "com- Accounts with mercial assets" by exchanging its other hanks as credit-accounts for the use of its cus- equipment ^^^^^^ ^^ u^^^^,, ^^^ y^^^^ -^ j^ ^ different funding relation than the merchant accom- modated; while the merchant may settle his credit balances by bank-credit, the bank must make pro- vision for the settlement of credit balances in money. (2) The checking out or transfer of the accounts of one bank to customers of other banks outside of the immediate locality must be settled through the estab- ASSETS TO BE HELD AS "RESERVES" 117 lishment of an exchange base in other cities; whether this exchange base is in the form of money or of rights to "draw," a considerable portion of the fund cannot be made available for the payment of local demands and for the settlement of local exchanges. The exchange account is capital tied up for the sup- port of exchange transactions and cannot be con- verted into money without crippling the bank's operations. (3) To permit one bank to sell its "money-reserves" to another bank for a credit or "reserve-account," and then to permit the selling bank to treat the "account" as cash to any greater extent than it may be necessary for the second bank to retain the money in its vaults to meet the exchange demands of the first bank, is to permit both banks to extend their credit-accounts on the same capital support and thus to weaken the equipment of both, since a demand of one bank on another bank for settlement is a demand for money. (4) By account- ing "amounts due from other banks" as "cash," without distinction as to the exchange purpose of their creation, and through the regular practice of loaning money-surplus to reserve agents, the reserve city banks have been encouraged to give support to underwriting syndicates and to margin speculation at the same time that the "depositing" bank is ex- tending its credit-accounts with customers. A very large portion of accounts (deposits) held by customers against reserve city banks are credit-contracts created 118 THE BANK AND THE TREAStTRY in exchange for call-loans, which, under ordinary circumstances, may be quickly realized on by the reserve bank; these, however, are not immediately convertible in time of panic without undermining the whole credit structure ; at such times a general process of forcing liquidation constricts the circulating me- dium to an extent that proves ruinous to business. Whenever an unusual demand for payment of loans is made by country banks on reserve agents, such demands force the reserve banks to restrict their own accommodations, and thus contract the circulatiag medium. The underlying fallacy of the reasoning which is back of that part of the Bank Act, and back of the theories which give sanction to the practice itself, may be seen when we analyze the character of the investment. In so far as bank A does not need the reserve fund or account kept with the reserve city The fallacy en- bank B, as an exchange base {i.e., for gaged by the a current purpose) it is investing its '^^ '^ capital in the same kind of a credit obligation as is the call-loan customer of bank B. Bank A is degrading its investment judgment to the same level as an ordinary speculator, and receiving therefor a rate of interest . little if any higher than might be received on U. S. Government bonds. Bank A's investment (account with B) is one de- signed to be held as "available" for the purpose of obtaining cash to meet an extraordinary demand, 119 But extraordinary demand is usually associated with market conditions which make "call-loans" the most delicate of all commercial assets. Yet for this pur- pose bank A holds an open account of bank B, which in turn has treated the money borrowed from bank A as a "cash-reserve" to support accounts of specu- lators and to meet demands made on its own ac- counts. This is the common practice in New York City. By reference to Chart VIII, opposite page 152, it may be seen that the "deposits" of country banks furnish nearly all the money held by New York City banks as a means of supporting about $1,000,000,000 of demand accounts of customers. It is not a new experience in the financial world for reserve city banks to temporarily suspend money payment to protect themselves against the banker's demand for money on payment of drafts and ex- change-balances. The vicious tendency of such a practice of borrowing a money-reserve from other banks and of lending the credit of borrowing banks to speculative enterprise has been a subject of com- ment by every Comptroller from the foundation of the National banking system down to and including Mr. UnavailabUUyo} Knox; and the undesirabiHty of in- reserve accounts vesting capital of commercial banks in in time oj strain ig^ns to " reserve-agents " was again pointed out by Mr. Dawes in 1898. While under ordinary circumstances they may be convertible, "loans to other banks" cannot be considered the 120 THE BANK AND THE TREASURY best kind of reserve-capital investment. There may be many reasons why the banks of reserve cities would be in favor of such a practice, but from the point of view of elasticity and general welfare the practice should be publicly and legally condemned. "Securities" as Reserve-Capital Investments As to State banks, private banks and trust com- panies, it is shown that a large proportion of the securities owned are in forms not easily marketable when occasion requires. The National banks have no published statistics of the proportion of the several classes of stocks, securities, etc., held, but the reports Ahoui one-half 0} do show that about one-half of their hank capital so capital and surplus is invested in mveste stocks, bonds, and other securities; it is also shown that these assets yielded little support to the credit-accounts in time of emergency or extraor- dinary money-demand. Such a showing and such experiences, however, do not warrant the conclusion that stocks, bonds, and other securities which may at once be converted into cash to meet money-demands on accounts outstanding may not be effectively used as "reserve-capital investments." It may be stated as a demonstrable conclusion that such investments are not always convertible into money hy sale without loss to the bank. But while a favorable market may not always be found in which even stocks and bonds which are considered ASSETS TO BE HELD AS "RESERVES" 121 as "gilt edge" may be realized on without loss to invested principal, in time of monetary disturbance, . securities of this class may usually be Converhhhty by i- ■, j , ,, g^lg realized on by sale as soon as the emergency is passed ; in time of finan- cial depression it very often happens that investments of the first rank rise to a higher point than during a period of credit inflation for the reason that "gilt- edge" securities are then relatively scarce and are the only ones to which investment capital is attracted. Elasticity, however, depends on immediate con- vertibility. Although, in an emergency, "gilt-edge" securities may not be converted by sale without in- vestment loss, money may always be obtained on , them by a process of hypothecation. The large finan- cial companies, such as savings banks, trust com- panies, insurance companies, etc., which have few demand obligations to meet and which at the same time have large funds available for Convertibility by . , , j. 1.1. hypothecation investment, may come to the rescue of the commercial banks through loans, in case the banks do not care to realize on their securities by sale at an unfavorable market rate. In obtaining cash by loans or sales of their own col- laterally secured credit obligations the banks are able to realize on reserve-capital investments of this kind, by hypothecating their securities with investment institutions. In such event the only part of the in- vested capital not available for present needs is the 122 THE BANK AND THE TREASURY amount represented in the "margins." It is by this process that the Government assists national banks to obtain money on such investments without loss. Special facility is given for such a disposition under our present Law. Two methods are provided where- by the United States Treasury may permit the imme- diate conversion of "gilt-edge" securities. In the first place, "United States bonds" may be hypothe- cated for "issues"; in the second place (under the Special jacilities ^ore recent ruling of the Secretary), for hypothe- when the Government has a Treasury '-'^^'^"^ surplus, "gilt-edge" securities may be hypothecated for gold, i.e., "Government de- posits," which immediately give to the banks receiv- ing them an exchange-balance against the Treasury. In order to avail themselves of these aids, however, the Government requires that the banks have unen- cumbered "gilt-edge" securities to hypothecate, and this is what the banks in many instances have failed to do. Again, "gilt-edge" securities which are unencum- bered may at any time be hypothecated in the general loan market. For the purpose of procuring tempo- rary loans, the loan capital of the Support of the .. . , , , , loan market entire commercial world may be availed of. There are no institutional or National limits to a good investment security. It is to assist in the process of international investment as a means of relieving National financial distress ASSETS TO BE HELD AS "RESERVES" 123 that the "rate" is so often raised by the Bank of England. The loan market is not local or National. In the past, the inability of banks, which have in- vested capital in securities, to obtain money by sale has been due to one of two practices: Either the bank has departed from the banking business and has be- come a dealer in securities for the purpose of making its profits on buying and selling instead of looking primarily to interest payments on commercial accom- modation, or its officers have been guilty of adminis- trative indiscretion in the purchase of securities which are intended to give support to their own credit- accounts. Their inability to obtain funds by hypoth- ecation has been due either to the weakness of the Practices which security itself (as frequently happens have prevented when the bank engages in underwrit- converston ^^^ ^^^ Other speculative ventures), or to the fact that they have already hypothecated their "gilt-edge" holdings. An instance of failure from the first cause — i.e., on account of the char- acter of the weakness of its investments — is found in a recent collapse of a large institution which had sought without success to obtain a million dollar loan on the security of eight million dollars of securities held. Instances of inability of banks to obtain money for pressing need on account of "gilt-edge" securities having already been hypothecated are many; and, under the present Law and practice, the Government holds out a permanent inducement for 124 THE BANK AND THE TREASURY banks to weaken their equipment through the hy- pothecation of their best investment assets. The in- ducement referred to is the offer on the part of the Government to exchange "notes" and "deposits" for secured accounts of the bank, without interest. The result is, that the banks, as a means of increasing their profits during times of ordinary money-demand, or so-called periods of prosperity, encumber their best invested assets by hypothecation, and in time of money stringency and extraordinary demand they are unable to support their credit-accounts (deposits) without forcing "loans." Commercial Paper as Reserve-Capital Investments Commercial paper purchased or held on capital account must be clearly distinguished from com- mercial paper purchased by means of credit-accounts, i.e., by exchange for deposits. Commercial paper which is obtained for direct investment of a bank's How capital is capital is usually obtained through its invested in com- own loan brokers, or through a com- merctal paper jngrcial paper house or note-broker. Their own loan brokers are represented in the "loan crowd" who are seeking to invest the money surplus for the bank. The note-broker would obtain a mar- ket for the paper of his customers. The business of the note-broker is to find banking houses or other loaners of capital who are looking for this kind of investment. ASSETS TO BE HELD AS ''RESERVES*' 125 Ordinarily a bank will not buy paper of one who is not a customer if it has enough paper offered by its customers to fully employ its capital. The reason for this is that a customer's note may be purchased in exchange for a credit-account of the bank (a de- posit). The bank with its own capital used as a "redemption reserve," therefore, may A " reserve " cap- , ^ ^- ix. ^ c ital investment purchase several times the amount of commercial paper from its customers that it can by direct investment of capital in the notes of those who are not customers ; as a result a propor- tionately larger return in profit will be received from the exchange with customers. The bank will loan through its broker, or will offer to purchase paper through a note-broker, only as a means of investing a "capital" surplus, and this may be used as an " invested-reserve " without contracting or forcing loans to customers. Demands for payment made on these notes do not reflect on the bank itself through forcing the customer (i.e., the holder of its own accounts) to convert. Neither do payments at maturity so seriously disturb the commercial world as do sudden demands on "call" or short- time paper. The paper purchased through note-brokers usually runs for fmpats'TaSy ^^^^y or ninety days, the definite period for which funds are needed by the one selling his paper), and payment will be made by vol- untary liquidation. Such demands, however, may 126 THE BANK AND THE TREASXJRY quite as seriously interfere with the principle of elasticity of the bank-account as a circulating me- dium, since a narrowing market for these loans, or the refusal to renew when renewals are asked, may require liquidation of the accounts where they are kept, and this liquidation may result in violent con- traction. Under such circumstances, commercial paper must be regarded as a very high class of investment for surplus "capital" so far as the interests of the indi- vidual bank are concerned. Such investments are also in the line of true banking for profits from interest accrued in commercial accommodations. But never- theless investments of capital-funds in commercial paper to be held as a "surplus-reserve" may be con- sidered of doubtful character for the community at large. Commercial paper is used by Doubtful charac- .1 i • j. \,^ • ter of practice *^^ busmess man to obtam current funds. Capital-investment in com- mercial paper may at any time put the bank in the position of forcing the customers of other banks to liquidate, and thereby may cut off banking accom- modation when accommodation is most needed. Besides, such a practice tends to relieve the banks of a locality from responsibility for capitalizing to meet the funding needs of its local constituency. Chapter X PUBLIC DANGERS IN THE PRESENT EQUIPMENT OF NATIONAL BANKS Although the liabilities of failed banks are re- ported as $216,000,000, the ultimate loss to customers has been $33,000,000. This, reduced to a percentage of loss on total liabilities of all National banks per year, would amount to about one-twentieth of one per cent, or an average risk of less than one two- hundredth of one per cent for the usual period of credit accommodation. The average direct loss, however, is not the primary consideration, more than is the average direct loss on the circulation of counterfeit coins, or the average Losses from bank t , , 1 • ^ 1 failure direct loss on depreciated currency. To the individual the loss is in the sudden disappearance of his entire account so far as its use as current funds is concerned. Without notice or opportunity to protect himself, he is deprived of his "cash." To him the immediate loss is as great as if he were the victim of a robbery; his indirect loss is greater, owing to the difi&culty of again providing himself with current funds at a time when the credit of the whole community is strained [127] i28 THE BANK AND THE TREASURE by the sudden shock and the concurrent cutting off of funds from all the customers of the failing institu- tion. This suggests, also, an incidental loss to the whole trading community, the extent of which cannot be measured or estimated. The suggestion here made is not intended as an arraignment of the National banking system so far as the solvency of its banks is concerned. The fact is that the individual bank has managed to protect itself against insolvency and that the direct losses to "depositors" have not been proportionately larger than to those of any other of the great banking sys- tems of the world. It is not to this aspect of the situa- tion that pleas for increased "elasticity" are directed. Arguments for elasticity have refer- Direct financial ^ ii i_t j.- ^i • loss not the issue ^^ce to the public question — the in- direct losses, due to inability of the banks of the system to adjust their credit accommo- dations to current demands. The plea is not for increased security to the stockholders of the bank as a means of protecting them against insolvency, nor for the guarantee of the accounts of banks. In so far as such proposals are made they are purely incidental. The whole question of elasticity is a public one, having to do with the protection of the circulating medium against sudden contraction as a means of preventing loss to the individual bank and to the individual customer. It is to this end that a correla- tion is advocated between the capital support pro- DANGERS IN PRESENT EQUIPMENT 129 vided for credit-accounts and the amount of credit- accounts to be supported. Capital Equipment and Credit Strain on the System That the National banking system may be under- stood with respect to capitaHzation, the resources and Habihties of all the National banks of the United States are exhibited in classified balance sheet form opposite page 130. In this an attempt is made to re-arrange the various items reported by the banks to the Comptroller in such a way as to show (i) the character of properties purchased by capital outlay which are unavailable for the support of banking transactions; (2) the classes of resources which are to be considered in the nature of redemption equip- ment, setting opposite these two classes of items the capital provided by the stock sales, surplus, and The character 0} undivided profits, plus the amount equipment illus- obtained by floating debt; and, (3) ^°' ^ the accounts representing banking operations and the relation of the redemption equip- ment to current demand liabilities. Owing to the indefiniteness and uncertainty of the data contained in the Comptroller's report for this purpose, these statements must be taken subject to the same quali- fications and questions raised on pages 94 and 95. But until a form of report is prescribed for the banks which will require specific declarations in classified form, the data given must remain the best obtainable. 130 THE BANK AND THE TREASURY Assuming this to represent the National banking situation on September 9, 1903 (and it cannot be far afield, for the reason that the items with respect to which question may be raised would not materially alter conclusions as to the results by classes), and assuming further, as does the National Bank Act itself, that an amount due from a reserve agent is to be considered a part of the "in vested-reserve" and therefore a capital charge, it would appear: (i) that $186,904,932.68 of the capital of banks was invested in properties and rights that were not available for current credit-redemptions (viz., in "banking- houses," "real-estate" and "margins"), and that the banks could have done just as much business as going banking concerns if they had not had these resources; these (though available for final liqui- dation) were unavailable investments and operated as a reduction of banking capital. (2) That of the two kinds of redemption equipment (assuming, as in Chapter VIII, that the foreign exchanges were only one-tenth of the local exchanges, and that $60,583,- 675.38 would be adequate provision for these) $669,157,468.20 was in the form of "cash-reserves," and $811,543,333.22 was in the form of "invested- reserves" — the total redemption equipment being equal to $1,480,700,801.42. (3) That the total capi- tal provided by the proprietors, including stock, sur- plus, and undivided profits, after deducting outlays for the unavailable investments, was only $1,123,189,- ri 3 a U w & hH ^ ^ C/3 00 t» •+Q0 CMO VO H O M W ./^ 00 O O tH^ M t^ H o> +^ >o -* .. ro w lA JH 10 t-'O 1 H ci 4« 00 en ■^ ^ t -a^o- ^ W M t^ -^ Ih IL> (T) M 10 3 1 '^" (^ ^^ <© o xn '.tidCt/; ■ % (5 eld by circ. . depos forde onds( Trea held.. g S ^ & u P 3g collaterals hi als on depos S. bonds for S. bonds for ler securities miums on b fimd with collaterals 1 fc- c "5 > lable Capi nking hoL al estate iaxgins" ( Collater ■(i) U. (2) U. (3) Otl (4) Pre G) 5% Total ' us 1 g^.- H ^.r^ •gtf " 3 0: - -C. ^ ro\0 H t-\0 e-a ;:::•- ja ;_>. " . ; II •13 do . tn cj ; wi reas lane ;nt.. Ilk Bills of other ba Fractional curren Specie Legal tender note U. S. Certif. of d g 13 hange balances: Exch'ge balances banks Due from U.S.T 'otal exchange ba 'otal cash equipme ,13 ..§•• ..11 S Bui ^1 H h |=«i ■|V3 2 Is C).n~: H Ch 1(1 y / ir / <^ ^ \ / / ^ ■ 1 H a 1 \ a* !<• >!' o .' V < r- -\ 1 1 z * \ N M 1/ ^ > -i (X) CO ?v\^ a <<- y 4v V ^ — , » \ c S'--. K h- oi ,/■ / ^ V < C y f » o C3 CO C3 § MILLIONS o T > 31 H t/i J. O S z a I o S H H T X 33 III o C T o III -H -< m o m 3) ^ m > en z m D 33 o I m -< o 33 7s DANGERS IN PRESENT EQUIPMENT 135 amount of "money-reserves" plus "unencumbered securities" has come to be larger than the combined total of "share-capital" and "surplus." This situa- tion, however, has not been associated with an in- crease in "money-reserves" proportionate to credit- liabilities, but with a decrease in capitalization. If we consider the loans to reserve agents as a part of redemption equipment, then the equipment of Na- tional banks for the support of credit-accounts far exceeds the proprietary capital provision made for its purchase — an anomalous position; a situation to be explained only by the assumption that a part of the banking equipment had been purchased on credit. From a point of view of the proportion of banking equipment represented as being available, the banks are in a much stronger position than they were before 1893, but this representation is without consideration of the adaptability of equipment to the purpose for which it is provided and used. As a matter of public concern, equipment is for the purpose of supporting the credit-accounts without contracting loans, and it is with reference to these that its strength must be measured. Capitalization must be considered simply as the means by which the equipment is to be pro- cured. Judged from this standard, the capital is inadequate to provide equipment used; and equip- ment used being procured on credit and weakened by this character of charge is inadequate to support banking demands. 136 THE BANK AND THE TREASURY As before shown, the operation of the legal reserve clause of the National Bank Act has been to prevent a decrease in the amount of money held below a point necessary to meet ordinary current needs; but at the same time the credit load which the banks have attempted to carry has been multiplied until within the last ten years the proportion of total capital-re- sources to demand obligations has been materially lessened. Proportionate to the credit load to be supported, therefore, banking equipment has been weakened not only with reference to its quantity but also with reference to its quality. The increase in Increase in money-reserves has been due to an in- money-reserves . , ,. , r i. i. i due to increased urease m relative weakness of total credit weakness banking equipment through an in- crease of credit-accounts outstanding. The equip- ment now used to support outstanding demand- credits is not only relatively weaker, but a large part of it, instead of being provided by means of capitali- zation, has been purchased or provided by means of the very current-accounts (the demand-credit) which the equipment so purchased was intended to support. Methods Employed to Increase Equipment without Increasing Capitalization Under a banking law which allows banks to pay interest on "deposits" of (loans from) other banks, ■ — a law which permits the depositing (loaning) bank to count the loan a part of its cash — a premium is DANGERS m PRESENT EQUIPMENT 137 placed on an inferior kind of redemption equipment, and a practice has grown up which in many instances has destroyed the equipment character of the loan. On August 22, 1907, there were over $600,000,000 of these reserve loans. Several points of weak- ness of the "loan to reserve agents "have aheadybeen rAe"te(^j«g"o/ referred to. A practice which com- " accounts with pletely thwarts the purpose of the Act reserve agents" ^^^ renders the " reserve-account " wholly unavailable is known as "loading" balances or "mutual balances." Bank A deposits with (loans to) bank B (its reserve agent) $100,000. Bank B loans to bank C $100,000. Bank C loans to bank A $100,000. Under our present system of reporting, by such a series of transactions bank A having $100,000 in cash may count it as $200,000. If, how- ever, bank A were required to send in a report on some such classified form as that hereinbefore sug- gested, every transaction of this kind would appear on the balance-sheet as well as in the private instruc- tions to the Comptroller. The method of purchase of commercial assets de- scribed by Mr. Vanderlip has also been employed for procuring the capital equipment used to support com- mercial credit-funds. A corporation ZselfsLCuies wishing to float an issue, obtains an underwriting; or by some method it may get a quotation on the Street or on the Exchange. These issues, if underwritten by the bank, to the 138 THE BANK AND THE TREASURY extent that advances are made on this account, are considered as "stocks, securities, etc." If not underwritten by the bank they may be used by the broker as collaterals for procuring increased loans; if the broker cannot obtain a loan on this sort of collateral at reasonable margins and interest, other securities may be substituted, and the broker may carry the new flotation against his own capital until the new issues are disposed of to the public. For the purpose of buying these increased loans to which the The credit pur- securities stand as collateral, the bank chase of "money- uses its own increased credit-accounts, which m turn are used by customers as cash to buy other securities. As the public grad- ually absorbs the securities offered, the banks are able to absorb larger volumes of money through voluntary payments made on loans, without increas- ing capital. This process of "loading" and of credit acquisition of equipment reserves may continue so long as credit inflation continues and the money supply of the country is increased by a favorable balance of foreign exchange on sales of goods; or the same result may be accomplished by decreased demand for legal- tender money to be used as "current cash" in the community. At last the tables turn. There is an increase in the demand for money on outstanding accounts. The balance of foreign exchange, on account of goods, DANGERS IN PRESENT EQUIPMENT 139 grows less; with the increase of business activity the demand for money, for "till cash" and "change" increases; and again, the demand for money may be still further increased by the decreased use of bank- credit-accounts, due to doubt as to the ability of the The inherent banks to meet their customers' ac- weakness in such counts outstanding. At the same time prac ices there is a corresponding decrease in the demand for securities. The public no longer con- tinues to absorb stock and bond flotations offered by speculators and promoters, and the brokers are forced to carry increasing quantities of undigestible securities against their own capital. With falling prices of secur- ities, the banks inaugurate a process of liquidation of the loans, which in turn, not only wipes out margins, but also, on occasion, when the shrinkage in prices and in available assets of speculative customers has been too rapid, forces the bank to take securities in satisfaction of loans. These securities so taken are also added to their holdings of "stocks, securities, etc." The upshot of such practice is this: (i) That while money-reserves may be temporarily maintained to meet the provisions of law without curtailing com- mercial accommodation, market con- Jf^f ^^'' '"''' ditions which call a halt to speculation place the banks in a position which forces liquidation of loans to maintain these "money-reserves"; (2) the current-accounts expand beyond a safe proportion to total resources purchased 140 THE BANK AND THE TREASURY by means of invested capital; (3) the capital-invest- ments themselves become impaired in quality and are not readily convertible; (4) a part of the capital of the banks which should be used in the business is diverted to underwriting and speculative ventures; and (5) in time of credit contraction (the burden of procuring money as a means of meeting demands in the credit-accounts used by the banks to purchase income-bearing assets being forced on the commercial and industrial community) all profitable business suffers for lack of current funds. From the practice of National banks during the last ten years, some other interesting conclusions may be drawn. In the first place, it is evident that elas- ticity requires some sort of protection against the expansion of bank-credit beyond the margin of safety to available capital equipment provided by the bank for its support. In the second place, the conclusion before drawn seems beyond question, viz., that if banks are to give support to underwriting and to margin speculation, such capital equipment as is used to this end should be clearly distinguished from the equipment used in the commercial banking busi- ness. In the third place, the conclusion would seem beyond controversy, that when a bank Inherent dan- .... ... , , .^ „g„ m its various capacities overloads its capital support, or permits itself to extend its credit beyond a point of safety, the only way the credit relations of a community may be DANGERS IN PRESENT EQUIPMENT 141 maintained and brought within Hnes of safety with- out contracting commercial accommodation, and forcing a reduction in current credit-funds, is by enlisting the support of new and increased capital — a banking capital large enough not only to support its regular commercial business with safety, but also to provide the funds necessary to carry on the various underwriting and speculative enterprises through which the banks are forced into a position of contrib- uting capital for the permanent equipment of new promotions. The Increasing Weakness of Banks in Periods of Credit Expansion or So-Called Periods of Prosperity To illustrate the need for a correlation of both "money-reserve" and "reserve-capital investments" (or total redemption equipment) to credit-accounts outstanding, the exhibit on Chart XIII is referred to. Taking the record of the last forty years it would be shown that periods of credit strain have been periods of relatively low capitalization and over- taxed equipment. These also have been periods in which demands for greater elasticity have been Failure in the heard. It is also quite as apparent past to coordinate ^^^^ ^^^^^ ^^ ^^^^ ^^ ^^^^ increasing credtt support . . ° •with credit strain ratio of credit obligations to capital equipment. Assuming the most favorable hypoth- esis possible — that the whole capital of the banks 142 THE BANK AND THE TREASURY has been properly invested in resources which may be used to support accounts outstanding — no other evi- dence is needed of over-issue of credit-accounts or over- sale of "deposit" obligations on the part of the banks. Periods of speculation have carried credit-accounts out of all safe proportion to capital invested as a means of providing equipment for the business. As a result, when money-demands on exchange-balances have increased, the banks have been forced to curtail loans to customers to procure the money necessary to make payments to other banks. Periods of de- pression and of financial reorganization have followed so-called periods of prosperity and credit expansion; so-called periods of depression have been seasons of readjustment of current credit to capitalization. If we reduce this experience during the last period of prosperity to a base of percentages, a tabulation of results would be as follows: Per cent of Per cent of Per cent of Vo^i- Capitalization v Capitalization -^ Capitalization ^^" to Customers- ^'^'"^ to Customers- ^^^ to Customers- Accounts Sold Accounts Sold Accounts Sold 1896 56 igoo 35 1904 34 1897 49 1901 31 190S 31 i8g8 42 1902 32 1906 31 1899 33 1903 36 1907 31 Again engaging the most favorable assumption (that, duing this period, all of the capitalization of the National banks was invested in the best of bank- ing equipment, and that during all this period there was no weakness in the character of capital-resources held), the showing is an interesting one. From the DANGERS IN PRESENT EQUIPMENT 143 foregoing it will appear that in 1896 the capitalization (share capital and surplus) was fifty-six per cent of Increasing weak- the amount of credit-accounts (de- ness in periods of posits) sold to customers. From 1896 pros pen y ^^ igoi, or the period of credit expan- sion, the banks had so far increased the proportion of the demand-credit obligations sold to customers that they had reduced their capital equipment to thirty- one per cent. Forced liquidation in 1902 and 1903 brought the ratio up to thirty-six per cent. Sub- sequent credit expansion carried the ratio in 1906 below thirty-one per cent — a complete dem- onstration of need for correlation of capital to expansion. The disturbances caused to business were well- nigh equal to those caused by the issue of green- backs during the Civil War; during the years of liquidation the loss sustained to securities (by parties The credit dts- on whom these documentary proper- turbance equal to .. , , ■, ^ t t ■ ^- e that of the green- ties had been unloaded m times of hack inflation so-called prosperity) was quite as great as the cost of carrying on the greatest military campaign in history. And it is not certain that the lesson has yet been learned; for we find that imme- diately following long periods of forced liquidation when money and credit-demands had suddenly grown less, the New York banks alone again in- crease their sales of credit-accounts (deposits) many millions of doUars. This operated on business in 144 THE BANK AND THE TREASURY the same manner as if there had been a sudden in- crease in the money circulation of like amount. The press again congratulated the public on a business revival. Little thought was given to a possible day of reckoning. The experience of the last forty years of National banking (and the same experience might be shown in State and private banks) suggests that some limit should be placed on bank-credit issues (deposits) other than that found in the "legal money- reserve"; that "reserve-capital investments" A limit of safely i i j -i • i j n needed should be considered as well as money-reserves ; that, while the Comp- troller may properly interest himself in the money equipment of a bank as a safeguard to credit, he should also have the power to call a halt on increasing credit-issue beyond a safe proportion to total un- impaired redemption equipment — i.e., the total cash and assets readily convertible into cash without calling in commercial loans. Federal authorities should be given such powers that they might force the stockholders of a bank to increase its capitalization when it attempts to handle a volume of business disproportionate to its capital- Should be regu- i^ed equipment — ?.e., to force the lated by federal banks to discontinue the practice of '^^ °''^^ issuing credit beyond the point of safety. Such legislative and administrative control over our credit institutions is just as imperative as DANGERS IN PRESENT EQUIPMENT 145 that directed toward the limitation of credit-money strain on the gold-reserve of the Treasury, the limi- tation of strain on the structure of bridges or the equipment of mines, or the enactment of legislation for safety of buildings devoted to manufacturing, etc. It should be recognized that the credit equipment, when overstrained, is hazardous, not alone to those immediately involved, but also to the business in- terests of the entire nation. A step in the right direction has been taken by Senators Culberson and Haybum, each of whom on January 7, 1908, introduced bUls requiring that the "legal reserve" shall be a money-reserve. Sen- ator Haybum (S. 3044) goes farther than Senator Culberson (S. 3027) in that he would Two bills before ■,., ., , t_t v - Congress arbitrarily estabhsh twenty per-cen- tum as the minimum of lawful money- reserve to be held. Whatever be the ratio fixed it should have reference to experience and a liberal margin of safety should be added to prevent violent contractions due to money-demands. In Senator Hayburn's measure a wholesome provision is sug- gested, viz.: whenever the lawful money of any such association shall be below the percentum re- quired the bank shall not increase its liabilities or make new loans till the ratio is re-established. Chapter XI WHY THE "unencumbered SECURITIES" OF NATIONAL BANKS ARE NOT READILY CONVERTIBLE INTO CASH It has been assumed that, under our present bank- ing system, "unencumbered securities" are the most available of the capital assets or redemption equip- ment to meet money-demands in time of strain without curtailing commercial accommodations. At the risk of tedium, the reasons for this conclusion will be retold: (i) That commercial paper, whether purchased by means of capital or on credit-account may not be converted into cash, except in so far as it may be voluntarily paid, without impairing the elasticity of credit accommodations, for the purpose of obtaining money to meet demands on credit-ac- Points 0} superi- counts without contraction ; therefore, 7umbeLd7cur- ^^^^^ "^^^^ ^^ Considered as "contin- iiies" gent." (2) The effect of forcing pay- ment of loans to (amounts due from) reserve agents, at times, is to curtail banking accommodations of the reserve banks and therefore to impair the elasticity of "customers- accounts " in the reserve cities — i.e., to cause contraction instead of allowing expansion of [146] WHY SECURITIES ARE NOT CONVERTIBLE 147 this form of current funds. (3) The securities de- posited "for circulation" and "for deposits" of Gov- ernment cannot be utilized. When the cash-reserves are threatened, the only class of assets of considerable amount remaining that is readily available, and which will make possible the expansion of credit-accounts when expansion is demanded, is "unencumbered securities." The Use of Banking Capital for Outlays in Unavailable Assets With the exercise of good banking judgment, "un- encumbered securities" might be utilized to obtain new supplies of cash to support the "money-reserve." Assuming that the assets of this class held by banks are "available," our commercial-credit institutions are in a stronger position to-day and may give greater elasticity to their credit-accounts than ever before. This delectable conclusion might be admitted, were it not for two trite facts: (i) that during the two years following September, 1902, the banks were hard pressed for money and the business community suffered enormous liquidation on account of "inelas- Investmentin ticity" of bank-credit; (2) that the unavailable se- banks during this time did not to any curihes great extent, indeed, throughout a long banking experience, they have not taken any considerable portion of securities to market and sold them for cash to relieve sudden pressure. The un- 148 THE BANK AND THE TREASURY encumbered securities held have been constantly increasing; the amount held by the National banks has during the last thirty years increased from a small holding to about $700,000,000. The increase has been gradual, almost without a break in the line (see opposite page 244), yet the banks have not to similar extent utilized securities to meet money-demands or to support money-reserves; they have not by sale converted them into cash. On the contrary, they have, on numerous occasions, in time of financial peril, increased their holdings of securities, and thereby increased the weight of liquidation which has been thrown on assets acquired by means of their own demand liabilities. Now the question may fairly be raised — Why is it that so large a part of the capital-assets of banks has not been used to obtain money to protect de- mands for money made on their credit-accounts; why has the principle of elasticity of accounts been sacri- ficed, when unencumbered assets were at hand to The pinciple of support the credit of institutions elasticity sacri- whose business it is to purchase com- '^'^^ mercial paper "on account" and to provide current funds to the community when needed? By referring to the chart (page 244), it will be seen that "commercial assets" and not "se- curities" have responded to money-demands. The fact stands out boldly that the customer has been sacrificed and that business accommodations have WKY SECURITIES ARE NOT CONVERTIBLE 149 been neglected; good commercial paper has been turned away and good loans have been called or reduced to protect capital-investments in the form of securities owned. It is in this fact and in this situation that we must look for much of the practice that has stood in the way of "elasticity." If we ask a banker why he does not sell his stocks and other unencumbered securities for cash with which to protect his customers-accounts without curtailing loans, he will say that under the existing system and practice he cannot do so without loss to Why the banker the capital-resources of his institution. does not sell The practical business problem is, securities therefore: ShaU the bank suffer a capital loss in its efforts to obtain money with which to make good its accounts, or shall the public suffer from inelasticity of bank-credit? In such an emer- gency, there is only one way that a faithful bank officer can answer such a question: The burden of loss must be shifted, if possible, and forced liquida- tion is the result. A better solution would have been not to have allowed the bank to get into such a situation. But for this the banker is not entirely at fault; this has not come from any disposition on his part to curtail accommodations nor to deprive his customer of needed funds. The trouble has been in the kind of competition that he has been forced to meet and in the system which he is employed to operate. 150 THE BANK AND THE TREASURY An explanation which has been offered to account for the relatively unvarying amount of securities re- ported by banks is, that these securities are used as collateral security for "bills payable" and "other liabilities" such as temporary loans from other finan- cial institutions. WhUe there is considerable of fluctuation in "biUs payable" and "other liabilities," and these fluctuations respond in a measure to periods The claim that of extraordinary money-demand, they they are used jor do not account for more than a small collateral ^^^^ ^^ ^^^ evident "inconvertibility." A better reason why "unencumbered securities" have not been "convertible into cash in time of panic," as a means of support to "money-reserves," seems to be in an interpretation of the statistical exhibits of the annual reports of the Comptroller. The increase in Stocks and Other Securities owned by National Banks during the ten years 1898-1907 inclusive, in millions is given as follows: 1898, 255; 1899, 320; 1900, 367; 1901, 448; 1902, 493; 1903, 518; 1904, 589; 1905, 667; 1906, 674; 1907, $700. The Character of Securities Held by Banks The securities owned have been an increasing "un- encumbered asset." The power of one to convert property into money depends on a market; the gain or loss depends on the price obtained as compared with cost; the price obtainable depends on the pur- chasing demand at the time the offer is made. This WHY SECURITIES ARE NOT CONVERTIBLE 151 takes us into a more general banking situation. The National bank is only one of four classes of institu- tions pressed for money at the same time and having the same kind of securities for sale. It must enter a market in which State banks, private banks, and the trust companies, — besides, on occasion, in a smaller way, the savings banks, — are also buying and sell- ing. If we take into account the holdings of simi- lar unencumbered securities by these institutions for five years they appear as follows: Railroad Securities (Amounts in Millions) 1898 1899 igoo 1901 igo2 1903 1904 1905 1906 1907 State banks $ .6 $ .2 $ .3 $2.4 $3.3 $3.3 fc.S ( .9 ^2.4 $5.1 Private banks 7 .3 .5 1.3 .7 .8 3.2 4.5 .6 .5 Trust companies 14.6 12.5 10.4 22.0 18.0 21.7 32.8 31.6 46.6 31.8 Totals $15.9 $13.0 $11.2 $25.7 $22.0 $25.8 $39.8 $37.0 $49.6 $37.4 Banks, Stocks, etc. (Amounts in Millions) 1898 1899 1900 1901 1902 1903 igo4 190S 1906 1907 State banks S2.6 $2.2 $ .4 $1 $ .2 $ .2 $ .9 $ .4 $ .5 $i.x Private banks 3 .3 .4 .4 .4 .j .3 .6 .2 .» Trust companies .9 1.2 .2 3.2 2.6 3.4 4.1 4.4 lo-i 6.5 Totals $3.8 J3.7 $1.0 $3.7 $3.2 $4.1 $5.3 ts.4 $io.S $7.8 Other stocks, Bonds and Securities — not including United States, State, County and Municipal Bonds (Amounts in Millions) 1898 XS99 1900 190X 1902 1903 1904 State banks .. . $121.5 $160.7 $179-6 $228.3 $267.1 $276.5 $332-8 Private banks. 2.1 2.0 2.4 4.1 3.2 4.2 3.8 Trust Go's... 137.8 216.4 3°S.O 358.5 412.8 535.9 609.8 Totals,.,,. $261.4 *3'9-i |4?7.9 $591.1 $683.1 $816.6 $946.4 $1132.2 $1083.7 $1218.4 igos 1906 1907 $39S-6 *394-4 »47S.4 4-3 4.7 7-9 732-3 684.6 73.'i-l l899 1900 1901 1902 1903 1904 1905 1906 1907 $i3-o $11.2 $25.7 $22.0 $2S-8 $39-8 $37-o $39.6 837.4 3-7 I.O 3-7 3-2 4.1 5-3 S-4 10.8 7.8 379-1 487.9 S9I-I 683.1 816.6 9464 1132.2 1083.7 1218.4 152 THE BANK AND THE TREASURY Total Securities Owned by State Banks, Private Banks and Trust Com- panies, other than United States, State, County and Municipal Bonds (Amounts in Millions) 1898 Railroads $is-9 Banks 3.8 Other stks., etc. 261.4 Totals $281.1 $395-8 $500.1 $620.5 $708.3 $846.3 $9915 $ll74-6 $il34-t $1263.6 Total Stocks and other Securities Owned by Commercial Banks (Amounts in Millions) 1S98 1S99 1900 1901 1902 1903 1904 1905 1906 igo7 National bks. $255.2 $320.4 $367.3 $448.6 $493.1 $518.7 $589-2 $667-2 $674-9 $700-4 Other bks . . . 281. i 395.8 500.1 620.5 708.3 846.5 991.5 1174.6 1134.1 1263.6 Totals $536.3 $716.2 $867.4 $1069.1 $1201.4 $1365.2 $1580.7 $1841.8 $1809.0 $1964.0 The foregoing exhibits show that in State banks, in private banks, and in trust companies, there has been a remarkable increase in securities held, and that nearly the whole amount has been in stocks and bonds other than "Railroads," "Banks," "United States," "States," "Counties," or "Muni- cipals" (for these are not included). The increase has been largel}' in those securities known as "other stocks, bonds, etc." We know that many of these institutions have been active in underwriting in- dustrial and other current issues; Proportion of . r ,% ^ j industrials, etc. ^^ ^o far as these are represented they are still in the form of "un- digested securities." We have no sufficient data for the closer classification of "bonds, securities, etc.," owned by National banks, but it may fairly be assumed that they have been somewhat simi- larly involved in the practice that has been so prev- / • (^ H • 1 0) CD < \ < — f H O / { ID I \ ro ro > X^\ H i^ ?N H CO en .^•y IJU rn - X > o i <;''^ to s* < j^ i» ^ f^*— --^ (L) m H """"^^^^^^^-^^"^ • W > I S m O > \.'\ H }/• JJ c s ID Z O // ^ H C ?H 1 i H QD .-^ ^S^ a > ^ "/ h- CD CD O > CO P o / y H .>\ CD (0 \. V vl I o \, ^->, m < il 11 > H CD CD "~-'^ ]7~~~~'--~.^ (JU QO CD CD V RESERVES NT DUE FRO TO OTHEF ./ ^ :j» :s -n \ > H ^^ o ^ m • -. N CD O o iio pii < £.-< ^:^ |cDg •^ ^ ui >^ ?*: -( 2 oo -< — 1 CO -< '- r CD n So S ca , L. *~^ M en S ^ ^ — , ~, O 03 // H .^ to X m JO SCALE o IN o MILLIONS o D ^a ::- WHY SECURITIES ARE NOT CONVERTIBLE 153 alent with private banks, State banks, and trust companies. In this practice, which ties up the capi- tal of banks in securities which are not readily ac- ceptable as collateral, and in the efforts of the banks to prevent investment loss in forced sales, may be found one of the reasons for the present "inconvert- ibility of securities." The Effect of Call-Loans on the Use of Unencumbered Securities as Redemption Equipment The uncomfortable financial gastritis caused by "undigested securities," however, wUl not explain the persistence of similar conditions of inconverti- bility extending back thirty or forty years. For explanation of this another market situation may be appealed to. From the report of the Comptroller it appears that at the time of great liquidations these various banks were holding a large amount of col- laterally secured loans, to which, if we add a twenty per cent margin as a basis for estimate of the stocks held in trust, would make an aggregate of securi- ties much larger than their own holdings, to the sale of which they look for the payment of loans. In this situation may be found a continuing or persistent force — a reason in self-preservation — for the inconvertibility of securities owned. To attempt to sell their own holdings of $1,964,000,- 000 in time of financial strain would threaten the market for a much larger amount of collateral 154 THE BANK AND THE TREASURY security, on the sale of which loans depend for pay- ment. The loss from sudden conversion of "stocks" owned, therefore, would be a double one. It would depreciate the properties owned by the bank and at the same time would threaten loss on collateral loans. In these circumstances the only solution, without loss to the bank, is such a careful handling as will allow the bank to obtain money desired without any sud- den shock to the stock market. The Need lor Separate Capitalization for "Speculation" and "Underwriting" The present and continuing practice of under- writing and of loaning on collaterals to speculators gives the key to the inability of the banks to use this class of capital assets to support their credit — to the inconvertibility of "unencumbered securities." In- stead of looking to stocks and bonds for investment of "surplus capital-resources" and holding these as a means of protecting the money-reserve from deple- tion, instead of looking to these investments as a part of the equipment provided out of capital to support the current-accounts of customers (the stock in trade of the bank) there has ever been a temptation for The different banks to turn a part of their capital- fZft'esftZ: ^^^°^5^^^ ^^.^y f^°™ the commercial nesses banking business. In the early part of the past century real-estate was the attraction; investment and speculation in this came to be so WHY SECURITIES ARE NOT CONVERTIBLE 155 dangerous a practice as to bring forth universal con- demnation, which resulted in the enactment of stat- utes prohibiting real-estate purchases. Later, stocks and bond issues of corporations attracted the funds of the banker. The more recent practice has been defended on the ground that securities are more readily convertible into cash. As a matter of prac- tice, however, under our present system of "reserves" and "call-loans," they are not and never have been quickly convertible assets when an invested capital reserve is really needed to support customers-ac- counts. They have proved not quite so dangerous to the banks themselves as real-estate investments, but quite as dangerous to the country at large; and the institution so owning "securities," when sorely pressed, have not been able to utilize them to ad- vantage as an in vested-reserve. In May, 1907, when money-demands were large, it was found ex- pedient for the National banks to borrow $83,000,000 of bonds from other institutions. When with all their "securities" they have been unable to obtain the requisite funds, they have done the only thing possible to do, viz., turned to commercial assets, forced their loans, and shifted the burden so far as possible on the community, rather than themselves suffer an investment loss on forced sales of securities. The principle that the commercial bank should furnish funds for speculation without special capi- talization for that purpose is a wrong one ; it results 156 THE BANK AND THE TREASURY in destroying, in part at least, its usefulness as a conunercial banking institution* If marginal specu- lation is to remain a prominent fea- Conclusions as . • <- • i ■ i • j.-^ j_- to practice ^"^^ ^^ financial circles, institutions intended primarily to serve such a constituency should stand on their own basis of capitalization, and should have a financial equip- ment in the form of resources especially adapted to success in the rendering of such service. The com- mercial bank which builds up a "call-loan" con- stituency encourages a practice and a use of banking capital which in time of strain not only precludes the possibility of converting unencumbered securi- ties owned, but also loads the market with collat- eral loans and shuts the door of opportunity for obtaining money, by sale or by hypothecation of capital-resources held in reserve. *To show the disturbing influence of speculation the chart on p. i6o has been prepared. From this it will be seen that during the period from 1893 to 1897 t'^^ individual accounts (deposits) and the " loans and dis- counts " of New York banks followed along parallel lines. This was a period during which New York banks were supporting a relatively small volimie of speculation. From 1897 to 1902 the speculative activity of the metropolis was the most conspicuous feature. The disturbance of commercial-credit relations is traced in the erratic movement of the lines. At times the loans and discounts nearly equal current obligations. Again, within a few months there will be a disparity amounting to several hun- dred miUions of dollars. This speculative result cannot be considered a wholesome one for a commercial bank. Chapter XII FALSE ASSUMPTIONS MADE BY THE GOVERNMENT WITH RESPECT TO CURRENCY AND BANKING The failure on the part of legislators and admin- istrative officers to appreciate the distinction between the functions of the Treasury as the sole agency of money-issue, and the functions of the commercial bank as the sole agency for the issue and redemption of commercial-credit used as current funds under the American financial system, has led to legal provisions and to practices which are in large measure respon- sible for the undesirable condition of our circulating Failure to appre- medium as well as for the present ciate character of inadequacy of bank capitalization and Treasury issues redemption equipment. It was not until the last decade that a proper appreciation was had of the provisions to be made for the support of the credit-moneys issued by the Treasury. This having been brought to the attention of the country in 1893, the same motives which moved the people to demand security for State bank issues after the fall of the first and second banks of the United States, the same motive that sanctioned the establishment [157] 158 THE BANK AND THE TREASURY of an independent Treasury, that made the issues of the National Treasury more acceptable in business than the mixed and uncertain State bank circulation, and that brought popular support to the National banking system, called forth an expression favorable to "sound money" on every occasion that the issue has been raised. The controversy of the recent money campaigns was not one as to whether the Treasury should so fortify itself that its issues or money promises should be immediately redeemable ; this point was conceded by both factions. The question was as to the stand- ard to be adopted as a basis for issue and redemption. The silver party urged that gold was becoming rela- tively scarce, as evidenced by an almost continuous fall in prices since 1873, and that the adoption of a gold standard of money and credit would perpetuate conditions unfavorable to commerce and industry; the gold party held that the adminis- Contention in the , , . , , .. j r -i. i i. - 4. money campaign t^^^ive attitude for the last twenty years had been to make all contracts for money pa)mient gold obligations, and that a change of standard such as the silver party urged would cause financial disturbances that would be ruinous. The refusal of the silver party to make a declaration that all past contracts should be con- sidered as gold contracts lent color to accusations of intention to dishonor. But whatever may be said of the standard controversy^ it must be admitted that ASSUMPTIONS MADE BY THE GOVERNMENT 15d the sentiment for "sound money" — a money every dollar of which would be redeemed on demand at par in the standard adopted — was practically unani- mous. In the elections which followed the people chose gold for the money standard, and the subse- quent increase in gold production has reacted in price ratios in such manner as to make this choice acceptable to both parties and to eliminate the "standard" controversy from politics. The effect of the last few years has been to so fortify the Treas- ury as to enable it to redeem its money obhgations in gold — in other words, to make a gold standard credit-money a sound one. The recurrence of a period of credit contraction and financial depression has brought the other arm of our financial system under popular as well as official scrutiny. As never before the public is be- ginning to realize that there is something wrong with institutions of commercial-credit. Animated by the same motive as in the past — a desire for soundness Failuretoappre- ^ the financial system — but con- ciate the character vinced also of the need for a sort of of hank-credit adjustment that will make the system capable of adapting itself to the fluctuating demands for commercial accommodation, the thought of the people is again turned toward financial reform. The "soundness" required of banks as public agencies of commercial-credit is not only one of ability to pay, but ability to pay without disturbing 160 THE BANK AND THE TREASURY the credit relations of the country. With respect to the banks, as well as the Treasury, it is recognized A campaign for that in the past the Government faHed elasticity in to appreciate its responsibilities. It ^'^"^'^ has also failed to grasp the problem before it; it has assumed an attitude that has proved harmful — has engaged assumptions which must be abandoned before a better adjustment can be made to American business conditions. The Assumption of the Government that the "Cash-" Reserve is the Only Reserve Needed for Credit-Accounts The dangers inherent in the reserve practice have been discussed in another relation. It may also be considered with respect to the attitude of the Federal Government. The first effect of the assumption that the "cash "-reserve is the only guarantee needed for credit-accounts was the incorporation of this fallacy in the National Bank Act. It has already been pointed out that such a legal requirement may be complied with without the use of a bank's capital by borrowing money from customers or from other banks; it has been further shown that Gives no key to ,, . . . j ^i -n i capital strength the permission given under the Bank Act for a bank to count its loans to other banks as "cash" allows the banks to inflate their legal reserves by process of maintaining "mu- tual balances." The lack of legal provision requir- CO M >»- .^' en CJl 03 =— o O o o o o o o o o n ' s^ \^- S^ • X 1 1 H GO O ^ ^ / / 3 3- \ i =» \ % S / / iii J \ \ H y^ / iS?i (JO ^ c ERCIAL [ T CREQI s. -1= i- ^ N PER HELD KCITY ACOOJNT N H CD CO \ 05 CO ^1 \^ -^ -^ -< 'A \ ^^__^ — — •' III \ *<;^ H _^ (J) ■<—. '^^ ^--^ ^ CD QD — -Xw \, .^^ \ H (7) ,^ _ — -— __ — ■" ""^ o ■ — -~^'\ r -"^ \ H L ~'~~-~~- "^T CO o n '^~^^~Z^ • ^^ :i ^.^^ H ^,„y^ ) o • / H , ~~~—~.^^^ v-^l —■ — ' / n ^^ 1 / to ASSUMPTIONS MADE BY THE GOVERNMENT 161 ing a coordination of equipment provided by means of capitalization with total "deposits" or credit- accounts outstanding leaves no protection to the customer and no adequate guarantee of such a char- acter of soundness for commercial-credit-funds as will protect the public. Aside from the capital weakness induced by prac- tices thus encouraged, another effect of the provisions of the Bank Act, based on this assumption, is to leave the system without possibilities of credit ex- pansion when there is a coincident increased demand on the banks for money — i.e., without power to adapt itself to the expanding and contracting de- mands for commercial accommodation without vio- lation of the " legal preserve " requirement. Under such a provision of law, the money-reserve itself is Government con- ^ot available to meet demands on trol of this kind credit obligations. And there is no jorces inelasticity provision made for obtaining more money to support new credit-accounts. As a result, when demands increase, accommodations must be restricted in order to preserve the integrity of the legal money-reserve kept by the bank to meet money- demands. The Government, through its Depart- ment of Comptrol, therefore, having first set up a fund to guarantee the financial integrity of the insti- tutions issuing credit, places itself in the way of the bank using this fund for the very purpose for which it was created. By this attitude the Government 162 THE BANK AND THE TREASURY often forces a bank to fall back on its constituency and force a reduction in accommodations. Thus, under the operation of the assumption made, the legal system of control becomes an element of pri- mary disturbance, and the bank, even when finan- cially sound, may fall into the hands of a receiver, thus adding still further to the credit-constrictions and credit-contractions against which complaint is entered. Another result of the Law requiring a minimum reserve to be kept, and looking to this only for pro- tection of accounts, is to limit the exercise of functions of comptrol and prevent inquiries Limits intelligent , . , i- i ^ i i j i control which are essential to a knowledge of financial condition. Before reform in legislation can take place there must be a complete abandonment of the "reserve" principle which now stands as a fundamental feature of the Bank Act. An Assumption that the "Note-Issue" is not a Loan to the Bank without Interest A second assumption that has led astray legisla- tors and bankers is, that the "note-issue" is not a Government loan to the bank without interest. It has before been pointed out that the Weakens capital , • ■,, . •it..-li, i .• support ^'^^^ ^^ obtamed by the bank entermg into a contract with the Government for the delivery of an amount of money equal to the amount of issues received, the contract for pay- ASSUMPTIONS MADE BY THE GOVERNMENT 163 ment being secured by United States bonds. It has also been observed that this amounts to an ex- change of obUgations by which the Government (through the bond market thus created) receives money for its purposes and the banks obtain "issues" with which to do business, a device which ties up the capital of the bank and places on it the duty of first redemption of the note. But the weakening of the capital support to the banking business — that sup- port available for redemption of current credit-obli- gations — is not the only public danger which lies in the assumption. Viewing the bank-note as a money-issue, the policy of the Government favoring the expansion of this part of the currency is directly opposed to its policy restricting issues of Treasury-notes. Since the close of the Civil War there has been a growing sentiment favoring the payment of the outstanding National floating debt in the form of "greenbacks." Cam- paigns for "sound money" have been waged to re- duce demand-credit-obligations and to secure the foundations of gold-standard currency-issues. One Induces currency 0^ the most threatening features of disturbances our whole financial system has been tkroughnote-issues ^^^ relatively large amount of credit- money obligations proportionate to the reserve kept to enable the Treasury to redeem. The operation of the "endless chain" through the Treasury in 1893, the shock to credit, private and public, following the 164 THE BANK AND THE TREASURY threatened disappearance of the gold-reserve, the pledges of 1896, the currency act of 1900 increasing the reserve to $150,000,000, making the reserve a trust fund and securing it against impairment by giving to the Bureau of Issues and Redemption a first lien on the current assets of the General Treas- ury, the loan power placed in the hands of the Treas- urer as a means of giving force to the instruction to maintain the gold standard of credit-money redemp- tion, the increasing demands for the retirement of Treasury-notes and proposed legislation for making silver subsidiary, — aU these acts and tendencies are directly antagonized by an increase in bank-note issues. By the inflation of the currency w^ith paper issues in the form of collateral notes that may be arbitrarily injected into the circulation as a matter of high finance, gold and gold-bearing obligations of the Treasury may be supplanted and the money system itself may become unsettled. Another dangerous feature of the practice of note inflation is in the possibility of increasing obligations for gold payment (for the note is ultimately reduced to this) without making any additional provision for gold redemption-reserves in the banks or in the Treasury. By law the banks must Lessens gold re- ,, . •<• . j t -i. serves V^Y the notes if presented. In its original form the Law contained pro- visions for a redemption-reserve. This, however, has been repealed to further stimulate the investment of ASSUMPTIONS MADE BY THE GOVERNMENT 165 bank capital in Government bonds. Having in it possibilities of increasing issues to such a point as to drive gold out of circulation it lays bare our credit- money system at its most vulnerable point. The danger is increased at two particulars: (i) The gold supply may by exportation become too small to support the credit-issues of the Treasury, without provision made for Government loans to stimulate gold importation; and (2) the paper-issues may be- come so far expanded that the present stock of gold may be found inadequate even though no exportation takes place. That such a result is not beyond reason may ap- pear in the experience of the last three or four years. Since the bond refunding acts and the Law of 1900, amending the Bank Act, this inflation of the currency has been marked. February 4, 1898, only $184,106,- 000 of National bank-notes were outstanding; Feb- ruary, 1900, the amount had risen to $204,916,000. One year later they had increased over $104,654,000. September 9, 1903, the amount of notes outstanding are reported as $375,037,000; and January i, 1908, the bank circulation was reported in excess of $600,- 000,000, with a rapidly increasing output of this class of currency. The effect of crease in issues the increase in bank-notes on the money circulation is identically the same as an increase of like amount in greenbacks would have been. The greenbacks and silver obli- 166 THE BANK AND THE TREASURY gations remaining about the same, the bank-note has supplanted that much of gold, has made unprofitable gold importation, and at times has made profitable the exportation of the standard metal when otherwise exportation would have been improfitable. For ten years we have been devising ways and means to retain a larger amount of gold as a foundation for money and credit. Since 1897 we have more than doubled our credit and increased our money cir- culation over $900,000,000. At the same time, by encouraging an increase in bank-notes, we effect- ively barred the way to gold importation until the note expansion reached a point to produce a shock in credit relations. Many editorials have been written in financial periodicals attempting to ac- count for the gold movement, but, strangely enough, the influence of the bank-note inflation has scarcely been adverted to. The great public danger which lies in the assumption that a note-issue is not a loan to the bank without interest is to be found in the fact that such an assumption permits the bank-note to be made a part of the permanent money stock in- stead of forcing upon it an emergency character which will allow of its issue with profit only when the money-demand is increased, and will compel retirement when money-demands fall off. In ninety per cent of the measures now pending in Congress the authors of bills would permanently increase the bank-note circulation by failure to provide for an adequate charge on notes outstanding. ASSUMPTIONS MADE BY THE GOVERNMENT 167 The Assumption that "Deposits" by the Govern- ment are not Loans without Interest The third dangerous assumption is, that so-called "deposits" of money by the Government are not loans to the banks without interest. Mr. Eckels pleads for treating the Government deposits in the same manner as customers' deposits. He holds that the attitude of the Government requires security for deposits is one which tends to discredit the bank. This conclusion may be conceded to jor deposits '^ *^^ extent that the Government is in need of active credit-accounts in the transaction of its business. The fact is, however, that at the time Mr. Eckels' comment was offered, the Government had on deposit with banks about $170,000,000, whereas its current needs, or its use for credit-accounts of banks, amounted to only from $5,000,000 to $10,000,000 as represented in the de- posits of disbursing ofiScers. The balance, some- thing over $160,000,000, was an inactive account, and was in the nature of a loan to the banks without interest. A business man who has from ten to twenty times as large a cash fund as is needed for current use, cer- tainly would not be expected to keep this on deposit in a commercial bank, unless the commercial bank made an arrangement with him to pay him a liberal rate of interest on his deposit. Such an arrangement 168 THE BANK AND THE TREASURY would amount to a loan from the customer to the bank. When such deposits are made they are usually represented by certificates-of-deposit, The " deposit" a j i, ,. . I^g^^ ^ or are under such agreements as to distinguish them clearly from the ac- tive accounts of customers. To argue that a deposit of all the revenues of the Government should be made with the banks, and that these should be considered as an ordinary customer's account, does not comport with the practice of banks nor with the business rea- soning of those very men who are now using the argument for the purpose of bringing public opinion to support such a conclusion. If the contention were that the Government should make such deposits, but that the bank was to pay a reasonable interest for the same, then there might be some ground of support to the argument. But in How " deposits" \]!xt same process of reasoning by without interest i • i •. • i i j ^.t i ^i r^ ,. weaken capital ^^ich it IS held that the Government support should be considered in the same light as other depositors, the advocates of this doc- trine also affirm that the bank "cannot afford to pay interest on such deposits." The result of such a transfer of money from the United States Treasury to the banks has been to encourage the banks in time of minimum money-demand to rely on the funds of the Government for the support of their own credit- accounts, instead of relying on their own capitaliza- tion, ASSUMPTIONS MADE BY THE GOVERNMENT 169 The weakening of capital support to bank-credit- accounts is not the only cause for public anxiety. The "deposit" of general funds of the Treasury leaves nothing to support the gold-reserve but bank- credit. Under such a financial plan we would have a credit-money that in time of special financial stress would find its foundation in the credit of the very institutions on which the greatest pressure is brought Makes the Gov- ^0^ money payment. Gold redemp- emment a disturb- tions and the maintenance of the mg jac or Treasury reserve when redemptions are made in emergency must fall on the bank. But the monetary disturbance does not end here; a "de- posit" of gold by the Government causes the bank to dispose of gold previously held. This dislodge- ment of gold from the reserves also leaves the bank in a less advantageous position for redeeming its note-issues when demands may be made on these. The whole effect is the same as a credit-money in- flation; it tends to increase gold exportation in time of minimum money-demand, and to accentuate or increase gold importation in time of maximum money-demand . In appeals to the confidence of the public it is common practice for banks to advertise themselves as "Government Depository." The imphcation is that such a relation should commend them to the public. In the light of the present financial relations question might be raised as to whether borrowings 170 THE BANK AND THE TREASURY of this kind should not be used as a reason why the public should seek another institution for current credit accommodations. The conclusions just an- nounced do not mean that the practices on the part of the Government of loaning to the banks by "is- sues" and by "deposits" may not be used to great advantage, and that this advantage Possibilities in , ■, j. -i c i. li. • these practices ^^Y ^^t be mutual. Such a result is possible, provided the practice is sub- ject to regulation which will prevent the loan from weakening the institution of commercial-credit. To accomplish such results and to secure the advantage referred to, however, the Treasury-deposit to the bank must be properly considered as a loan from the Government to the bank, which is made under such conditions only as to provide a market in which the banks may obtain money by hypothecation of capi- tal-resources at a fair market rate, when otherwise in the open market they might be forced to pay rates which would force a curtailment of commercial ac- commodations. Chapter XIII ADVANTAGES OF NATIONAL BANKS OVER STATE AND PRIVATE BANKS UNDER THE PRESENT PRACTICE Other conditions being equal there are two ways only, under the present practice, by which a National bank may enjoy an advantage over private and State banks: The first advantage lies in the possible in- creased income to be obtained from Two advantages i j , ^ ■ s- ,,• „ enjoyed bonds used as a basis for "issues"; the second advantage lies in the pos- sible increased income to be derived from "Govern- ment deposits." At the ruling market prices and the present rate of interest receivable, the possibility of obtaining an increased return on investments in Government-bonds without the issue-privilege is small, if not wholly lacking. A statement of the net investment-return on bonds as computed by the Government Actuary is as follows: Investment-Return stated in Dollars per Hundred based on January Prices, 1895-1902 SS of 1904 4S of 1907 4S of 1925 3S of 1918 2S of 1930 189s $3.01 $2.76 _ _ _ 1896 3.29 3.01 $3.21 1897 2.88 2.71 2.91 - - 1898 2-SS 2-33 2-5S 1899 2.45 2.32 2.48 $2.54 1900 1.81 1.91 2.25 1.7s $I.8£ 1901 1. 18 1.69 2.04 i,.58 1.75 igo2 1.67 1.72 1.90 I. 1.6529 [171] 172 THE BANK AND THE TREASURY Assuming that all of the Government-bonds held by a National bank are hypothecated for issues, and that "par value" be received in notes, these notes " Issues" com- "^^7 then be used by the bank as pared, with legal- money. They may not, however, be tender reserves counted legally as a part of the re- serve. If the notes are used to purchase "commer- cial paper" then the bank may not purchase more "paper" than it has notes, whereas an equal amount of legal-tender money held in reserve to support credit-accounts (deposits) would permit the bank to buy from two to four times as much of the commer- cial paper offered by customers (depositors). Such a use of the notes would therefore cause the bank to do business at a loss. The bank, however, may make the notes available for the highest banking return by paying them out in response to money-demands (as for example in set- tlement of balances due to distant banks) and hold the legal-tender money received as Elements oj gain ^ „ mv- j • -^ ^i and loss reserves." This device permits the National banks to avoid the disabiHty attaching to the "notes," which prevents the "notes" from being held as reserves, but for the same reason forces the bank-note into general circulation to sup- plant the legal-tender holdings. Assuming that the bank in question succeeds in thus exchanging its entire "issue" for legal- tenders, then the only dis- ability which it suffers is the tying up of the amount ADVANTAGES OF NATIONAL OVER STATE BANKS 173 of its capital represented by the "margins," i.e., by the "premiums," the "five per cent fund with the Treasury," etc. With these two factors alone to be considered, then, if the investment return on the bonds were two per cent, and the "margin," including the "premiums" and the "five per cent fund," were ten dollars per hundred (and if again it be assumed that one dollar in reserve will support four dollars of credit-accounts, and that the rate of interest in com- mercial loans were five per cent), then the margin of income lost to the business on account of capital invested in "margins" would equal two per cent or exactly the same amount as the income realized on the bonds. Under such circumstances the advantage to the National bank would be nil. The same conclusion may be drawn from the computations of the Government Actuary found on page 33 of the Comptroller's Report, 1902. In this it is assumed that the notes may be invested at the rate of six per cent, and on this assumption the result exhibited is as follows: 2S of 1930 $6.62 per $100 3s of 1903 6.16 per 100 4s of 1907 6.19 per 100 4s of 1925 5.94 per 100 5s of 1904 5.96 per 100 Such a result does not show any considerable ad- Advantage small vantage from "bond investment and under present issue " as it would not be logical to practice assume that the "note" may be in- vested at any higher rate than could the "legal- tender 174 THE BANK AND THE TREASURY money" used to purchase the bond. Assuming that the note may be used with equal advantage, however, in the above showing, there would be a fraction of one per cent of profit on three classes of bond invest- ments, and a fraction of one per cent of net loss on two others represented. In this result, however, the assumption is that the "note" is as useful to the banker as are gold certifi- cates or other forms of money. If this be an over- statement, then there may be, in truth, a loss to the bank on every class of bonds which is here made the basis for actuarial calculation. To say the least, the margin of net profit in "issue" is, in the judgment of bankers, so small that few have Possibilities of a -i i ^i i r ^.i Ig^g ever availed themselves of the maxi- mum issue privilege. Quoting from Mr. Ridgely, in an address delivered on the evening of December i8, 1903, at a banquet given by the New York State Bankers' Association: "In the Re- port of the Comptroller of the Currency just made there is given a table showing the percentage of the issues outstanding to permissible circulation, from 1863 to 1902. The maximum of 81.6 per cent was reached in 1882, and the minimum of 44.1 per cent in 1892, and since the Act of 1900 it has been a little over 50 per cent, now being 53.32 per cent. It is hard to figure now whether there is any profit at all, as it depends upon the amount of notes which can be outstanding and the prices of bonds. On circu- ADVANTAGES OF NATIONAL OVER STATE BANKS 175 lation based on some classes of bonds there is a positive loss." In the foregoing discussion the assumption has been that the banks which receive "issues" from the Government have desired to keep them outstanding, and the present practice conforms to the assumption made. When this is done, however, the question of advantage or disadvantage of "issue "-privilege must be considered as pertaining to a use of "issues" in lieu of "credit-accounts," for the purchase of legal "cash "-reserves. In the first case, there would be a "Notes" com- positive loss in that the capital of the pared with "de- bank could not be used for banking ^""^^ purposes; in the second case, the in- creased income from bonds would not more than compensate for the margin of capital which is made unavailable — being invested in "margins." The point here made is, that viewed in the light of present practices (i.e., looking upon the issues as a form of funds to be currently used as a part of the permanent money stock) the issue-privilege is of little or no advantage to the National bank, and in certain cir- cumstances may stand in the way of obtaining the best business results. Advantages in the "Government Deposit" Privilege The second special privilege accorded to the Na- tional bank by the Government (viz., the privilege of hypothecating invested capital-resources, or "gilt- 176 THE BANK AND THE TREASURY edge" securities, for Government loans) presents a somewhat more alluring prospect. By such an arrangement, under present practice, the money surplus of the Treasury is looked upon as a prize to be taken for the use of banks as "reserves" without the payment of interest, in exchange for demand obligations against which no "reserve" need be kept. The advantage in this is two-fold: (i) The money received from the Government does Elements of ad- , „ ., , i j- ^.•^^l. i j vantage ^°^ suffer the legal disability placed on "issues." It is in the form of gold or demand obligations of the Government (credit- money) payable in gold. (2) It is procured at a less expense than "issues," not being subject to a tax, and being relieved from the cost of plates, from maintenance of a redemption fund, etc. Assuming that the amount invested in bonds is a part of the capital which would be permanently needed for "cash-reserves," and that the bonds were hypothe- cated, then the money obtained from the Govern- ment could be used to the same advantage as if it had not been invested in the bonds. The bank, however, would be required to use more capital to obtain the amount necessary for current redemptions. The only elements to be considered in estimating profit or loss in the practice could be found in the capital-return on the bonds and the amount of bank- ing capital tied up in "margins." In this there might be a small advantage over the "issue." But ADVANTAGES OF NATIONAL OVER STATE BANKS 177 assuming that the amount so invested in bonds were a part of the "in vested-reserve" {i.e., the capital surplus over and above the permanent cash require- ments), then the money obtained from the Govern- ment might again be re-invested to the same advan- tage as if no bonds had been purchased. Assuming that the margin were ten per cent and that the net return on the bonds were two per cent, the bank would obtain twenty per cent on the amount invested in the margin. Reasons why the "Deposit-Loan" Privilege is more Advantageous than the "Issue-Loan" Privilege It is not in this character of items, however, that the large advantage lies. The practice of the Gov- ernment being to make "deposit- " Deposit-loans" i i, i i. • • in emergency ^o^ns" only when emergencies arise, the National bank has a Government fund at hand to which it may apply for cash in time of greatest need. This practice is sustained by the history of nearly every financial stringency since the establishment of the National banking system, when the Government was in a financial condition to lend aid. During the period of forced liquidation from 1 901 to 1903 the aid lent by the Government to the National banks was the most striking single feature in giving support to the money market. An addition of over $100,000,000 to the money-reserves of Na- tional banks by transfer from the Treasury within 178 THE BANK AND THE TREASURY a few months went far toward preventing a wholesale collapse in the overstrained credit of commercial banks, while they were slowly applying pressure to those who had obtained credit-accounts in exchange for collateral loans. A private bank or a State bank in time of financial stress must look to the market for funds. To obtain money with which to maintain its credit-accounts, without curtailing loans to customers, it must convert some of its capital-assets. This may be done either by sale or by hypothecation. If by sale, then the bank must take the market price for securities, and on an unfavorable market must suffer an investment loss. If by hypothecation, then the bank must pay the market rate for money. The National bank, on Advantage of t^e other hand, if it has "gilt-edge" "eOTe>-^mcy"Zoa«5 securities "reserved," may obtain vjithout interest ^^^^^ ^^^^ ^^^ Government by hy- pothecation free of charge — i.e., without payment of any interest at all. To illustrate this advantage : Let us suppose that the market for securities is five per cent below the price paid by the bank. To sell capital-resources under such conditions would entail a direct investment loss of five dollars per hundred. Again let us suppose that the market rate for money has risen to ten per cent in the market, then this extraordinary rate must be paid on h3^othecation. Either circumstance would put the State bank or private bank at a disadvantage in competition with ADVANTAGES OF NATIONAL OVER STATE BANKS 179 the National bank, which may obtain "issues" or "deposits" from the Government on hypothecation of its investments. The "issue-privilege" might be used with the same advantage as the "deposit-privilege" if the banks chose so to do. The difference lies in the practice of the Government rather than in the nature of the right. The "deposit-loan" privilege has been "Issues not ^^ opportunity extended for the con- loaned in enter- version of "invested-reserves" or re- ^^"'^^ serve capital-resources in time of emergency, thus seeming to increase the banking power; the "issue "-privilege is an opportunity to use "money-reserves" for direct investment, which seems to permanently increase the money stock without adding anything to the banking power. This con- clusion is drawn from present practice under the National Bank Act, and does not reflect on the pos- sibilities of using both privileges to a much better result. Chapter XIV THE AMOUNT OF MONEY AND CREDIT FOR WHICH ELASTICITY SHOULD BE PROVIDED An essay on elasticity and sound banking would be without bearing if it failed to consider the amount of fluctuations and demands for current funds. And such a consideration, to be of value, must have reference to commercial and financial experience, rather than to arbitrary conjecture. The current funds for which demands are made in business are of two kinds, viz., money and credit. Each of these has its own peculiar history and importance. Of fluctuations in total money-demands the statistics published by the Department of the Treasury are the best record. Fluctuations in Total Money Supply and Demands of the Country The general money supply is increased or de- Variations in creased by coinage and redemption, total national by importation and exportation. Aside money-demands ^^^^ ^^^^^^ ^^^ ^^^^^^^ ^j variation are comparatively insignificant. From the Treasury statistics it is found that the greatest variation [180] AMOUNT OF ELASTICITY REQUIRED 181 within a period of a single year since 1890, allowing for the average rate of increase, is about $244,000,- 000, or about ten per cent of the National money supply. It would seem that the fluctuation in total money supply of the country is not a serious matter — that the increasing and decreasing need of the future, as in the past, may readily be met through present agencies of coinage, issue, and importation without seriously disturbing the world's markets. But the fluctuations in total National money-de- mand with respect to total money supply are not as significant as are the variations of supply and demand with respect to the several financial groups and insti- tutions of which the National system is composed. This is true for the reason that within the National group specific variations of much larger proportions Greater impor- ^^1 ^e completely lost sight of. For tance of variations example : Within a period of a year the inspecificdemand r^^^^^^^ ^^^ ^^^^ ^ monetary loss of $250,000,000, while the bank-reserves may show a gain of equal amount. These fluctuations would not in any manner affect the total money supply of the country. Again, the banks might lose $250,000,- 000 from their reserves and the money in circulation among the people might increase in like amount. Such fluctuations would be lost sight of in an exhibit of National money supply and demand. Each year just such fluctuations as these rise like a spectre be- fore thoughtful bankers. 182 THE BANK AND THE TREASURY As between the several financial groups there are three separate inquiries: (i) What are the fluctuations in the money-demands made by the Federal Govern- ment and by the several State treasuries; (2) what are the fluctuations in money-demands made by banks for money-reserves with which to support their credit-accounts; and (3) what are the fluctuations in the demands among the people for JpIcTfifdema^s "tiU-cash" and "pocket-change," etc. As to these several classes of fluctua- tions in demand we may never have complete data. Fortunately, however, we have reports and statistics from which a safe approximation may be reached. The Bureau of Statistics of the Department of Com- merce and Labor furnishes monthly statements of changes in the money supply in the Treasury and in circulation. Five times per year the Comptroller of the Currency makes public the changes in National bank-reserves; several inquiries have also been made with reference to the daily averages of deposits and withdrawals of National banks by months; the State banking and fiscal reports furnish supplementary evidence for different sections. Fluctuations in Demands on the Treasury Giving consideration first to the demands of the Treasury, the widest variation from the average in- crease in fiscal needs during the last fifteen years has been about $160,000,000. This amount is well AMOUNT OF ELASTICITY REQUIRED 183 within the customary money balance carried. But assuming, as now happens, that money-demands on the Treasury may increase, at a time when the reve- nues are decreasing, this customary balance may be threatened with extinction. Nevertheless, the prob- lem of adjustment of Treasury resources to Treasury needs is not in itself a factor disturbing to business. Through the ample loan-power of the Treasurer, money may be obtained by importation at any time that a money surplus in the vaults of the banks is not available to the Government. It is only when the American money rate is low, when the money stock of private institutions is so large that they can afford to sell at rates far below the usual commercial rate, that the fiscal needs of the Treasury will be supplied from the banks. In other words, when the Govern- ment is forced on the world's market to obtain funds for its own needs, importation wiU serve to strengthen the National money situation. When loans are Fiscal transac- taken by our own people, such invest- Honshave httle j^^g^ts serve to deter speculative ex- heanng on elas- . , i ticity cesses coincident with a large private surplus. The monetary disturbances that in the past have arisen from Treasury needs have been due to threatened attack on the financial integ- rity of credit-money-issues of the Government or to the calling in of loans previously made by the Treasury to the banks. The purely fiscal trans- actions of the Government have served to strengthen, 184 THE BANK AND THE TREASURY rather than to weaken, our institutions of private- credit. The popular notion that the money in the vaults of the Government is abstracted from the money stock of the country is erroneous. Assuming that $150,000,000 were the average reserve carried in the general fund of the Federal Treasury, and that $100,000,000 were the average money-reserve carried in the vaults of State and local treasuries, this aver- age reserve amounting to $250,000,000 would be taken, not out of the money stock available for busi- ness use in the United States, but out of the money stock of the world. If originally the Treasury re- serves had suddenly been abstracted from the money Notion that Treas- circulation of the United States, it ury fundsreducena-would, by business necessity, soon tion's stock in trade -^^^^^^ equalized by importation; and after an equilibrium had thus been established this reserve would no longer be a factor in the money market. Only the fluctuations or variations in this Treasury reserve would ever reach the exchanges. An increase in Treasury reserves without importation would operate to decrease the supply for other pur- poses. Conversely, a decrease in fiscal money sup- plies without exportation would operate to increase the money supply of the country which is outside of the Treasury. The effect of this increase or de- crease, it is true, would first be felt by persons or institutions of first contact, but should the amount N* to U 1^ en 01 ^ o O O O o o , o b O o o o o o O O o o o O b p b poo b b b p b p b •S- 3- o o O o o o o o o o o o ^/ /' \ J / ■n ^'-'i X f 03 \ O -1 \ 1 u^ 12 \ ^ / > ?3 ^ 00 CO \a ^ ^ .^ \ r {" ¥ ^l \ H C o M GO )^ T>' z a J£7) /J /5 cn /■ c CP \5 \u /■ 5 H /CI 1 V. 1 5 to \s V^ ./ ^ a .<■ o 'V A CO , i^ / ^ > \iA ,/ ^ ^ 1 o v. I 9, ■0 V"^ \° ^ ■J(J \% V^ •\> o 1^ / "^^ 3 \ / ^ 1 p \ H 1) 1 / / \ \ \ • / to AMOUNT OF ELASTICITY REQUIRED 185 of increase or decrease affect the funding needs of these persons or institutions of first contact, the de- mand or supply would at once be passed on through the market, and the equilibrium again restored. Fluctuations in the Money-Demands of the Banks and of the People From the point of view of elasticity the only money- demands that are serious, and therefore the principal ones to be considered, are those made by the banks as a means of supporting their own credit-accounts, and those made by the people for "till-cash" and for "change," etc. These two demands may be treated as practically the same, since the method by which money is obtained by the people is directly or indi- rectly to draw on the banks. The purpose of selling commercial paper or other bankable assets to a bank The chief fluctua- is to obtain a current fund for use in tions in money- business. Under ordinary circum- demands oj banks gt^nces a customer prefers these funds in the form of a bank-account. But when occasion requires the bank may be asked by the customer to pay its account, and thus money is withdrawn from the bank-reserve. The banks stand in the position of a money market to the people. The banking business is one of selling money "short" and then making delivery "on demand." It is through the process of making deliveries on "short sales" of money by the banks that the reserves are depleted. 186 THE BANK AND THE TREASURY The largest fluctuation from the average increase or decrease of money-reserves of National banks recorded during the last fifteen years is about $155,- 000,000. This was under circumstances of extreme monetary disturbance, and a general condition of doubt, which in many localities amounted to actual Amount of das- panic. Assuming that this amount ticity needed in r • ■, i. it. • n bank money-re- ^^""1^ represents the maximum fluc- serves tuations in money-demands on other banking institutions proportionate to their capitali- zation (and the assumption would seem a conserva- tive one since the National banks are depositories for private banks, State banks, and trust companies), the extreme fluctuation in money-demands made by all banking institutions would not exceed $375,000,000. This may be taken as the degree of elasticity needed in the money circulation to meet the money-demands of banks, and, through the banks, to meet the money-demands of the public. Fluctuations in Demands for Credit-Funds Turning to the question of elasticity for which provision is to be made in the other form of current funds used by the business community (viz., bank- accounts), the same process of reasoning may be followed. Taking the statistics of National banks five times per year as a basis for calculation, the largest variation in average decrease or increase within fifteen years has been about $875,000,000, or AMOUNT OF ELASTICITY REQUIRED 187 about fifteen per cent of the average amount of active bank-credit at the time outstanding. Using another basis for calculation of the extreme possibilities of fluctuations in demands for credit- accommodations which may be sought by the busi- ness community, the statistics of daily averages of deposits and withdrawals may be invoked. From the investigation made in 1903, it would appear that the average daily demand on National banks is about $226,000,000, and that this average daily demand fluctuated by months from $258,000,000 to $200,- 000,000. In other words, from the month of Jan- Computation uary to the month of August there was jrom daily a fluctuation in daily averages of about averages $6o,ooo,ooo. It also appears that the total amount of funds provided in the form of bank- accounts changed hands on the average about once in fifteen days — that is, that the average length of time for which the business man provides current funds needful to his business is about half a month. Assuming that $60,000,000 is a maximum fluctuation in daily demands on National banks for credit-ac- commodation, and, further, that the active accounts of all commercial banking institutions is about $9,000,000,000; assuming again that the credit fluc- tuations in other institutions are in like proportion to those of National banks, and that the average period for which credit-accommodation is asked is fifteen days; assuming further that this gross fluctuation in 188 THE BANK AND THE TREASURY demand fell within the period of average loans, in- stead of within a period of a year, then the maximum fluctuation in demands for credit-accommodations would rise to $1,800,000,000 or about twenty per cent of the active accounts outstanding. This would seem an extreme estimate as to the elasticity required under conditions most favorable to credit expansion. Using the foregoing conclusions as a basis for determining the amount of elasticity actually needed to date, it would seem that the preparation to be made for response to fluctuating demands for money by banks amounts to about $400,000,000 — i.e., that provision for an emergency currency of about thirty per cent of the National bank capitalization would be adequate to meet every fluc- Total elasticity , ,• j j vi i. • required tuatmg money-demand without un- portation or high market rates. By the same criterion it would seem that the banks should provide for an increasing and decreasing credit fluctuation of from $1,000,000,000 to $2,000,- 000,000, or from ten to twenty per cent of the average volume of credit-accounts used as current funds. How Fluctuating Demands Affect the Present System Before reaching conclusions as to the manner in which this fluctuating demand for money and credit may be met, it may also be well to trace the effect of AMOUNT OF ELASTICITY REQUIRED 189 demands on our system as at present operated. This can best be done by means of charts, which at a glance will give the results of many years of ex- perience. Under our present practice the loan to reserve agents, or the "reserve deposit," is the form Money-demands '^ which the surplus money of banks oj the country jail is invested in time of low demand. on reserve hanks j^ j^ ^^ ^^^ ^^^^^^^ ^^ "calling" these reserve loans that the investing bank expects to re- store to itself the funds loaned in time of money need. On Chart V is represented the money-demands made on all National banks of the United States by their customers, and also the demands made by investing banks on reserve agents. From this it conclusively appears that the demand for money made by cus- tomers on all of the many banks of the United States finally falls on the reserve agents — that is, through our peculiar system of investment of capital surplus all of the fluctuations in money-demands of the people fall on a few banks. Another fact quite as conclusively appears from Chart VI, opposite page 70, viz., that the demands made on reserve agents finally fall on the banks The demands on of the city of New York. Trac- TTffr'" ing the fluctuations on this chart it which fall on ° New York will appear that every variation in money-reserves held by banks of the country at large finds a similar variation in New York City banks. That this may the more surely be traced to the 190 THE BANK AND THE TREASURY "reserve" system, another chart is prepared (page 134), which shows the "amount due from all reserve agents" and the "amount due from New York City banks." The experience here recorded leaves no question but that the avenue through which money- demands reach New York is the "reserve bank." Another clue to the situation is found in Chart VIII, opposite page 152. From this it seems that the amount due from New York banks to other banks, in every fluctuating detail, is almost exactly the amount of "money-reserves" kept by the banks of New York to support their own credit-accounts. The borrowed That monetary disturbance would money-reserves of occur under such circumstances is a New York banks conclusion which might be reached by conjecture; that monetary disturbances have actually occurred is a matter of history and expe- rience. The record of the past and the evidences here presented can leave no doubt of the fact that under the present practice of investing capital-re- serves in loans of other banks, every monetary de- mand falls directly on the banking centre and tends to throw the whole commercial-credit system into a condition of unrest — a condition which at times deprives outside banks of the support of central banks, and, again, forces New York banks to resort to Clearing-House certificates for settlerhent of money-balances among themselves, — a condition of financial paralysis to commercial enterprise. The AMOUNT OF ELASTICITY REQUIRED 191 present method of supplying money-demands, a method which simply shifts the demand from one bank to another, is one of the features to be consid- ered in devising ways and means to overcome present defects, and to give greater elasticity to the money medium and greater safety to banking institutions, without forcing the banks again to shift the fluctu- ating demand back to the constituency where it arises, thus standing in the way of extension of commercial accommodation when accommodation is needed. Certain other features in credit-demands may be developed with reference to fluctuations and methods of providing credit-supply. From the charts of credit- fluctuations (pages 184, 202) it will appear that quite a different practice prevails in different sections of the country. In the cotton and tobacco States fluctuations in credit-demands are as regular as the seasons. In manufacturing Pennsylvania the varia- tion by seasons is scarcely noticeable. To meet these local conditions quite a different method of capital equipment would seem to be necessary. That a Conditions in di}- practice prevails in the cotton States jerent sections to peculiar to themselves when com- be considered ^^^^^ ^j^j^ ^^^^^ sections would ap- pear from Chart X, opposite page 176. In the cotton and tobacco section a large portion of the current credit given is procured from other sections by means of "bills payable" and "notes re-dis- 192 THE BANK AND THE TREASURV counted." The fluctuations in these two items of account follow the seasons of crop removal with all of the precision that do the credit-accounts of cus- tomers. In a section of variegated industry such as that represented for comparison, this practice does not prevail. On the other hand, it appears that the necessity for meeting periods of extraordinary fluc- tuation, due to industrial depression and speculative reaction, is very much greater, and should be brought into the calculation of credit strain on redemption equipment. Chapter XV POSSIBILITIES OF ELASTICITY UNDER OUR PRESENT NATIONAL BANKING SYSTEM Many writers have argued to the conclusion that under our present practice the bank-note has in itself no possible use as an emergency currency. To enlarge more fully on this position three reasons are urged why National bank "circulation" may not be increased to relieve a monetary strain, viz.: (i) That in time of ordinary money-demand the com- Reasons assigned mercial constituency do not wish for inelasticity in bank-notes for use in their business 'issues' J.Q g^j^y greater extent than they al- ready use them; if they did wish more notes it is afi&rmed they would call for them at the bank in exchange for commercial paper or other bankable assets sold, instead of opening bank-accounts. In so far as note-issues are increased, therefore, the in- crease is in the nature of a substitution for other forms of money circulation. (2) That in time of extraordinary money-demand under the present prac- tice, the bank has no power to extend either its money or its credit-accounts to meet the enlarged business need for current funds; the bank must literally buy [193] 194 THE BANK AND THE TREASITRY its "notes" from the Government before issuing them; moreover, the "notes" must be purchased by use of the bank's credit, collaterally secured by United States bonds on hand and other collaterals, and these collaterals will cost them more than the amount, in "notes," realized; the bank which is in straits for legal-tender money, therefore, has no power to obtain "notes" from the Government. (3) That when so obtained, the notes may not be as effectively used as other forms of money, viz., legal- tender issues of the Government. Elasticity as an Individual Banking Problem The problem of elasticity to the individual bank is one which pertains to its own credit-accounts. Un- der a highly localized banking system a single insti- tution cannot control the money supply of the nation ; it cannot adapt general money supply to general money-demand. If a bank possess powers of credit- note-issue to meet the demands of its own customers Problem one fo'" money, it would to this extent be which pertains to able to relieve its own necessities and credU-accounts ^^ ^^^^ ^^^^^^ ^^ ^^^ ^^ ^^^ ^^^^^ market. But the principal money-demand made on a bank does not come from its customers; it comes from other banks. Under such a system as that sug- gested by the "commercial assets" school, there is no reason to suppose that other banks would accept these notes so issued in settlement of balances. Or, ELASTICITY POSSIBLE IN PRESENT SYSTEM 195 if they were accepted, banking experience further suggests that the system itself would prove dangerous. Commercial-assets money-issues are safe only when provision is made for other banks to send issues "home" for payment as fast as they are received. When notes of other banks are promptly redeemed they operate in the same manner as do checks and drafts. Credit-money-issues by banks, if properly safe- guarded, cannot materially affect the fluctuations in bankers' demands, and this is the chief fluctuation in money-demands to be provided for. Such issues may have the effect of supplanting the stable and "Issues" cannot constant money supply issued by the supply chief Government which is now used for money-demand u^^^^ ^^g^" and "pocket change." That is to say, bank-issues might operate to drive gold, sUver, and Government-notes out of circulation, but could not supply the demand made by one bank against another. As near as may be estimated from statistics at hand, the constant money-demand for "till cash" and for personal uses is at present about $1,600,000,000, or 60 per cent of the money out- side of the Treasury. This stable or permanent circulation might be supplied by the credit-note- issues of the bank, but to make such a circula- tion sound it would be necessary for the banks to increase their capitalization to carry the credit- money-load which is now on the Treasury — a charge 196 THE BANK AND THE TREASURY on capital equal to about fifty per cent of the present redemption equipment of National banks. The possibility of the individual bank solving its own problem of elasticity in credit-accounts under the present Law, however, is not wanting. This may be done through adequate capitalization and adequate redemption equipment. As before indi- cated, the only Umitation to the amount of credit- Individual bank accounts that a bank may carry is to S^r^'^?"^^ ^«^^^ ^^ ''' unimpaired capital; accounts the only limitation to the possible elasticity in the credit-accounts of such an institution is to be found in the amount of redemption equip- ment which it provides for itself. If the minimum of credit-accounts demanded by its customers is $500,000 (assuming that twenty-five per cent is an adequate cash-reserve to meet all demands on its current obligations), then the minimum capital sup- port required would be $125,000. If the maxi- mum demand from customers for credit-accounts is $1,000,000, then, under the same assumption, the maximum capital requirement would be $250,000. But in order to make possible this $500,000 expansion of credit-accommodations the bank should be capi- talized to meet the maximum redemption require- ment. Assuming again that all the redemption equipment were invested, except such portion as is necessary to be carried in cash as a twenty-five per cent money- ELASTICITY POSSIBLE IN PRESENT SYSTEM 197 reserve to support credit-accounts outstanding, then when the demand for customers' accounts is at a Power of expand- minimum the bank, if capitalized at ing credit in its $250,000, would have $125,000 of its own an s capital invested and temporarily held as an income-producing asset awaiting an increase in money and credit-demands. The only question in determining ability to expand accounts to meet in- creased wants of customers would be in the character of these capital reserve-investments held — that is, a question as to their immediate convertibility into cash. Should it at any time appear that a bank were unable to meet demands for current credit-accounts or for cash, this inability would arise from one of two occasions: (i) a too small capitalization, or (2) an unwise investment of surplus capital for purposes of redemption reserves. Possibilities 0} Elasticity in the National Banking Sys- tem as a Whole, without Change in the Present Law The possibility for elasticity in the National bank- ing system as a whole under the present Law differs from that of the individual bank in this, — that a system of banking such as the National banking May give elas- System, including within it over 6,500 ticity to money different banking institutions, makes circulation possible a degree of elasticity in the money circulation adequate to meet the fluctuating money-demands of the nation, as well as a degree of 198 THE BANK AND THE TREASURY elasticity in the credit-accounts of individual banks sufficient to meet demands of customers. While one bank, with its comparatively insignificant capitaliza- tion, can do little to affect the money market, 6,500 banks can do much. Under the present Lavsr the possibility for money expansion and contraction to meet commercial demands lies (i) in the "issue- privilege" and (2) in the provision made for Govern- ment "deposits." The National banks alone enjoy these privileges. The "issue" powers not only give to National banks increased facility for the conver- sion of their invested redemption equipment into cash by hypothecation, but also furnish a method under the present Law whereby an increase in the money circulation of the country may be effected without importation and without disturbance of the money-funds of the National Treasury. But such a result may be attained only by cooper- ration on the part of the many banks of the system by which the various individual institutions making up the system would refrain from hj^othecating their bonds in time of minimum money and credit- demands, and would hold them as an unencumbered capital-investment ready for hypothecation when Amount of das- money-demands might increase. The ticity which may amount of fluctuation in the money- e given demands made on National banks has never exceeded $200,000,000. The total amount of bonds owned by National banks, July, 1904, ELASTICITY POSSIBLE IN PRESENT SYSTEM 199 was over $650,000,000. The total fluctuating money-demands of the entire country has never ex- ceeded $300,000,000. If the capital invested in bonds by National banks alone were used for the purpose of supporting the fluctuating banking and business demand for money, instead of being em- ployed as a means of supporting the bond market and for increasing the permanent money supply of the country, this capital investment would be adequate to meet every need for elasticity in the money medium. The elasticity thus given to the money circulation would be in response to money-demands made through the banks. In other words, the elasticity would be provided through those institutions upon which demands were made. Such a practice would supply the fluctuating banker's needs for money as a means for payment on credit-accounts, as well as the fluctuating popular demand for "change" and for other personal payments, which give rise to drafts on the bank. This adaptation of money-supply to May give elas- nioney-demand would be in direct ticity to credit- support of expanding credit-accounts junds p£ banks, and this use of capital in- vestments in bonds owned by banks would admit of a sudden increase or decrease in credit transactions during a period of fluctuating demand of at least $1,600,000,000, while the greatest fluctuation from the average of accounts of National banks during the last fifteen years has been only $350,000,000. 200 THE BANK AND THE TREASURY How the Credit- Accounts of National Banks may be made Elastic under the Present Law without the Use of the Issue-Privilege The possibility for elasticity through issues is quite equalled by the possibility for elasticity with- out issues. The difference is this, that the issue- privilege makes possible elasticity of the money cir- culation as well as credit accommodations without importation and without disturbance of the resources ElasticitywUhout o^ the Treasury, while the elasticity issues limited to provided for under the Law without credU-accounts -gg^^g ordinarily would involve a drawing down of Treasury resources and possibly an importation of gold. The second possibility of increasing elasticity lies in the privilege before dis- cussed — the privilege granted to the National banks to receive "deposits" from the Government upon the hypothecation of securities acceptable to the Treasurer. The deposit- (loan)-privilege is accorded to National banks as a means of making the Treasury surplus available to them for money-reserves in time of need. It is a happy supplement of the issue- (loan) -privilege. This provision of law under the recent decision of the Treasurer allows the banks to hypothecate not only United States bonds on hand, but also other "gilt-edge" securities, discretion as to the advances to be made being left with the Secretary. By a ELASTICITY POSSIBLE IN PRESENT SYSTEM 201 proper use of this privilege elasticity may be given to the credit-accounts of banks and much relief may be afforded to the community seeking accommodation. Such a use of the deposit- (loan)-privilege has in it Attainable with- the possibility under favorable con- out disturbing the ditions of making practically all the money mar e surplus capital-resources of banks (that may have been conservatively invested) im- mediately convertible into cash, by hypothecation, when cash is needed to keep up the lawful money- reserve of banks, which in turn may be used to in- crease credit-accommodations. By such a practice the entire money surplus of the United States Treas- ury might be used as a subsidiary money-reserve to the money-reserves of commercial banks. This added facility for immediate conversion of invest- ments into cash has its chief significance in the fact that, while money may be withdrawn from the Treasury (at such times as the Treasury may have a surplus available) the credit-accounts of banks may be expanded and adequate support may be given to them in money-reserves without appeal to the money market and without disturbance of money rates. There may be, however, few conditions favorable to the use of the Government deposit (loan). The h)rpothecation of investments with the Government as security for these loans (sales of money by the Government to the banks) depends upon the coinci- 202 THE BANK AND THE TREASURY dence of a disposable Treasury surplus with a bank- er's pressing need. It has happened that during the years 1898 to 1902, with foreign importations increasing faster than Government expenditures, the Government had a surplus of money in its vaults which was available to the banks without serious Conditions under inconvenience to the Treasury; 1903 which this would and 1 904 found Other conditions preva- not obtain j^^^ ^^ ^^^ National capitol. The same has been true of every period of trade reaction and financial retraction. When tariffs have been lowered or the American commodity market has been less favorable to impor- tation, the Government has not had a large loanable money surplus. In fact, it has usually happened that during such periods of depression the Govern- ment has not been in a condition to lend a helping hand to private institutions. The situation has oft- Conditions under times been reversed. Deposits or which disturb- ^ . 1 1^,111 ances would be ^^^'^^ previously made to the banks increased must be recalled as a means of meet- ing the deficit created by the excess of expenditures over receipts. Owing to this fact, under the present practice the loan-deposit has proved a somewhat dangerous device. Under any circumstances, the possibility of gaining support from the Government is highly contingent and not to be permanently re- lied on as a safeguard against inelasticity. At best it must be treated as an auxiliary support, but IN DOLURS 175.000,000 150,000,000 125,000,000 100,000,000 75,000,000 50,000,000 CO s 1— m \ 1 r H r c c 5 "t- QD H r \ z tn O -n V o V33 H 00 I "^ ?^^' H 00 H O -n ■2. H IK 3> O > r Jo /o / * H (B s 01 r \ 2 -1 I { H 00 1/ -0 8. \^-. H 00 to -A "V^-^c i. % H 00 CD ■" H 00 to to { \ H ELASTICITY POSSIBLE IN PRESENT SYSTEM 203 nevertheless, at such times as it may be used, it may be one of the most efl&cient supports to credit conceivable. Possibility under the Present Law oj Increasing Elasticity of both the Money Circulation and of Credit-Accounts through the Loan Market There is under the present system a third possi- bility of making capital assets in the form of redemp- tion equipment immediately convertible into cash without forcing a contraction of commercial accom- modations. This possibility lies in the practice of so using the invested-reserve as to make it an instru- ment of immediate conversion in the loan market itself. The general loan market is the third resort for a National bank, but it is available to all banks and persons doing a banking business. A bank which finds its money-reserves running low may obtain relief from other banks in the community by hypothecation or by sale, unless these other banks Elasticity through are under similar constraint, in which convertible invest- case banking relief must come from ^^^^^ outside. The condition precedent to such a use of the money market, with its powers of money importation, is an adequate unencumbered invested-reserve. If a bank has an adequate amount of "gilt-edge" capital assets it may at all times obtain money to support an expansion in its credit- accounts, whether or not it has Government "issue" 204 THE BANK AND THE TREASURY and "deposit" privileges. For such an institution the problem of elasticity is solved. This elasticity may come through the employment of idle funds already in the community or by a process of money importation from the outside world. In a large banking community there are always to be found many customers of banks and other persons having accounts or claims against other financial institutions in the immediate locality who are willing to exchange these accounts or claims Possibilities ^^^ good investments. The induce- without appeal to ment which brings out these funds e mar e ^^^ makes them available for cur- rent use is the offer of increased investment return. A bank which needs $50,000 in money, by offer of an increased rate of interest may find among its own customers (depositors) those who are willing to pur- chase $200,000 of the bank's "bills payable" or time-notes secured by stocks, bonds, or other avail- able assets, the effect of which would be not to in- crease its money-reserves but to reduce its outstand- ing credit-accounts (deposits) of customers. Such an adjustment would relieve the strain on its money- reserves without restricting its commercial-accom- modations. Again, through bankers or otherwise, the bank might find customers (depositors) of other institutions who were willing to purchase $50,000 of its "bills payable," secured by the hypothecation of reserve capital-investments. Such a disposition ELASTICITY POSSIBLE IN PRESENT SYSTEM 205 would have the effect of giving to the bank hypoth- ecating its securities credit-claims against other institutions amounting to $50,000, How the market 1 ■ , , ■ ^ . ^ ^ . is reached which amount might at once be trans- ferred to its own vaults. This would put the bank in a position to support outstanding commercial-accommodations without calling loans. The great investment companies, old line insurance, savings banks, etc., have large current means that may be made available by secured loans. By similar process, when the domestic loan market may not furnish the desired money-reserve, foreign negotia- tions might set up a gold balance by importation. But any method of safely meeting money-demands requires an adequate unencumbered capital reserve; adequate support to commercial banks by the loan market and investment companies would require the discontinuance of paying interest on deposits by which commercial banks in ordinary time borrow all available funds of these institutions. One Obstacle in the way 0} Elasticity without Legal Enactment As has been suggested, the elasticity to be given to the circulating medium of the country, whether in the form of money or in the form of credit-accounts, must come by cooperation of the many banks of the National system. It is in this that the improbability of securing such a result as that outlined obtains. 206 THE BANK AND THE TREASURY In the first place, the banks do not do business that way. In view of this fact, even if a majority of bankers were of the opinion that such a change might be advantageous, they would not be willing to alter their methods unless general cooperation were assured. Against a change which would have such a degree of uniformity as would insure the elasticity Voluntary co- desired is set all of the force and operation to this inertia of custom — a factor which end improbable requires the strong arm of law and the closest supervision of Government to overcome. In the second place, a very large majority of bankers have not this view of the case. In fact, judging from expressions made, many influential bankers would favor changes in method which would still further lower the percentage of capitalization required to business transacted. In the third place, to effect such cooperation in the interest of the greater elas- ticity needed, certain practices and collateral em- ployments of banking capital would have to be abandoned. There has been a growing tendency toward underwriting. The class of securities com- monly underwritten is not such an investment of capital as contributes to elasticity. There has been a growing tendency toward banking consolidation, by which the surplus capital of controlled banks is loaned to (deposited with) the controlling bank, without any increase in capital strength being effected through the consolidation. Investments in ELASTICITY POSSIBLE IN PRESENT SYSTEM 207 the accounts of "central" banks may lend them- selves to the purposes of an individual bank or group under ordinary circumstances, but conversion of these investments into money to support local de- mands weakens the credit-support at the centre. Such a disposition of capital does not contribute to elasticity in the banking system as a whole. In fact, it has two effects directly opposed to elasticity and soundness: (i) it weakens the capitalization of "cen- tral" banks, and (2) it ties up the capital of the "depositing" bank in such a way as to render it difficult to bring money into the system from without as a means of meeting increasing demands. Chapter XVI POSSIBILITIES OF INCREASING ELASTICITY BY SIMPLE MODIFICATIONS OF THE PRESENT LAW Elasticity is the need — the problem is to supply it. To re-state a conclusion reached in the preceding chapter, the present system will admit of an adequate measure of elasticity if bankers were brought into cooperation to this end. The impelling force in the present practice — a practice which stands in the way of cooperative results — is the constant desire to lower capital-cost of banking operation. This mo- tive must be reckoned with. It is ever-present in all The need for forms of business. It is the desire to legislation to se- obtain the largest income possible at cure cooperation ^ ^^^^^ capital-cost and current-ex- pense that gives point to the administrative devices of every institution conducted for gain. It has been the effort to lower cost and to increase profits (at times ill-directed) that has made necessary legisla- tion for the inspection of mines and factories, and for the introduction of safety appliances to the physical equipment of enterprise. The same necessity lies back of the present need for legislation requiring greater business safety or [208] MODIFICATIONS TO INCREASE ELASTICITY 209 "soundness" in the redemption equipment of com- mercial banks as a means of securing increased elas- ticity and better banking service. It is through compulsory legislation that a uniform practice may be introduced. Under circumstances of competi- To benefit the tion, reforms which require an in- bank as well as crease in capital-cost can be attained the public ^^ ^^ ^^^^^ ^^y ^^g ^^.f^ Qf ^j^g banking legislation of the past has been toward the imposition of requirements that will bring to the public protection against insolvency of individual banks. The demand of to-day is protection against the forced contraction of accommodation by the banks as a means of protecting their own expanded credit. And as past legislation must be recognized as of advantage to the banker as well as to the public, the same result may be predicated of a fur- ther evolution of our system of commercial credit to adapt it to the increased needs for a more sound and a more elastic medium of exchange. Changes in the Law to Increase the Soundness of Credit- A ccounts In the many plans proposed for increasing the elasticity of bank-issues and bank-credit, the element of the business safety of the latter has been ignored. An underlying fallacy has been entertained, viz., that the problem of elasticity may be solved without increasing the financial strength of those institutions 210 THE BANK AND THE TREASURY offering current credit-accounts for sale. But in- creased financial strength must come at a cost. Greater soundness of credit can be had only through reinforced redemption equipment for meeting the demands for money payment, and redemption equip- ment must be procured by capital investment. Larger and better facilities for rendering banking service are made possible only by means of stronger and improved machinery for credit support. In banking, as in other undertakings, experience has taught the lesson that without adequate capital-re- sources both the institution and the public may suffer many times more than the price of safety. Initial capital cost of equipment, however, must be met, and met by those who undertake the banking business. An Amendment of the "Money-Reserve" Section of the Bank Act The first change in the Law looking toward in- creased elasticity is one which would require in- creased capitalization and at the same time would take away the inducement to invest the capital surplus of the bank in a comparatively weak and dangerous form of redemption equipment. The oft-repeated recommendation of Comptrollers and of financial writers for the repeal of those sections of the Bank Act which permit one bank to loan a portion of its capital to another at interest is here invoked — a MODIFICATIONS TO INCREASE ELASTICITY 211 repeal of the clauses pertaining to "reserve deposits." It is unnecessary to re-state the dangerous character Re-statement 0} o^ this device, — that a "deposit" is defects in "re- a loan; that a loan is a sale of money serve" law f^^ ^^^^j^. ^^^^ ^^^ "reserve deposit" at best cannot be more than a capital investment, but too often is obtained by exchange of credit; that in times of money strain it shifts the burden from one bank to another; that such a device does not permit of the use of capital to effect an increase in the money-reserves of banks or an expansion of credit with safety ; that it hampers the operations of the use of bank capital in such a manner as to make elasticity in money circulation and in current credit-funds of the nation impossible. A deposit with another bank for the purpose of meet- ing exchange balances may be properly considered a part of the "cash" requirement, but for obvious reasons it may not with public safety be considered Effect of prohibit- as a partof the"invested-reserve." In ing interest on so far as a deposit with another bank depost s -g cQnsifjered as cash, the use of capi- tal for the purpose of obtaining such accounts should be restricted to the need for redemption of exchanges ; this restriction may be effected through the Act by a prohibition restraining one bank from paying interest on the "deposits" (loans) of another. As has been before pointed out by financial writers, such a pro- hibition would take away the inducement to this 212 THE BANK AND THE TREASURY form of investment of capital surplus. Without an income inducement, a bank would carry no larger deposits with other banks than would actually be needed for an exchange base. Besides, in case a commercial bank were not permitted to pay interest on deposits, there would be no inducement for trust companies, savings banks, and insurance companies to carry large credits with them. Or, to put the same relation in another form, the commercial banks would not become borrowers of money from these institutions as a means of supplying themselves with "money-reserves" to meet ordinary demands of cus- tomers on credit-account. Such a complete segre- gation of the funds of institutions of current account, from investment institutions, would do much to give stability to general financial conditions. The in- vestment institutions would carry a line of short- time papers, to be sure, and among these short-time investments might be secured bills payable and re- discounts of commercial banks. But such a practice would make the current revenue of investment insti- tutions an auxiliary support to the commercial banks when support were needed, instead of making the commercial banks the money market as well as the credit market, a plan which would make the various investment institutions and the Treasury of the United States independent and prominent factors in the money markets, and do much to place the banks in a position to gain support for the credit market. MODIFICATIONS TO INCREASE ELASTICITY 213 The "reserve" Law as it stands has proceeded from a popular misconception that a bank "deposit" is an amount of money owned by the depositor. Misconception as This fallacy is made use of by banks to meaning of themselves in their dealings with cus- eposi tomers, and by customers in thinking about banks. A familiar instance of such use is seen in advertisements of the financial condition of banks as a means of soliciting public confidence in then- paying ability. In almost any banking journal such a display as this may be found: THE FIRST NATIONAL BANK OF ECONOMY FALLS Capital $ioo,ocx3 Surplus 100,000 Total Capital and Surplus $200,000 Deposits $1,500,000 The above is assumed to be a statement of financial strength. If the advertisement were written to speak the truth it would be something as follows: Capital and Surplus $ 200,000 Call Loan Indebtedness i ,500,000 Excess of Demand Indebtedness over Capital... 1,300,000 A credit-account to a customer is a contract for the future delivery of money — a deal in "futures." The bank sells to its customers (so-called depositors) its contracts for the future delivery of money. These contracts are due on "call." They have not even the time usual on boards of trade and stock ex- changes where "puts" and "calls" are dealt in. In 214 THE BANK AND THE TREASURY stock transactions a "future" is usually entitled to at least one day's notice before delivery is to be made. "Deposit" an Institutions of commercial-credit do investment in not reserve this privilege, and if they ju ures ^j^ make such reservation the utility of their credit to customers as current funds would be destroyed ; they would stand in the same position as savings institutions. The commercial bank must deliver at once, without notice, or admit its insol- vency, and with such admission sacrifice all claims to public confidence as a basis for future credit sales. After several decades of experience we established a law requiring banks to keep a certain minimum pro- portion of money-reserves to demand-credit outstand- ing. A prescribed ratio of "cash" to credit-accounts outstanding should be established — "cash" to in- clude both money-reserves and exchange-balances. It should be permitted, however, that these may be used for the satisfaction of immediate demands. Should require ^^^ the law should also require that cash-reserve pro- this "cash "-reserve, including money videdoutofcapital ^^^ exchange-balances, should be provided out of capital. It should further require that every subsequent increase in credit-obligations should be supported by "cash" provided by capital investment. Such an amendment would prevent an expansion of credit beyond ability to support it, and would be equivalent to saying that a bank should capitalize its maximum instead of its minimum MODIFICATIONS TO INCREASE ELASTICITY 215 credit-redemption requirements. As a result of such an amendment the bank itself, to increase its own income, would see to it that such portion of its re- demption equipment as was not immediately needed, when credit-demands were not at a maximum, was invested in assets immediately convertible into cash. An amendment of this one feature of the Bank Act by repeal and by substitution of a provision author- izing the banks to invest their surplus capital-re- sources in first-class marketable securities only, to be accounted as an "invested-reserve" and to be considered as a part of the redemption equipment held as a basis for credit support, would at once add over $500,000,000 to the assets of National banks Increase in das- available to procure money by sale ticity of money-re- or by hypothecation without disturb- servesasaresuU -^g ^^^ ^^^^j^ relations of other insti- tutions. Such a change would greatly increase the possibilities of credit expansion in time of need. This increased strength of equipment can come from the superiority of investments of present capital em- ployed as banking equipment. In every other rela- tion the Law has recognized the investment of one bank in the liabilities of another as a policy not to be supported. Commercial banking institutions have failed, and until such a change is made they always will fail, to support an extraordinary strain which is general enough to reach the central bank. The present reserve provisions always have operated and, 216 THE BANK AND THE TREASURY under similar conditions, must operate 'to force a reduction of loans with increased money-demand. Moreover, such an amendment of this feature of the Bank Act would take out of the National banking system at the reserve centres over $500,000,000 of money that is now held there as an invested-reserve, but which is used by these central banks for the support of a much larger volume of credit represented Increased inde- '^ call-loans and other speculative pendence 0} indi- assets — a kind of security that is of vidual banks ^j^^j^ ^^^ ^^ ^^^ ^^^ ^j business that should be supported by commercial banking capital. The "call-loans" of National banks, as well as the call-loans of other institutions which depend on the money-reserves of National banks, are speculative loans. These loans are usually incurred as a means of carrying on margin speculation. This is about the only kind of business to which a call-loan is adapted. Under the present practice the National bank has become the mainstay to the speculator. In an emergency the National bank finds itself at times tied hand and foot with the man whose only interests lie in market fluctuations instead of in producing goods and marketing them. When gradual liquida- tion may be effected the banker may protect his commercial constituents against the speculative judgments of professional traders. On the other hand, when the strain is sudden and danger is immi- nent these call-loans may not be made available to MODIFICATIONS TO INCREASE ELASTICITY 217 protect commercial-credits. But even if by forcing liquidation the banker is able to preserve his own institution intact, the result is a shock to the commu- nity and it reacts unfavorably on commercial and industrial enterprise. Repeal of the provisions referred to would not only increase the elasticity of commercial-credit-accounts but would also purge the commercial bank of its most dangerous constituency. It would compel the speculator to seek call-loan accommodation with institutions and agents specially capitalized and equipped for such service. Such a change in the Would purge sys- Law would also require the conserva- tem of dangerous tive banker to seek other investments cons i uency ^^^ j^jg surplus money-reserves, and by this means would leave intact the capital-resources of commercial banks for commercial-credit support. It would tend to break down the practice of comming- ling capital assets of banks, would place each indi- vidual institution on a more independent footing, and would sever the bonds which have so frequently dragged all down into a common pool through the weakening or breaking of some central support. The individual banker would be banking on money- reserves and "gilt-edge" investments instead of basing his own credit on the credit of other banking institutions which in turn look to speculative or other customers for support in emergency — a system which brings the results of bank-credit over-expan- 218 THE BANK AND THE TREASXJRY sion down on the heads of those engaged in commerce and industry. Amendment Requiring a Minimum Proportion of Redemption Equipment to Maximum 0} Credit- Obligations Outstanding An amendment directed toward adequacy in capi- talization would not be complete without a clause requiring a prescribed proportion of "redemption equipment" to the maximum credit-funds disposed of for the accommodation of customers. As a mat- ter of public safety a bank should not be permitted to incur credit-obligations in excess of a prescribed ratio to unimpaired capital. That is, instead of the money-reserve being a criterion by which to gauge the soundness of credit-accounts, the law should adopt the measure of unimpaired capital available for redemp- tion purposes. Such an amendment would have the Controlling controlling effect: (i) Of imposing on effect 0} such an the Comptroller of the Currency the amendment inquiry as to what part of a bank's capital is tied up in "banking-house and fixtures," in "real-estate," in "mortgages," and in "other in- vestments" not available for the support of credit- accounts, such as "underwriting," etc. ; (2) of making it the duty of the Comptroller of the Currency and of examiners to inquire into the amount of capitaliza- tion remaining after procuring "redemption equip- ment"; (3) of requiring a specific accounting for the MODIFICATIONS TO INCREASE ELASTICITY 219 character of "redemption equipment" held — what portion in cash, what portion in investments — and as to cash, what portion is held in the form of money- reserves, and what portion in the form of exchange accounts; (4) of compelling a report in such form that this total redemption equipment may be com- pared with the maximum of credit-obligations to be redeemed. At present no question is raised so long as the money-reserve bears the prescribed proportion to "deposits." This money-reserve may have been borrowed; it may be swelled by padded or "mutual" balances. The bank's capitalization may be inadequate to support even the minimum of credit-accounts. No inquiry is made as to the character of redemption equipment other than cash. In fact, a Comptroller of the Currency has been known to say that so long as the loans of a bank are good there is little need for investigating further. A prominent banker also an- nounces as his belief that if the cash-reserve is kept intact it is of less importance to know that the "stock, bonds, and other securities" held are properly repre- sented in financial statements than that the "com- mercial assets" are not to be written down. These Need for a change opinions have in them much of truth, in the principle but not for the reasons assigned. It 0} control jg necessary that loans be good, for the reason that any loss on this or on any other account is a capital loss. There can be no other kind of loss in 220 THE BANK AND THE TREASURY a going business; only an insolvent can saddle losses on creditors. Assuming that all the "commercial assets" are good, a bank having capital-assets which are unavailable and of questionable character (while it may be able to liquidate on "winding up") will not as a "going concern" make an efl&cient banking institution. In case the money-reserves are not pro- vided for out of the capital, the bank is a constant menace to the community. As a going concern every extraordinary demand will be forced on cus- tomers, and the community will experience a peri- odical restriction in funds available for current use such as wiU make commercial judgments uncertain and enterprise extra-hazardous. It is to remedy just this defect in our present banking system that the present agitation for elasticity is being carried on. The Law must have regard for public welfare rather than the solvency or insolvency of an individual bank. An Amendment 0} the Bank Act to Enjoin the Pay- mejtt oj Interest on "Issues^' to Banks A third change in the Law in the interest of elas- ticity has been suggested. Writers and publicists have called attention to the fact that underneath the present Law a small, almost nominal tax is imposed on issues. Throughout the course of banking legis- lation, and in most of the recent proposals directed toward reform, an assumption has run that both the bank and the Government may use the same capital MODIFICATIONS TO INCREASE ELASTICITY 221 at the same time, without weakening the resources of either. The Government is in need of gold. It offers its bonds for sale, and as a means of availing itself of a better market holds out to the bank an inducement to buy. The inducement offered the bank to part with its gold is this: That the bank may continue to receive the interest on the bond and at the same time have its face value in notes to use as money. In this transaction the presumption is that the notes will not serve as an elastic medium; the presumption is rather that the amount of notes issued will, at once, be added to the permanent stock of money in circulation. The present nominal tax is based on the same theory as the plan of issue — a high tax on notes would reduce the inducement to purchase bonds and in like degree would depress the bond market. The ten per cent prohibitive tax on State bank issues proceeds from the same conclusion. The bond market is no longer a matter of public concern. On the other hand, an elastic currency is an end desired. If, in the framing of a banking law, all question of Government-credit were abandoned, and a tax were laid on issues (or interest were charged on the Government loan of "issues") for the purpose A use of the in- of regulating their use to meet the terest rate to regu- extraordinary money-demand — if, in late circulation ^^^^^ words, an elastic currency in- stead of a bond market were made the object of legis- lation — it is contended that elasticity may be at- 222 THE SANK AND THE TREAStlRY tained without abandoning the principle of safety found in a secured note circulation. For purposes of illustration, let us assume that the varying needs for money during the year did not fluctuate more than $300,000,000. Then the use of the $600,000,000 of bank-notes already outstanding might be regulated by interest charges as follows: Issues (loans) to the extent of five per cent of the capital of National banks or an amount ample to cover the active accounts of disbursing officers might be at the rate of one per cent as compensation for the use of the banks as disbursing agents of the Government. Such a low interest rate on a small portion of the "issues" would also have the effect of keeping a small amount of "issues" in circulation to guarantee the ready ac- ceptance of the bank-note by customary use. While due regard should be had for the right of the banks holding bonds with the expectation that issues might be had without charge, ultimately, all note issues over the suggested minimum might be charged with a rate of interest or tax which would make bank-notes an emergency money-reserve. A por- tion (let us say one-third) might be taxed at a rate high enough to preclude its use except in extreme emergency. The proposition is not a new one. The principle has been several times proposed under the name of a "tax," but has met with little support. The banks have not favored it for obvious reasons; the public MODiriCATIONS TO INCREASE ELASTICITY has not seen the need for such a restriction on the issue of notes by banks as will take them out Why proposition of the permanent money stock and at has not received the same time force the banks to suppor strengthen their capital-resources (i.e., to require them to do business on their own capital, under extraordinary as well as ordinary conditions) ; they have not considered the necessity of compelling the less provident of commercial banking institutions to furnish out of their own capital-funds a redemption equipment strong enough to make secure their credit- accounts (so-called deposits). The Strength and the Weakness 0} Secretary Shaw's Proposal Financial disturbances between 1902 and 1904 lend force to the reasoning which lies back of such a demand. Secretary Shaw in an address before the National Association of Merchants and Travelers at Chicago has become an open advocate of the prin- ciple. "If I were given authority to formulate a measure that would provide the requisite elasticity Elastic medium to our present currency system," says equaltoe,o per cent yix. Shaw, "I think I would add o j collateral issues ^^ amendment permitting National banks, with the consent of the Comptroller of the Currency, to issue a volume of circulating notes equal to fifty per cent of the bond-secured circulation, at a tax of six per cent, the same to be retired at will (by 224 THE BANK AND THE TREASURY the banks) or by direction of the Comptroller, by the deposit of an equal amount of lawful money, with any Sub-Treasury." Predicting the result of such a measure in elas- ticity. Secretary Shaw continues: "Three things I know: First, this additional circulation would spring Government in- i'^to existence almost instantly when- surance to elastic ever and wherever interest rates ad- medium yanced to the point of profit. Second, it would as promptly retire whenever interest rates became normal. Third, it would be absolutely safe, — as good as the present National bank-issue, and with a slight change, identical in form and appear- ance, — for the Government, amply protected by the six per cent tax, would underwrite it." In this we have stated the principle of a current charge on "issues" for regulation of that part of the money medium which we would have respond to the fluctuating needs that could be met by ordinary dealings in the market. The charge, however, is to be in the nature of a premium paid for insurance. In this we have a partial abandonment of the prin- Still clings to old ciple of "banking on the capital-re- idea oj support to sources of the bank." The coUater- hond market ally-secured note is still to serve as a part of the permanent money-supply, and the elastic medium is to gain its "soundness" from Govern- ment underwriting. In other words. Secretary Shaw, whUe announcing the principle of elasticity, still MODIFICATIONS TO INCREASE ELASTICITY 225 clings to the idea of bank-note issues for the support of the bond market, instead of limiting "issues" through banks to the fluctuating money needs of the country. An Amendment of the Bank Act to Encourage Investment of Surplus Capital in "Gilt-Edge'^ Securities To the above principles of emergency currency may be urged the objection that, from motives of business profit, the banks would very largely reduce their circulation, and reduce the holdings of United States bonds as a basis for issue. Thus, it may be said, such a change as that suggested for regulating issues, by interest requirement, or by means of any other current change adequate to compel retirement of issues, would defeat its own ends. To make effective a collaterally-secured emer- The inducement • j , to investment S^ncy currency, some mducement must be offered to investment in the kind of capital-resources which will be received by the Government as a basis for issue. Such an in- ducement must be found in the rate of return which the bank may get on the kind of investments of sur- plus money or other capital-resources that may be reserved for hypothecation or sale to obtain money when needed. Under the present Law investments of this kind are limited to (i) United States bonds, as a basis for 226 THE BANK AND THE TREASURY issue; (2) loans to (deposits with) reserve agents; and (3) more recently, to "gilt-edge" securities acceptable as a basis for Government loans. As to the first class of investment the banks get a return below two per cent. As to the second class, the rate of return is from two to three and one-half per cent; on the Investments un- average they are somewhat above two der the present per cent per annum. The most prof- '^^ itable return on " invest ed-reserves" is from those securities other than Government bonds and reserve deposits — "gilt-edge" securities such as have recently been received by the Secretary of the Treasury as collateral to "deposit" loans. The business advantage of investment of surplus capital-resources in this class of securities, and the unquestioned soundness of the collateral, suggest the application of provisions similar to those advocated by Mr. Aldrich and Mr. Pa)me for the security of Government loans to the banks (Government de- posits). In a bill introduced in the House of Rep- resentatives by Mr. Payne, February 26, 1903, it is proposed that the Secretary of the Treasury accept as collaterals the following securities: "Bonds of the United States, bonds or other interest-bearing obli- gations of any State of the United States, or any legally authorized bonds issued for municipal pur- poses by any city in the United States which has been in existence as a city for a period of twenty-five years, and which for a period of ten years previous to such MODIFICATIONS TO INCREASE ELASTICITY 227 deposit has not defaulted in the payment of any part of either principal or interest of any debt authorized Amendment pro- to be contracted by it, and which has StlfMr^'' -t such date more than fifty thou- Payne sand inhabitants as established by the last census, and whose net indebtedness does not exceed ten per centum of the valuation of the taxable property therein, to be ascertained by the last pre- ceding valuation of property for the assessment of taxes; or the first-mortgage bonds, not including street railway bonds, of any railroad company which has paid dividends of not less than four per centum per annum regularly and continuously on its entire capital stock for a period of not less than ten years previous to the deposit of the bonds." With the utmost safety the Treasurer as trustee for the note-holder and as guardian of the principle of "sound money" and "sound credit," might receive any of these investments as a basis for issues, thus giving to the banks a better return than they now receive on loans of surplus capital to reserve-agents. This would furnish the inducement to the banks to carry an "invested-reserve" that might be made immediately convertible. With such oppportunity given for investment of surplus money-reserves, and with the imposition of a tax which would insure that issues would not be put into circulation except when the money pressure was above the ordinary, both the inducement to invest and the convertibility of the THE BANK AND THE TREASURY investment by sale or by hypothecation and issue would be secured. Amendment of the Bank Act to Require Payment of Interest on Government "Deposit'' Loans to Banks The same reasoning as is urged in support of a charge on "issues" would suggest the imposition of an interest requirement on the banks for loans (de- posits) from the United States Treasury. What has been so carefully called "a deposit" of the Govern- ment with a bank is not a deposit in any sense of the word. It is nothing more nor less than a loan without interest. It is a sale of money to the bank in return The profitable ^^"^ which the Government gets a de- character oj these mand credit-claim against the bank ""'^^ secured by such collaterals as the Treasurer may require. These so-called deposits may be made immensely profitable to the bank; by using the money so purchased on credit and without interest, as a "money-reserve" the bank may pur- chase at least four times as much commercial paper "on-account" {i.e., in exchange for deposits). For this reason, it is that only when pressure is brought to bear on the bank by the Government that the money is turned back into the Treasury, where it belongs. Instead of the bank having an inducement to re- lieve its hypothecated investment from encumbrance as soon as the extraordinary demand for money is MODIFICATIONS TO INCREASE ELASTICITY past, there is a continuing inducement for the bank to stretch its credit to the limit at times when money- An inducement to demands are small, and then again to encumber redemp- appeal to the Government for aid in tion equipment tij^e of need. Another danger lies in the fact that the Government is not in touch with the commercial world except when appeals are made for assistance. It, therefore, knows not when to bring pressure for payment; the Government has only its surplus loaned and has no need to bring pressure at all until current public expenditures begin to run ahead of current revenues. For these several reasons, an interest charge, enough above the usual commercial rate, should be made, to compel the bank to do business on its own capital and to retain an unencumbered capital- surplus convertible by hypothecation with the Gov- ernment when commercial-demands might make hypothecation profitable. This would make the Government surplus an emergency fund that would be sought for by the banks only in time of financial pressure — a fund which would re- fefS charge"' ^urn to the Government immediately after the emergency had passed. This would, to the extent of Government surplus available, avoid the necessity of importing gold when there is an adequate supply in the country to meet all mone- tary needs, and at the same time would give to the banks the advantage of being able to obtain money 230 THE BANK AND THE TREASURY on favorable terms when they have good capital- resources to hypothecate. The Proposed Amendment for a Guarantee Fund to Secure Credit-Accounts It has been stated, and, since the days of wild-cat banking, the statement has gone without challenge, that a commercial bank should not be allowed to commence, not to say continue, business until it had provided itself with property equipment sufficient to make both its "deposits" (credit-ac- Capital support j_ \ j •,_ j_ • a to credit-accounts ^oMnis) and its note-issues secure. A proper regard for the principle of elasticity requires a re-statement after the manner suggested by Mr. Cannon. A bank should have a capital equipment large enough to protect its credit, and to meet aU commercial demands of its customers for money without calling in its loans. If we accept this as a proper statement of the principle of capitalization and equipment, it follows that any security given to a bank's credit-accounts, or to its note-issues, should be provided out of the Contrasted wUh resources of the bank. The recent Government suggestion of Secretary Shaw, in the underwriting ^^^^^^^ ^^^^^ ^^^^^^^^ ^^^ j^ ^^ ^^^ effect that the amount received from the tax on issues (premiums for insurance of issues) should be utilized to guarantee the Government against loss from un- derwriting the emergency notes of the banks. In MODIFICATIONS TO INCREASE ELASTICITY 231 this the Secretary of the Treasury has not abandoned the idea of secured issues, but he would have the direct security come from the Government. Those who have declared themselves for secured issues would have bank-notes secured by the hypothecation of the capital-resources of the bank, while others, still more conservative, notable among them Mr. Dawes, would have the principle of security extended to the "deposits" of the banks as well as to the "issues." The theory on which "security" or "insurance" of deposits rests, is this: that the credit-accounts (deposits) of the bank are the form of current funds most used in business; that the business of the com- munity depends quite as much on the "soundness" of bank-credit as on the "soundness" of Government credit-money; that the profits of the bank are derived from buying income-producing commercial paper in exchange for bank-credit; the bank, therefore, should protect those who have taken its credit in exchange, so long as it remains outstanding for current use. In other words, the public is quite as much interested in "sound bank-credit" as it is in "sound money," and since the bank is permitted to issue "current credit- accounts" for its own profit it should be required to protect these with its own capital-resources. The theory is eminently sound in principle, and in practice would add much to the integrity of commercial bank-credit. 232 THE BANK AND THE TREASURY If we require the banks to deal on their own capital, the note-issues should be secured by bank assets. Again, if we are to have a true system of assets banking, then in so far as the security for current accounts of banks is not provided by original capitalization it should be derived from their capital- ized current-income. An enforced contribution from income, in the form of interest payments on Govern- ment loans ("issues" and "deposits") A trust fund to se- . • j i. ii. • i i. cure "deposits" ^^ P^nods when the commercial rate is high, would not only operate to make elastic that part of our money system repre- sented by note-issues and credit-accounts, but might also be used to build up a "fund" which would be held by the Government for the benefit of the bank's creditors. The security of "note-issues" and of "deposits," it is argued, would give to all forms of credit used as current funds in the community that element of security the lack of which has so often precipitated wholesale panic and individual disaster. Such an insurance fund for "deposits," however, could not be built up and maintained on any other principle than that of "banking on capital-resources." The suggestion for an adequate guarantee fund for deposits is premised on an interest charge on secured issues, and on an interest charge on secured deposit- loans, so made and regulated as to make the capital- resources of the bank more readily convertible. The secured-note may enter into circulation without ques- MODIFICATIONS TO INCREASE ELASTICITY 233 tion as to the soundness of our credit-money system; the guaranteed credit-account might be used in busi- ness to give the same implicit faith as to the sound- ness of our commercial-bank-credit. With such a The benefits of rnodification in the Law, it is said, if secured credit- the Law were properly administered, accouns ^^ banks would be compelled to do a safe business. The banks would be required to do business at an increased capital cost, it is true, but this would not necessarily mean an increased rate of interest to customers, nor decreased profits for the banks. As a result of increased capital strength and enlarged redemption equipment their credit would be more readily salable, and the banks might do a larger business than under a system which compels them to refrain from credit expansion when accom- modation is most in demand. This would bring about that much desired condition so zealously ad- vocated by Mr. Eckels, in which the Government would be entirely divorced from the banking busi- ness. All commercial-credit business would still be done by the banks; the banks would be operating on their own resources; and the Government when acting at all would serve in an auxiliary capacity only — that of trustee for all parties in interest and administrative guardian of the welfare of the nation. Similar suggestion has come from several sources. The Fowler bill of 1897 contained a provision for a guarantee fund. The proposition has been argued 234 THE BANK AND THE TREASURY in financial journals. The opposition developed has come largely from the older and stronger banks. To them there is an advantage in the unsecured system Character of op- i'^ that their solvency is not questioned ; position to secur- and by virtue of their reputed ability mg eposis ^^ m.&ti current obligations they are able to make large sales of credit compared with capital employed. To establish a common fund for the security of all credit-accounts sold by all the banks in the system would give to the small bank the same reputation for soundness as is enjoyed by the largest institutions. This argument would be valid under our present system of banking, wherein there is no check on credit sales other than a "money-reserve." If, however, an amendment were made which re- quired a minimum cash-reserve to be provided out of capital, and the powers of the Comptroller were ex- tended to prevent the extension of credit beyond a certain proportion of that capital available in the form of redemption equipment, neither the large nor the small bank could extend its credit beyond the prescribed limit. Each bank would be restricted in its maximum business to a safe proportion to capital invested. Under such a provision, the large bank could not be deprived of business by a small bank unless the small bank increased its capital, in which case the small bank would be entitled to do a larger business. It may be questioned whether any pro- vision made for increased safety to business would MODIFICATIONS TO INCREASE ELASTICITY 235 reflect on the worthy institution. On the other hand, much may be gained by all parties concerned through the enlarged opportunities offered to banks for doing business. And through a system of mutual respon- sibility pressure would be brought by the banks themselves for an enforcement of the Law. Whatever may be conceived as a proper applica- tion, in concrete provisions of the Law, the principles governing increased availability of capital-assets of National banks and increased elasticity by simple changes in the existing system may be summarized as follows: (i) An amendment of the "money-reserve" pro- visions of the B ank Act, requiring a minimum ' ' cash ' ' - reserve to be provided out of capital, would operate to give increased financial strength to the banks; it would make possible increased elasticity of credit- accounts and credit-accommodations. (2) A change in the Bank Act fixing a minimum of "redemption equipment" to be provided out of capital, making this proportionate to the maximum of credit-obligations outstanding, would operate to increase the capitalization of banks. (3) An amendment requiring interest payments on "issues" (loaned by the Government to the banks) would operate to make the note-circulation an elastic currency. (4) An amendment of the Bank Act permitting the hypothecation of "gilt-edge" securities for Gov- 236 THE BANK AND THE TREASURY eminent "deposits" would encourage capital invest- ment in more highly convertible assets. (5) An amendment requiring the payment of in- terest on "deposit" loans would make the Treasury surplus an important support to the banks for the support of increased credit-accommodation. (6) The proposed amendment to constitute the Government income from interest on loans, taxation, etc., a contingent sinking fund has in it possibilities for increasing the soundness of bank-credit and for increasing elasticity in so far as elasticity depends on public confidence in the banking system. (7) A provision requiring that all capital used for the purchase of " banking house," "real estate," for underwriting, etc., be considered banking capi- tal impairment, would have a wholesome effect and would serve as a protection to the public. (8) A clause requiring that all special and prefer- ential deposits be stated in all published reports, would do much to correct present evils in banking practice. Every measure taken to enable banks to meet demands for accommodation by use of capital equipment would tend to minimize fluctuation in demand, and to decrease the amount of capital which must be held in reserve in low income-pro- ducing investments and thus be to the advantagfi of the banks as well as of the business community. Chapter XVII SUPERIOR POSSIBILITIES OF THE AMERICAN FINAN- CIAL SYSTEM FOR ADAPTING CURRENT FUNDS TO CURRENT NEEDS A CENTURY of adaptation to new and ever-changing conditions has given to America some remarkable institutions. In none is the strenuous character of the people more strongly marked than in our financial system. In none have we developed greater possi- bilities for solidity and working efficiency than in our concerns organized to supply the increasing demand for current funds. Living amid great natural re- Optimism and sources, hampered for lack of capital conservatism as and industrial equipment, working in jactorsinhusiness circumstances which require intensity of effort and strictest economy, the balance of National prosperity has been swung by two contend- ing forces — the one conservative, the other promo- tive. Our conservatism has consisted in measures to protect property already acquired. Our promo- tions have been efforts to apply all our own resources, as well as those which might be acquired from others through contracts of current credit and of capitaliza- tion. An inventive people, we have exercised our best talent in devising ways and means for doing [237] 238 THE BANK AND THE TREASURY business, and to this end both capital and current funds have been obtained in exchange for contracts made for the future deUvery of money. The re- sult at times has been to carry investment judgment beyond all reasonable certainty of return. Nor has the situation been an unnatural one. With teeming riches on every hand, awaiting only the intelligent application of capital for their recovery, when markets have been high the inducement to promotion and credit investment has been great. When failure has come, it has more often been due to changes in general market conditions than to dis- Failure to meet appointment in productive results. contracts for fu- Prospective money returns have not ture e tvery always been realized within the term of a loan. Failure in judgment as to the amount of money obtainable in the future has resulted in inability to make money delivery — in inability to meet credit- obligations. Even when the rewards of nature have surpassed all calculation, money payments required by contracts of capitalization and current credit have not been met. As before suggested, the money returns required by contracts of credit have depended quite as much on the market price obtainable of the thing produced as on the amount of the physical product. The mar- ket has been subject to world conditions and to fluc- tuations which the parties to the contract could not foresee; so violently have these fluctuations in world SUPERIORITY OF THE AMERICAN SYSTEM 239 conditions reacted on our credit relations that period- ically commerce and industry have become paralyzed Failures due to by forced liquidations and the with- world market drawal of working funds. In each con t tons period of increased world activity and increasing financial return, capital has been more easily obtained from abroad; with each period of decreasing world demand and consequent lower prices for products, capital has become more conserv- ative, forcing retrenchment and financial readjust- ment. Out of such a situation — alternately moved by the forces of conservatism (or protection to wealth acquired) and by forces of promotion and credit ex- pansion (or endeavor for increasing gains) — our funding institutions have arisen. In the organization and control of institutions of current credit, the guiding principle of the American people has ever been and to-day is to give to capital the highest utility compatible with safety. Pro- ceeding from this principle, alternating in control between the forces of conservatism and those of credit expansion, we have developed a National system that is unique — a system in which both our money and our commercial funds are on a credit basis. In the interest of National economy and business safety, our money (largely credit-money) is issued by an agency of Federal Government — the United States Treasury. For purposes of utility, our commercial-credit is issued and controlled by private 240 THE BANK AND THE TREASURY locally-independent institutions — our commercial banks. The more vividly to portray our National funding system, it has been described as a mammoth structure of delicate balance and adjustment resting on two independent and widely separated columns The principles oj or pillars: the one is a column of «£J™ 7.1 $1,500,000,000 of credit-money, which amy tn our pnan- ^ 'o > j ji cial system has for its foundation the gold Treas- ury-reserves ; the other is a column or pillar of about $13,000,000,000 of bank-credit, which has for its foundation the reserves of the commercial bank. On these two columns or pillars is superimposed from $30,000,000,000 to $60,000,000,000 of business-credit that looks to the resources of the two independent and widely separated institutions above referred to — the Treasury and the bank — for support. The great problem of the century past has been to make this structure a safe one in which to do business. The problem of to-day is to so lay the foundations that the columns may be able to support the constantly shifting strain that is placed upon them. In planning for the present as well as for the future we must plan for the business of a continent. Our The abandonment business demands are larger and more oj the European varied than those of any other coun- ^y^^^ try. Our plans, therefore, must be continental. We cannot confine our view to one State, as does France, or Spain, or Austria. We already have developed a banking power comparable SUPERIORITY OF THE AMERICAN SYSTEM 241 with that of all Europe. From considerations of local autonomy and National development we have long since abandoned the European system, the cen- tral feature of which is a State bank under Govern- ment direction and control. That the Treasury, under such a system as we have, cannot supply the people with current funds goes without saying. Even the money-demands of commerce and industry cannot be supplied except through loans, and the Government has permanently retired from the loan business. Loaning is the only method by which the fluctuating demand for funds may be met under any system of finance. In Ger- Therelationojthe many, in Russia, and in France — in Treasury to the fact wherever the general government money market j^ ^j^^ ^ ^^^j^^j. _ ^^^^^ j^^^g ^^^ ^^ made to the people direct. But under a system such as ours, in which the Government has no institution of commercial-credit, the only manner in which the Government can bring its large financial resources to the support of the market is through independently organized commercial banks. How under Our System the Treasury and the Commercial Bank may Work together to Provide the Elasticity Required Since both money-demands and credit-demands fall immediately on the commercial bank it is to this that we must look for the means necessary to supply 242 THE BANK AND THE TREASURY these demands. Our inquiry is, therefore, Under such a system as that with which we are working, how may the banks the better supply the fluctuating money and credit-demands, and how may the Treas- ury best lend support to the banks without weakening Proposed method its support to the credit- money-issues of Treasury of the Government ? Answer to this suppor inquiry has come from some of our leading bankers in the following form: "That the Treasury be required to deposit all its current funds over and above its currency requirements in the banks." The reason urged in support of this propo- sition is that such a requirement would "prevent the money of the country being locked up in the public vaults, thus depriving business of its proper use." In opposition it is said that the reasoning by which the above conclusion is reached proceeds from two fallacies: first, that the money held by Objections raised the Treasury is abstracted from the money stock of the country, and, therefore, operates to cripple business, and, second, that greater elasticity would be given to bank-credit by having the resources of the Government deposited in commercial banks. The popular notion that money in the vaults of the Government is abstracted from the money stock "of the country" has already been discussed. There can be no reasonable conclusion other than that the supply of money for business purposes finds its level SUPERIORITY or THE AMERICAN SYSTEM 243 through the market, and that whatever is regularly held in reserve by any particular government is not abstracted from the money-supply of a particular Treasury stock country, but goes rather to reduce the not wtthdrawn ., , , , i ^ ,, 11 from national available money stock of the world, money supply which may be made available for private business ends. If, therefore, the Treasury surplus of the United States may be made available for private business uses in time of extraordinary business demand, such Treasury-reserve instead of decreasing the money stock of the country will in- crease it to the full extent of the amount thus made available. Furthermore, it may be said that the money in the vaults of the Treasury is not idle. On the contrary, in so far as it is needed to support the credit-issues of the Government, it gives to the country from eight to ten times the amount of money which is held in reserve for the support of these credit-issues. The Treasury-reserves, therefore, enable the Government to supply to the people from eight to ten times as much money as it could do at the same cost if these reserves were not so held. Again, in so far as the general fund of the Treasury is not necessary to the support of credit-issues of Government they must be looked to as current cash for the carrying on of a public institution. To say that public business is not a part of the business of the country would certainly be erroneous. The actual need of the Government for current funds 244 THE BANK AND THE TREASURY with which to carry on its business has been variously estimated at from $100,000,000 to $200,000,000. To Treasury-reserves the extent that the amount held in the may increase na- rpi ■ i. i. 1 j. 1 tion's money Treasury is not to supply an actual supply funding need this surplus should be reduced — but not by loaning it to private parties. The Government has obligations of its own to meet, and may at any time apply a surplus to their reduc- tion. If at any time there may be said to be any idle money in the Treasury this is not a fault of the system, but rather a fault of those who are operating it. But the mere fact of the segregation of public funds from private funds leaves the Government at all times in a position to lend temporary aid to private funding institutions, which it could not do if the public funds had been commingled with those of private agencies. The second fallacy is quite as apparent. To make the commercial bank the regular recipient or deposi- tory of Government funds as they are received, when the Government itself is out of the banking business, cannnot add to the elasticity of bank-credit. If Gov- Government de- ernment-deposits with the banks were posits in hanks do ,■,■,, . .^ , ,-, • not increase elas- ^0 be kept at a uniform amount, this ticity amount would soon become absorbed in business, and the bank-reserves would be reduced to the usual safe working proportion. Whenever an extraordinary demand for money or for current funds might arise the bank would be in no better position o Q S OQOooooooooO aooo'" millions OOOO OOOOOO OOOO OO OOOOOF COLLARS l< 1 on ]{ }; \\ ^ } ?^ i / j \ ^ i) c '■-;, \\\ 1 1 M ) < i \l \ TOTAL CURRENT LIABILITIES TOTAL COMMERCIAL ASSETS TOTAL MONEY RESERVE TOTAL SECURITIES 1 V ? il ) > / 1 , ^, 11 ) i c» < "^ I 1 1 s s ^ CO V > CO to i; s \ < ^ '' / s / ^ K Tn / \ V- 00 / '\ 03 1 1 ( V '. g I / S \ •■■. -■■ s i < >/ vO 1 / 1 K <: ■--- ■h- 00 \ s r" 1 V b f/1 ) I ^ Ch ^ ^ -^ \ '\.. ' <■ > NO > '""•••. ^ s^ 8 I / I, *. ~x O ^ — H-^^NJhJNJtvJMWOiWCOW SCALE SUPERIORITY OF THE AMERICAN SYSTEM 245 than before to meet this demand. This is an assump- tion most favorable to such a reciprocal arrangement. The revenues and expenditures of Government are not uniform. Were the revenue receipts and current expense payments to be made through the banks this would be added cause of monetary and credit dis- turbance, since it often happens that the banks are hardest pressed and are required to keep the largest May increase reserves for their own protection at a monetary disturb- time when the expenses of the Gov- ances , • ,. , ernment are m excess of revenues and the Treasury surplus is running low. If, for exam- ple, the banks had been the fiscal agents of the Gov- ernment within the year 1903-4, it would have been necessary for them not only to have paid for the Panama canal purchase and to have arranged for the other extraordinary fiscal payments, but they would also have been required to meet a revenue deficit of $41,700,000. That is, all of these causes would have operated to reduce the Government surplus, and the Treasury must have drawn heavily on the banks as a means of protecting its own credit-obliga- tions. Had these drafts been postponed, the Gov- ernment, with a large surplus, would have been forced to borrow money to fund its current needs. To place the Government in a position of this kind would hamper public business without adding anything to the strength of the banks. Such an alliance between the Government and the banks would reduce their 246 THE BANK AND THE TREASURY ability to extend commercial accommodation and would stand in the way of, rather than permit, in- creased elasticity in the system. The Independent Treasury Increases the National Money Supply So long as the Government remains out of the banking business (and with us this seems to be an established policy), the greatest elasticity obtainable must come through the collateral support which an Independent Treasury is able to give to independent commercial banks. The fact that the National Treasury carries in its vaults from $100,000,000 to $250,000,000 in money over and above its currency requirements, and that this may be kept free for collateral support to the banks, suggests the basis on which the Government may aid the banks to meet increased money-demands and at the same time permit the banks to increase their credit-accounts to customers. It usually happens that the Treasury surplus becomes largest in periods of low money- demand — at times when the banks are giving an inordinate expansion to their credit. For example, from June 30, 1899, to June 30, 1902, the ordinary Causes money to receipts of the Treasury exceeded the %Zf^Z7 ^'^dinary disbursements by $345,000,- demand 000. During the same period the bank-credit of the country expanded about $2,000,- 000,000. From June 30, 1902, to June 30, 1904, the SUPERIORITY OF THE AMERICAN SYSTEM 247 ordinary receipts of the Treasury exceeded the ordi- nary expenditures only $12,000,000, and during the latter fiscal year there was an actual deficit of $41,- 700,000. This falling off of Government revenues was coincident with great financial pressure on the banks, and a consequent reduction in credit-accom- modations to the public. The net results of the Independent Treasury sys- tem during the years referred to have been to bring into the United States in time of greatest prosperity, and to keep here during a period of credit expansion, at least $200,000,000 in gold, which if placed in the vaults of banks would doubtless have caused still greater credit expansion on the one hand, and at the Treasury-reserves same time would have set up an ex- released in high portation of gold. Even if no finan- money-demand ^-^^ ^-^ ^^^ ^^^^ ^j^^^ ^^ ^^^ y^^^^^ by the Treasury, the result of the independent fiscal system would have been beneficial. During the period of low money-demand the Treasury was gradually absorbing an increasing surplus, thus pre- venting exportation of gold, while during the period of extraordinary money-demand the Government was gradually disbursing the surplus to meet its own revenue deficit. The same effect may be traced through the recurring periods of credit expansion and credit retraction since the Independent Treasury was established. 248 THE BANK AND THE TREASXJRY Collateral Aid of the Treasury to Prevent Credit Contraction But the history of the last ten years (1898 to 1908) teaches another lesson, which by the banks should never be forgotten. When the effects of speculative loans had brought about credit reaction, and business conservatives began to demand settle- ment on contracts for money delivery, and when in- creased pressure was brought on the banks for money payment, the rapidly disappearing reserves would doubtless have proved ruinous, not only to the banks but also to the commercial and industrial interests of the whole nation through the collapse of the bank- credit column supporting them, had not the National Treasury responded to pleas for aid from commercial- credit institutions. A volume of credit had been May support piled up which was too great for the the banks in time banks to support on their own re- 0/ 5 ress sources. The crumbling foundation of bankers' reserves would doubtless have gone from under and given way to the financial stress which business interests were bringing to bear on them had not the Government transferred about $200,000,000 to their support. Had the prescription above referred to as a remedy for inelasticity and for financial weak- ness been followed, had the Government previously deposited its surplus in the banks during these years of so-called prosperity, instead of giving to the great SUPERIORITY OF THE AMERICAN SYSTEM 249 National credit structure the solidity and the power of endurance which is bespoken for it, it would have had the effect of adding nothing to the capital strength of our commercial-credit institutions; it would have made the superstructure still more top- heavy — would have placed our funding system in the same position as were those of Germany, Russia, England, and France. That our business suffered less than the commerce and industry of Europe during the same period was largely due to the very subsidiary reserves of which certain individuals are heard to complain. The Independent Treasury gives to the American system a strength that is not attainable under any of the much lauded foreign financial devices. The fact is that we have not used the Independent Treasury to its highest advantage. The deposits made by the Government with banks are loans without interest. So long as the Government does not call these loans there is no inducement for the banks to pay them. On eight different occasions from 1899 to 1908 the Treasury has helped the banks to support their financial burdens. In each case the strain upon them was due to an over-issue of their own credit and to inability to make the money feTenll?''^ '''' payments demanded without a vio- lent contraction in credit-accommo- dation. The Government has stepped in to prevent this contraction. But when the stress was past, what 250 THE BANK AND THE TREASURY then? Did the Government again gradually repos- sess itself of the moneys gratuitously loaned? Has it again reclaimed the means by which assistance was rendered ? No ; following just such reasoning as has been quoted, loans have remained with the banks still without interest. At times the Treasury has been able to come to the relief of the banks by reason only of its constantly increasing surplus. The weakness in the situation lies in the failure of the Government to charge a rate of interest which will cause the banks themselves to voluntarily repay loans when the emergency is past, and when the reserves of the banks become adequate to support their credit. In July and August, 1904, the bank- reserves piled up till they were becoming a source of possible weakness. When the Panama canal pur- chase was to be settled for, when the present practices Government revenues began to fall off, instead of demanding a return of loans to the banks and thus reducing the large sur- plus-reserves which the banks had accumulated, the Government preferred to still further reduce the reserves in its vaults, calling on the banks for only such an amount as seemed necessary. During the month of September there was a gradual withdrawal of bank reserves to supply the business need. Under circumstances of weakening bank reserves and of gradually decreasing revenue of Government, with the consequent disappearing of the Treasury surplus, SUPERIORITY or THE AMERICAN SYSTEM 251 the banks may not only be deprived of collateral aid in time of financial stress, but may be required even to still further weaken their money-reserves by making payments to the Government. Under such circumstances, the banks would be left to their own resources, with the Government money-demand as well as the public money-demand to supply. The result would be that in their own protection the banks would be forced to contract business accommodation in such a way as to make the present practice posi- tively dangerous. How the Treasury Surplus may be kept as a Reserve for Collateral Support to Credit At no time in the history of banking were the time and circumstances more opportune for Treasury sup- port to banks than in 1902 and 1903. At no time in our history might the Secretary more wisely have withdrawn the Government deposits than in July and August, 1904, when the money-reserves were piled up in the vaults of the banks. The effect of failure to do this was twofold: (i) The cheapness of Interest charges money caused an exportation of gold; to insure prompt (2) the low rate of call-loans encour- payment of loans ^^^^ speculation. In September we had the result made apparent of a concurrent flow of money to the interior and abroad, and at the same time an increase in speculative activity which went on unabated till about December first. Thus again 252 THE BANK AND THE TREASURY we had a brief period of increasing credit expansion and decreasing bank-reserves. These movements did not prove threatening, it is true, but there was present a possibility that the banks might again call to the Treasury for collateral aid, and under conditions which would require the Treasury to turn a deaf ear. Following a practice by which the Government loans its surplus to the banks without interest or below the ordinary market rate, the continuous aid of the Treas- ury to the banks may depend on the exercise of dis- cretion by the Secretary. If, however, the Govern- ment were to charge the bank, not an exorbitant rate, as would a money-lender in time of stress, but the usual commercial rate, the bank would promptly return the loan when money falls below the usual price. In either case, whether by exercise of official discretion or by charging a rate which would make the restoration of reserves autonomous, the Treasury support to the system would not be weakened. Elastic Possibilities in the Bank-Note It has been pointed out that even if the Treasury never had a surplus to loan to the banks in periods of emergency, under the American system we have possibilities for increasing circulation for current needs that are not inherent in foreign systems. This is in the so-called issues of banks. If the bank has unencumbered resources (mind you, unencumbered resources) necessary to obtain a Government "de- SUPERIORITY OF THE AMERICAN SYSTEM 253 posit " (loan), these same resources may be pledged for issue — a loan from the Government in the Equal to fluctu- fo^m of "bank-notes." July i, 1904, aiing money- the Treasury reported that there were eman s $449,000,000 of bank-notes in the hands of the banks or in circulation. These issues alojae were more than ample to meet all fluctuations in money-demands of the country. The only trouble is (as in the case of a permanent policy of depositing Government surplus with the banks) that when the banks are in trouble these notes are not available. Like the Government deposits, they have already been absorbed in current circulation, have all been used to support the ordinary banking operations during periods of low money-demand, and in time of strain the banks have their best securities tied up for funds with which to do business when there is no strain to be met. In time of extraordinary demand the banks were left helpless. Why should this be so? Why might not these notes have been used in such a way as to have per- mitted an increase of $400,000,000 in money circu- lation and a simultaneous increase of at least $1,600,- May he made to 000, 000, of bank-credit-accounts at the respond to de- time that extraordinary demand for mands iunds, were made. Many bankers have suggested as a way out of the difficulty that a tax be placed on issues. Secretary Shaw in his Chi- cago address four years ago pointed to this. Re- 254 THE BANK AND THE TREASURY quire the banks to pay a tax equal to the commercial rate of interest (let us say five or six per cent) on all issues over and above a determined minimum — or call it interest on the "issue loan" of the Government to the banks — and the banks would not encumber their assets except when money-demands were above that rate. These suggestions are made with much force. The result may also be predicated on ex- perience. As the trustee of collaterals and as the department of issue and control of the bank-note, the Treasury might thus lend as much support for the expansion of money circulation and current credit accommodation as the system itself would require. Aside from making the bank-note circulation in large part an emergency currency, aside from giving elasticity to our National money and credit system, the effect of such a Law would be twofold. By taking a large part of the present issue of bank-notes out of circulation, except when an extraordinary de- mand arose, the ordinary demand must be supplied Theeffectsojalaw by Other forms of money — the IT'd^poX'"^^ amount taken out of ordinary circu- and" issues" lation must come from some other source. This would necessitate an increase in gold certificates or other forms of money-issue. The ordinary money requirement would be met, but it would not be met by bank-notes. The necessary money-funds would come either from an increase in issues of Government or from importation of gold. SUPERIORITY OF THE AMERICAN SYSTEM 255 The second result that would obtain has a bearing on the financial strength of the banks themselves. If the banks were not encouraged to encumber their best resources in time of low money-demand; if, it may be said, they were required to retain their capital in such form as to make it available for sup- port of their credit and were permitted to deposit "gilt-edge" securities of such kind and quality as might be prescribed by the Treasurer for bank-notes in time of strain, the support which is now given to the credit of Government in the form of increased strength to the bond market would then be given to the banking business. In other words, the net result would be an increase of banking-capital for banking purposes and an increase in standard money in the country — a result which in itself would be desirable as a means of supporting greater elasticity in credit- accommodation. Support which the Treasury may give to the Money Market Another conservative principle is contained in the American system that is not afforded by that of any other country: As the one institution permitted to issue credit-money the Treasury gives to the people a form of currency more convenient in use than gold, and less expensive to itself. The silver dollar, the greenback, the silver certificate, etc., cost the people who use them just as much as gold coin or gold 256 THE BANK AND THE TREASURY certificates, but the cost to the Government of these credit-moneys is less. By means of their issue the Financial advan- Government is able to carry on its tage of credit- own business and to decrease its inter- money4ssues est-bearing debt about $600,000,000. What the Treasury stands pledged to do and what it is necessary for it to do under our system is to pro- tect these credit-issues, i.e., to make payment in gold when gold is demanded. So long as no doubt arises as to this there can be no financial disturbance on that account. But there may be a distinct advantage to the money and credit system. If at any time our ioreign balances demanding settlement become so great as to cause a drain on bankers' gold reserves (the foundation for some $13,000,000,000 of bank- credit), it may become necessary to stay the tide of exportation as a means of protecting the National credit structure. This result will be effected through the demands made by the banks on the United States Treasury for payment of Government credit-issues. That is, through their own reserves the banks may reach the gold reserves of the Treasury and bring them to their own support. Under such circumstances and at such time the Government will be brought into the gold market as a means of meeting its own de- mand debt, and gold may be had for the support of the credit of American Funding Institutions at a rate more favorable than it could be had by any indi- vidual, private banking corporation, or foreign nation. SUPERIORITY OF THE AMERICAN SYSTEM 257 No greater fallacy was ever put forth than that which concludes that a Government which is not in the banking or loan business can supply money capital direct for private business. If all the gold coin of the world were stamped and issued from the United States mint, so long as the business habits of our people remained the same, no greater amount of gold would find its way into American channels of trade. On the other hand, if the Government did not issue or coin a dollar the people would have the same amount of money which they now have with which to do business. Our circulation would not increase or decrease in either case. Instead of buying gold and taking it to the mint we might buy foreign coins; instead of retaining the currency issued by the Government or that put out in payment of its own obligations we might have some other form of cur- rency. But the usual amount of currency would be supplied from one source or another by coinage, by issue or by importation, in exchange for products of our mines, our manufactures, etc. What the Gov- ernment can do and does do is to make the moneys ordinarily needed and currently used conform to a National standard, and to protect these in their Superiority of financial and physical integrity against American system ijnpairment. More than this, the tn elasttc possi- "^ bilities Government may provide a means by which extraordinary demands for money may be met without resort to importation. It may make pro- 258 THE BANK AND THE TREASURY vision for meeting this fluctuating demand through the banks, and it may make this extraordinary money-supply more readily obtainable than might be if our traders and manufacturers were required to go abroad for it. This may be done either by direct money loans to the banks from the Treasury reserves, or by temporary credit-issues to the banks. Instead of the banks pledging securities abroad, the w^ay should be opened to pledge them with the Treasury and thereby obtain any amount of money for such extraordinary circulation that is needed without dis- turbing domestic and foreign trade. And for this purpose no system is so well adapted as the American system, having for its main support the two independ- ent financial institutions — the independent com- mercial bank and the Independent Treasury, the one representing the financial resources of fifteen thou- sand independent banking institutions, the other representing the combined resources of the nation. Chapter XVIII RECENT EFFORTS TO ADAPT OUR CURRENCY AND BANKING SYSTEM TO THE NATION'S BUSINESS NEEDS Among the results already accomplished in the effort to adapt our funding system to the nation's business needs, prominently stand out the following : (i) The abandonment of the European funding system. This was effected through the refusal of the Federal Congress to incorporate the third bank of the United States, and by the contemporaneous withdrawal of the several States from commercial banking enter- prises. (2) The establishment of independently capi- talized commercial banks in each locality whose private funding needs and resources were sufficient to induce capital to interest itself in this form of undertaking. (3) The establishment of an Independent Federal Treasury — a department of Government which pro- vides the means necessary for meeting public fiscal obligations without drawing on private capital and Adaptations al- without disturbance to local business. Amirkan'con- (4) The Legal Tender Acts, and the ditions several Currency Acts, and National Bank Act — which not only completely segregated the functions of money coinage and money-issue [259] 260 THE BANK AND THE TREASXJRY from those of banking, but also collected into a national system the best experience of a quarter of a century of independent banking. (5) The gold standard currency Act of 1900 — which made certain all question as to the standard of money valuation and of credit-money payment — which enjoined the Treasurer to maintain all the money-issues of the Government at a valuation equal to the prescribed standard — and which adequately capitalized the ability of the Division of Issue and Redemption of the Treasury to redeem all credit-money obligations (i) through placing in the hands of the Treasurer an adequate gold fund to be protected as a "reserve," (2) by giving to this fund a first lien on the "general fund" of the revenue department of the Treasury, and (3) by arming the Secretary with the full loan power of the national Government, as a means of ultimate redemption of credit-money-issues. These results are accomplished facts. The credit- money-issues of the Treasury are "sound." They pass without question in any part of the world at par with gold coin of the United States. American National banks, as independent institutions likewise, are as "sound" as those of any other country. The need which Neither has our banking system as a has not been sue- whole, and our business, suffered more cessjullymet f^^^ "inelasticity" of current-funds than have the older nations of Europe. Still, our funding system is admittedly far from being satisfac- EFFORTS TO MAKE FURTHER ADAPTATIONS 261 tory; there yet remains a condition present which we cannot fail to recognize as a subject of serious con- cern — viz., that our own funding system (as well as theirs) has not satisfactorily met the shifting and fluctuating demands of trade, and that business has suffered much on this account. This is the subject of present solicitation and of many prospective meas- ures of reform, a critical review of which is presented. Before undertaking a critical review, however, some definite standard of analytical and critical judgment must be found. This standard is taken from two fundamental conclusions which would seem to be well established in American thought: (i) That an institution, public or private, which is authorized Standards ojjudg- to issue credit-money should be capi- ment of measures talized sufficiently to enable it to proposed maintain adequate reserves with which to redeem these credit- issues in the standard money of the realm, at par, on demand. (2) That a commercial bank which is not supported by the Government should be required to do business on its own capital. That is to say, that an institution which is authorized by charter to circulate its own credit-accounts in the community for current funds should have a capital sufficient to make it a safe institution with which to do business; and that the capital should be guarded as a special fund to main- tain "reserves" with which to meet current demands for payment on these credit-obligations without 262 THE BANK AND THE TREASURY forcing commercial credit contraction by liquidation and without endangering public welfare. Accepting these general conclusions as principles fundamental to "sound currency" and "sound bank- ing," several other conclusions would seem war- ranted: I. That so long as we retain the gold standard of valuation and of credit redemption, all issues of the Treasury (including silver coins and sUver certifi- cates, as well as currency obligations) should be interchangeable and should be recognized as prom- ises of the Government to pay gold on demand. It being made the duty of the Treasurer to maintain all issues at par, the "gold reserve" in the Division of Issue and Redemption, the lien on the "general fund" of the Treasury given to this division, and the loan power in the hands of the Treasurer for reim- bursement of the gold reserve thus created, should be placed behind the silver coins and silver certifi- cates of the United States as well as behind the green- backs and the Treasury notes of 1890. The duty of the Treasurer with respect to the prompt redemption of these issues should not be left subject to doubt through failure to make specific mention of them for a guide to official conduct. II. In passing judgment on measures proposed to increase the "soundness" of commercial credit-funds issued by banks (bank accounts) the following prin- ciples of capitalization should be recognized: (i) EFFORTS TO MAKE FtTRTHER ADAPTATIONS 263 That no resources of a commercial bank should be regarded as "unimpaired capital" which are not proper capital investments and which may not be available as a fund to supply the bank with "cash" to redeem its outstanding credit. (2) That the amount of capital which is to be con- Sound banking -j j -i -li / • ■ j\ conclusions ^idered as available (or unimpaired) for the support of credit-accounts should be specifically "reserved" for that purpose and protected as a "reserve fund," and should not be allowed to become encumbered or to be so used as not to be at all times accessible for the redemption of demand credit-obligations. (3) That all funds which are to be considered as "reserves" for redemp- tion of current credit-obligations should be capital funds, and the accounts kept and reports published of "reserve funds" should not include money or other assets borrowed from customers — i.e., ob- tained in exchange for credit liabilities. (4) That banks should never be permitted to extend credit (sell an amount of credit-accounts to customers) which is not adequately protected by such capital reservations; i.e., a limit of safety should be placed on the amount of credit-obligations which a bank may issue proportionate to "unimpaired capital." (5) That when any portion of the capital of a bank shall be lost, or encumbered, or in any manner rendered unavailable (as in the purchase of real- estate or in underwriting), that the Hmit of credit 264 THE BANK AND THE TREASURY issue permissible to such bank should be reduced in proportion to the amount so rendered unavailable for current redemption purposes. (6) That if branch- banking be authorized, the amount or proportion of unencumbered capital "reserves" should be the same as those required of individual banks. III. Government issued currency, and privately issued commercial-credit funds, having been ren- dered "sound" by the Treasury and the bank each adequately capitalizing its redemption needs, "elas- ticity" in such a funding system as ours would re- quire: (i) That, since the Treasury cannot supply directly to the people the funds required in business to meet the fluctuations in money-demand as well as in commercial credit-demands, these funds must be supplied by commercial banks. (2) That, since the banks are organized and capitalized to supply current Conclusions with credit-accounts to the public at a respect to elas- profit, and the chief fluctuations in *"-'' money-demands are bankers' de- mands to keep up the money-reserves drawn against by those holding current accounts, the unimpaired capital of banks should be sufficient to procure this extraordinary money-supply when needed. (3) That the surplus capital reserves of banks, kept for the purpose of expanding the money-supply, either as a means of supporting credit-accounts or of expanding credit-accommodations, should be invested in such securities or other assets as are readily convertible EFFORTS TO MAKE FURTHER ADAPTATIONS 265 and such as will be received by the Treasury as collateral for money loans to the banks. (4) That these Treasury loans, whether in the form of gold ("deposits") or credit-money ("issues") should bear a rate of interest which will cause the banks to retire from circulation the extraordinary money-supply when not needed — i.e., when customers reduce the extraordinary amount of credit-accommodations ex- tended to them by the banks. With the foregoing canons of critical judgment before us, the following proposed measures will be discussed in the order set out: (i) The Baltimore Plan; (2) the Carlisle Plan; (3) the Fowler Bill of 1897; (4) the plan of the Monetary Commission of the Indianapolis Convention, 1898; Measures dis- ^^^ ^^^ McCleary Bill of 1898 ; (6) the Gage Bill of 1900; (7) the Currency Act of 1900; (8) the Fowler Bills of 1902 and 1903; and (9) the Payne Bill of 1903. In taking them up for detailed discussion, it should be held in mind that at the time the Baltimore Plan was proposed, con- flicting legislation had brought the Treasury into financial disrepute and shaken confidence in its credit- issues. The Currency Law of 1873 had es- tablished the gold standard and had made it the duty of the Treasurer to maintain all issues at par, but the only means placed in the hands of the Treasury to do this was the gold-reserve fund ($100,- 000,000 for redemption of United States notes THE BANK AND THE TREASURY created by the Resumption Act of 1878) and the loan power given to the Secretary. Notwithstanding this and the fall in the price of silver, measure after measure by Congress was made law which forced into circulation such volumes of silver and silver obligations as to render impossible the maintenance of parity of money-issues by means of the fund at the Treasurer's disposal. The results were a vio- lent shock to national credit, Government bor- rowing to support an inadequate reserve, and the sound money campaign. The Baltimore Plan Just emerging from this situation the Baltimore Plan (a proposition made by a committee of bankers to the American Bankers' Association meeting at Baltimore in October, 1897) became a subject of general interest. Though primarily intended as a currency measure, the plan proposed also bears a close relation to the bank, since the Treasury prob- lem was to be solved by placing its burdens on the bank. Currency was to be furnished to the country by permitting the banks to issue to the extent of seventy-five per cent of their capital. No bond de- posits with the Treasury were to be required, (i) be- cause the National debt was fast being paid, and (2) because it was thought the currency could just as well be secured and the fluctuating demands could better be met without such a provision. To make EFFORTS TO MAKE FURTHER ADAPTATIONS 267 the bank currency "sound," current redemptions were to be made through the Treasury out of a five A sound cur- P^'' cent "redemption fund" as at rency provided present. Ultimate redemption was to ''"' be provided for by the creation of a common "guarantee fund" equal to five per cent of the total circulation, and by making the issues of each bank a first lien on its assets. This would have met every requirement as to soundness, since so long as the bank remained solvent the redemptions would currently be met out of the "redemption fund," and as soon as the bank became insolvent the very cause of its insolvency (credit expansion) would add strength to the notes; that is, the greater the credit liabilities incurred by the bank the greater would be the amount of the assets acquired on which the note- holders would have a first lien. In the event of the adoption of this plan, therefore, sound currency would have been obtained through decreased banking strength. The capital of institu- tions created for the purpose of supplying sound commercial credit-accounts to the community would have been impaired by using it to capitalize the credit currency issues — to do for the credit-money Sound currency circulation what the Treasury had at the expense of failed to do. By placing their re- banking strength go^rces back of the money circulation their banking capital would have been encumbered and to that extent rendered unavailable for support THE BANK AND THE TREASURY of credit-accounts — the true banking purpose. This impairment would have resulted in two ways: (i) By permitting the banks to issue notes equal to seventy- five per cent of their capital and to use these notes for money, their current money needs would have been met by their own obligations to deliver legal- tender or standard money in the future — thus en- couraging low capitalization; (2) by making these note-issues a first lien on commercial assets and requiring no deposit or specific reservation of capital assets for their ultimate redemption, the capital assets to be used for banking support as well as the commercial assets for the final redemption of out- standing accounts would be reduced without making this fact apparent to the public. Provision was made for elasticity in money-supply by permitting the banks to issue notes equal in amount to fifty per cent of their capital at a nominal tax (one-half of one per cent per an- Provisions for \ 1 r • i ,i • elasticity num), and for issues above this amount subject to a tax heavy enough to com- pel retirement except when money rates were high. This was a true principle for an "emergency circula- tion," and the amount provided would have been adequate to supply all ordinary money-demands. But if at any time an extraordinary demand were made for standard money this emergency currency would have been an added cause for the contraction of credit-accommodations. In other words, while EFFORTS TO MAKE FURTHER ADAPTATIONS the method proposed provided for an increase in credit-money circulation to meet the bank's fluctuat- ing money-demands, it did not provide for an ex- panding standard money base of credit expansion; it did not provide for "elasticity" in the very sort of funds in which greatest elasticity is required — credit-accounts. As a banking measure it was weak, both from the point of view of "soundness" and of "elasticity." The Carlisle Plan Under similar circumstances Mr. Carlisle (then Secretary of the Treasury) suggested a measure of relief. Like the Baltimore Plan, this was also in- The primary tended to solve the sound money purpose of the problem. Again the Government is- measure ^^^^ -were to be strengthened by shift- ing the credit-money load from the Treasury reserves and placing it on the banking reserves. Instead of increasing the capital support of the Treasury for meeting its own current monetary obligations, as was finally done in the Currency Law of 1900, the credit issues of the Government were to be supplanted by credit-issues of the banks. Not only were the National banks to be permitted to issue notes to the amount of seventy-five per cent of their capital and surplus, but under like conditions the State banks and institutions were to be given the same issue privileges. 270 THE BANK AND THE TREASURY As a money measure this one was also, in principle, eminently "sound." Current redemptions were to be made by the banks and through such agencies as were to be officially designated. Security for ulti- mate redemption of issues was to be Sound money • i i i i -^ r m provisions provided by a deposit of Treasury issues equal to thirty per cent of the amount of circulation taken out; a common guaran- tee fund was also set up similar to that contained in the Baltimore Plan, and the notes were to be a first lien on all assets and on the contingent stockholders' liability of the individual bank issuing them. The notes, therefore, had all the security that might be desired. As a banking measure, all that has been said con- cerning the Baltimore Plan may be urged with reference to this, except that the banking capital would not be so seriously impaired. A bank must capitalize thirty per cent of its note-issues before ob- Unsoundness oj taining them, but the remaining the plan as a seventy per cent of notes outstanding bank measure -u .i •. i were an encumbrance on the capital intended for commercial-credit support. The banks were to assume these public money burdens, which with a $100,000,000 gold-reserve the Treasury had been unable to bear up under, and without making any provision for an increase in capital. The anoma- lous position was again taken that what had proved a burden on the Treasury would not prove a burden EFFORTS TO MAKE FURTHER ADAPTATIONS 271 to the banks. The credit-accounts of the banks were to be sacrificed as a means of giving financial strength to the money circulation. If adopted, the measure would have crippled the banks for perform- ing the commercial-credit functions for which they are created. In the Carlisle Plan no provision was made for an elastic money medium. Every inducement was offered the banks to force out notes and to make them the permanent money stock of the community. If they failed to keep out all their notes it would be only because the country could not use as No provision for , , , ^i • j elasticity much money as they were authorized to put out, and in case the full amount were absorbed, then no provision was made for an increase. But even if they did not succeed in keeping out the full amount of the authorized issue and an extraordinary demand were made for gold or legal- tender issues of Government, then the volume of bank-notes outstanding would force a contraction of credit-accounts as a means of obtaining a supply of legal-tender Government issues for banking reserves. Any extraordinary money-demand would therefore increase the weakness of the credit-accounts of the banks and would cause still more violent credit reactions. The Fowler Bill of 1897 Like the Carlisle Plan, the Fowler Bill of 1897 was intended to relieve the Treasury as well as amend the 272 THE BANK AND THE TREASURY Bank Act. As a currency measure it proposed to supplant completely the credit-issues of the Treasury. This was to be accomplished by requiring all banks availing themselves of the issue-privi- The general plan lege to purchase and surrender to the Treasury for cancellation, legal-tender notes, Treasury notes of 1890, and gold certificates equal to their "legal reserve" requirements, and to receive in return an equal amount of gold and silver coins. This would have taken care of the Treasury issues by forcing the Government to pay them. The ordinary money requirements for general circulation were to be supplanted by bank-notes secured by bonds ($700,000,000). Besides the gold and silver banking-reserves, and the bank-notes for general circulation, an "emergency currency" in the form of bank-notes was provided for equal to the combined capital and surplus of banks availing themselves of the issue-privilege. This emergency currency was to be taxed at a graduated rate from one to ten per cent, the tax ranging from six to ten per cent after the amount of issues reached sixty per cent of capitaliza- tion. As the average rate of taxation below this amount was only two and one-third per cent, it is to be presumed that at least sixty per cent of the "emer- gency currency" might have been used to supply ordinary money-demands, only the amount above sixty per cent being intended for retirement after the extraordinary money-demands had passed. EFFORTS TO MAKE FURTHER ADAPTATIONS 273 Considering the question of "soundness" the Treasury issues were practically to be ehminated by Sound currency payment. The bank-notes were to and sound hank- be partly secured by bonds, and the ing provisions remainder were secured by a first lien on assets and a first claim against stockholders. Besides, a common guarantee fund was to be created by the several forms of tax levies, which fund was to be used (i) to redeem the bond-secured notes, and (2) for the redemption of emergency notes. This fund was to take the place of the bonds as they were gradually retired. Provision was also made for se- curing the current bank liabilities through the crea- tion of an insurance fund of five per cent of the average deposits. The customer was to be further protected by closer supervision and control. Branch- banking was to be permitted under conditions which gave the public the same protection as with individual banks. Had the measure become a law and been enforced on all of the banks. State as well as National, the Treasury would have been completely relieved from its credit-money obligations, a sound credit-money would have been provided, the banking reserve re- quirements would have restricted the bill ^ ^^ ^ credit-money-issues to the amount de- manded for general circulation, the banks would have been forced to increase their initial capital, and an increasing capital surplus 274 THE BANK AND THE TREASURY would have been accumulating as a guarantee fund for note redemptions. Furthermore, the competi- tion between the banks would have forced them to insure their accounts, thus again increasing the capital surplus for the protection of holders of credit- accounts, and the interest of the stronger banks in a common insurance fund would have forced a rigid inspection and official control of the aflfairs of the less provident. To meet these requirements the rel- ative capitalization of banks for redemption of notes and credit-accounts must have at least doubled. But the law had two weaknesses: (i) That its accept- ance by National banks was made optional; (2) the capital requirements were so great that if made com- pulsory it would have driven all National banks out of business in competition with State banks. Such a law could never have been made effective unless State and private, as well as National banking institu- tions — all concerns permitted to do a banking busi- ness — had been required to adopt its provisions or as a penalty for non-acceptance be placed under a still more serious disability. The Plan of the Monetary Commission 0} the Indianapolis Convention Immediately after the election in 1896, the presi- dent of the Board of Trade of Indianapolis issued an invitation for a National sound money conference. In response a convention assembled January 12, EFFORTS TO MAKE FURTHER ADAPTATIONS 275 1897, the principal result of which was the appoint- ment of a commission to prepare a report and memo- rial representing the best "sound money" ideals. As a part of their work a bill was drafted, which was introduced into the House of Representatives by Mr. Overstreet. This was the first reflection of the direct "Soundness" 0} spirit of the campaign which required "^mp/y'Trovided ^" adequate capitalization of Govern- jor ment credit-money-issues. The Treas- ury was to have a special division of Issue and Re- demption, to which were to be transferred all funds created for the redemption of Government monetary obligations. The outstanding issues were to be made sound by transferring from the general fund to this division gold to the amount of twenty-five per cent of all United States and Treasury notes of 1890. Silver coins and silver certificates were to be made exchangeable for gold, and besides the value of the silver contained in the coins and held against cer- tificates, five per cent of all silver obligations was to be added to the gold-reserve to insure current re- demption. This solution of the money problem, however, was to serve a temporary purpose only, since the gradual retirement of all obligations of the Treasury except silver was specifically provided for. The ultimate solution of the money problem was to be by the same method as proposed in the Baltimore Plan, — to shift the burden of money issue from the Treasury to the banks, and to secure their payment 276 THE BANK AND THE TREASURY by a current "redemption fund" (five per cent) and a common "guarantee fund" (five per cent), and by making the issues a lien on all assets of the bank issuing them, besides by assessment making all of the banks in the system responsible for a deficit. The money provision was eminently "sound." The "soundness" of the commercial-credit system was not so well guarded. No additional capital strength was to be given to the commercial banks undertaking to carry this new financial load. On the other hand the capital requirements of banks were to be distinctly lowered. The bond deposits to be originally made were only twenty-five per cent of the capital, while the banks were to be permitted to issue to the full amount of "unimpaired capital." Banks were to ^ut these original deposits might ulti- U greatly mately be withdrawn. The only wea ene banking capital that was to be set aside for note redemption was the five per cent fund, which was not to be counted as a part of the reserve for the redemption of credit-accounts. Elasticity in the currency was to be attained by taxing all notes issued above sixty per cent of the capital of the bank issuing them at six per cent. In other words, sixty per cent of the bank-notes was p. .. intended to supply the permanent de- mand for a circulating medium, and forty per cent of the authorized issue was to serve to supply extraordinary demands — this emergency EFFORTS TO MAKE FURTHER ADAPTATIONS 277 currency to be retired through the autonomous action of the tax after the extraordinary demand had passed. But for ultimate redemption in standard money, only twenty-five per cent of the banking re- serve was to be in coin, and this might be silver. Such a National currency provision needs no further comment. That such a measure would not in- crease the elasticity of bank credit-accounts is cer- tain. Under circumstances similar to those that had prevailed when the Treasury found difficulty in meeting its outstanding obligations, it is to be fairly presumed that our National credit would receive a more serious shock than in 1893 and the years following. The McCleary Bill Closely following the Commission Bill came the McCleary measure, introduced into the House May II, 1898. In this we again have reflected the spirit of the campaign of 1896. In its Treasury features it was almost a direct copy of the Commission Bill. By its provisions the several forms of issues of the CredU-money to Treasury were specifically recognized be made sound by as obligations of the Government to gold redemption ^^^ g^y ^^ demand, and all forms of money-issue were to be made interchangeable. By this the financial needs of the Treasury for redemp- tion of its credit-issues were also to be independently capitalized. A division of Issue and Redemption was to be created, similar to that provided for in the 278 THE BANK AND THE TREASXIRY Act of 1900; this was to be made guardian of the fund created to protect money obligations. The reserve was to be equal to twenty-five per cent of all legal- tender notes, and silver Treasury notes of 1890, and five per cent of all silver coinage. The principle of shifting the burden, however, was not abandoned. National banks were to be permitted to obtain notes on deposit of bonds as at present, the provision being, however, that the bonds might be gradually with- drawn. In addition, they would be required to issue "reserve notes" to an amount equal to at least twenty-five per cent of their capital, on deposit of an equal amount of United States notes. They were to receive as a bonus the privilege of issuing an equal amount of "national currency notes" not to exceed forty per cent of their capitalization — the total amount of note-issues (bank-notes, reserve notes, and currency notes) not to exceed one hundred per cent of the unimpaired capital. WhUe, therefore, the Treasury obligations were clearly recognized, and adequate provision was made for their redemption, every inducement was given to the banks to grad- ually assume the Government's monetary responsi- bilities. These bank issues were also to be rendered "sound" by all of the methods before suggested. As with the measures previously proposed, the McCleary Bill was one which would have operated to weaken capital support to bank accounts — the principal form of funds with which business is done. EFFORTS TO MAKE FURTHER ADAPTATIONS 279 The amount of direct capital requirement for support of money-issues, however, was increased, and to this extent it was superior to the several Results on sound , . , j -n r banking ^^^^^ previously proposed. Before issues might be had, the bank must invest at least sixty per cent of the amount of notes applied for in collateral securities or Government notes for deposit, as a fund for final redemption. The bank with $100,000 capital could not issue $100,000 of notes unless it first purchased $20,000 of bonds, and $40,000 of United States notes. Its available "cash" from such a capitalization, there- fore, would not exceed $140,000; and of this only $40,000 (the emergency circulation) would be a prior lien on the other assets — that is tfi>nipi:^6|fcooo of capital-resources would be left for the final redemp- tion of current banking accounts. The notes could not wipe out the entire capital and leave stranded the holders of accounts. In addition to these provi- sions, fifty per cent of the "money-reserves" of the bank was required to be in gold (double the amount of coin required by the Commission Bill), thus pre- venting gold exportation with increasing credit-issues. A very definite provision was also made for elas- ticity in the money supply. All issues over eighty per cent of capitalization were to be taxed at the rate of one-half of one per cent per month or six per cent per annum. This would have been adequate to meet all usual fluctuations in money-demand. As a 280 THE BANK AND THE TREASURY funding measure its weakness lay in decreasing rather than increasing the capital support to be pro- Elasticity pro- vided for in the banking business — a vided for in the capital support which had proved too currency weak to sustain credit-accounts in time of financial strain. The Gage Bill Secretary Gage's measure for currency reform was the immediate forerunner of the Currency Act of 1900, which adequately capitalized the Treasury to protect its credit-issues. It contained the provisions proposed by the Monetary Commission Bill and the McCleary Bill for the erection of a special division of Capital^tion ol*^^ Treasury to be known as the currency de- "Division of Issue and Redemption." mands ^^ ^^g division was to be transferred $125,000,000 in gold, to be held in trust for the re- demption of Treasury credit-issues, and a lien was to be given on the general fund to reimburse the reserve fund for redemptions made. It was deficient, how- ever, in specific provisions for support of the general fund. Secretary Gage still clung to the idea of ultimately relieving the Treasury from credit-money functions by enlarging the bank-note circulation and shifting the financial burdens of the Government on the banks. To the end of encouraging the banks to supply the ordinary money-demands, they were to be EFFORTS TO MAKE FURTHER ADAPTATIONS 281 permitted to issue to the minimum amount of fifty per cent of their capital, on deposit of bonds, United Bank issues to States notes. Treasury notes of 1890, supplant Treas- and silver certificates, and after which ury issues niinimum amount had been reached, to permit an additional issue of twenty-five per cent of such deposits without further collateral security — i.e., two- thirds of the issues were to be collaterally secured. The total issues were not to exceed the amount of the paid-up capital. For the current re- demption of bonds a ten per cent fund was to be deposited with the Treasurer. For final redemption a guarantee fund was provided for by taxing the "unsecured circulation" two per cent per annum; a lien was to be given on the general assets of t]je bank of issue ; and the notes were to be guaranteed by the Government. As in the other plans proposed, the notes were to be "sound" beyond question. As a banking measure it was the same in kind as those which had preceded, but better in a degree, in that it required the banks to capitalize Banking features a minimum of sixty-six per cent of the gross amount of issues by collateral deposits, and a ten per cent redemption fund; they were also required to create a surplus fund for the guarantee of ultimate payment of notes. While it was a stronger banking measure than the several previous propositions, it was weaker than the National Bank Act. No provision was made for increasing 282 THE BANK AND THE TREASURY capitalization, while the banks were to be encouraged to do a larger credit business proportionate to capital invested — to further encumber the resources used for current banking equipment. It is a logical con- clusion that if such a measure had become a law, whatever could have been gained by increasing elasticity in the money circulation would be more than lost in decreased ability to extend business accommodations. The Currency Act of 1900 This was the first bill which did not confuse the functions and obligations of the two independently organized national funding institutions — the Treas- ury and the National bank. It was a measure di- rectly in line with the evolution of American financial ideals of the century. The people had given unmis- takable expression to opinion with respect to the Treasury and its obligations — since the passage of the National Bank Act they had not directly con- sidered the bank. Four years after the election of 1896 the first positive legislation pertaining to the currency was spread on the statute books, reaffirming the gold standard law of 1873, and providing for the Credit-tssuesoftke redemption of credit- money- issues in ireasury made 1 j a • i i sound by adequate go^d. A negative measure had pre- capitalization viously passed repealing the Sherman Act, thereby relieving the Treasury from increasing burdens in the form of silver obligations, but the EFFORTS TO MAKE FURTHER ADAPTATIONS 283 Act of 1900 undertook adequately to capitalize the redemption demands of the Treasury. At that time there were outstanding about $1,000,000,000 of credit- issues. To provide for current redemptions of the different forms of monetary obligations, the device suggested by the Monetary Commission, by the McCleary Bill and by the Gage Bill was adopted, creating a special department of the Treasury to be known as the Division of Issue and Redemption, and to this was transferred $150,000,000 of gold coin (about fifteen per cent of the credit-issues to be re- deemed). To guarantee ultimate redemption of all Treasury obligations, the Secretary was enjoined at all times to maintain the value of issues at a par with gold, and as a means to this end gave to the Division of Issue and Redemption a first lien on all revenue funds of the Government ; collateral to this, the Law placed in the hands of the Secretary of the Treasury the power to make unlimited use of the credit of the Government to procure gold to replenish the general fund whenever such might be found necessary to reimburse the Division of Issue for redemptions. The effect of this Act was to fortify the Treasury issues against all possibility of discredit, and to place behind the public institution of credit-money circu- lation the united revenue and loan powers of the nation. 284 THE BANK AND THE TREASURY The Fowler Bills of 1902 and 1903 After the enactment of the gold standard currency Law of 1900 the two bills which take title from the Chairman of the Committee on Currency and Bank- ing come as voices from the tomb. The Currency Act of 1900 was in direct line with the development of our funding system and had finally established the credit currency of the country on a financially sound basis. There remained only two other steps to be taken to perfect the adaptation to our funding needs, and these were both primarily banking questions: (i) How may the banks obtain money to meet the extraordinary money-demands of their customers; and (2) how may they equip themselves to expand their credit to meet fluctuating demands for credit- accommodation and at the same time maintain safe proportionate money-reserves for current redemp- tions. Legislation which would accomplish these results must be banking legislation. To attain either of these results would require that provision be made for a capitalized reserve which would be adequate to obtain the cash necessary both for increasing the money circulation and for maintaining increased credit-accounts. That such reserve must be a capital reserve follows for the reason that a reserve of assets acquired in exchange for bank-credit would defeat the very purpose for which it was held — on con- version of such a reserve commercial accommoda- EFFORTS TO MAKE FTIRTHER ADAPTATIONS 285 tions would be reduced instead of expanded. The Fowler Bills referred to made no provision for either of these desirable banking results. They attempt again to solve the "sound money" problem which was already solved by the Currency Act of 1900. The excuse for reopening the money situation is to provide "elasticity." But in the measures proposed the character of the demand, as well as the necessary means successfully to meet the demand, were over- looked. The first principle of business, so far as obtaining money is concerned, is to have something to offer for it. The measures here introduced would permit the banks when in straits to obtain money from the Division of Issue and Redemption to meet demands on their own credit-accounts without hav- ing anything to pledge for it. That is, the banks would be relieved from doing for their credit what the United States Treasury had found it necessary to do — to capitalize their redemption demands, and, in lieu of the current redemption reserve proving too small, to have another fund or reserve which it might draw upon for collateral support. A large part of Mr. Fowler's Bills was designed to break down the Treasury system now established on a sound basis, and in lieu of the Treasury reserve to do what many others had proposed — to secure the bank-note by depriving the bank depositor of his security. It cannot be thought that such a system will ever add to the "soundness" (the capital strength) of our 286 THE BANK AND THE TREASURY banking institutions, nor that increased banking weakness can contribute to "elasticity" in bank- credit. The Payne Bill, 1903 The measures proposed by Mr. Payne in the House and by Mr. Aldrich in the Senate are steps in the right direction. The principle here invoked is one that carries with it the largest possibilities for elas- ticity, both in the currency and in bank-credit, if carried to its logical conclusion. The Bill proposed to place in the hands of the Secretary of the Treasury the power to receive from banks invested capital reserves ("bonds of the United States, bonds or other interest-bearing obligations of any State of the United States, or any legally authorized bonds for municipal purposes . . . which for a period of ten years previous to such deposit has not defaulted . . . and the first mortgage bonds of any railroad company which had paid dividends of not less than four per centum per annum regularly and continu- ously on its entire capital stock for a period of not less than ten years") as collateral for loans. The banks were to be encouraged to carry surplus capital- resources in the form of gilt-edge securities. A bank, therefore, which is not suffering from under- capitalization, which has not already increased its credit-obligations beyond a safe proportion to total unimpaired capital (capital available for redemp- tions) even though its cash reserve provided for EFFORTS TO MAKE FinRTHER ADAPTATIONS 287 current redemptions were threatened, could obtain the cash needed. If it had an invested capital-reserve to fall back upon it might immediately convert this into cash at the Treasury. Assuming this measure had passed, that it had been supplemented by a law which restrained banks from incurring credit liabili- ties to exceed three or four times its unimpaired capital, and that it were also required to keep this redemption capital "reserved" in the form of cash, or investments such as the Treasury would receive, under such circumstances the bank would be re- quired to capitalize its customers' greatest needs. It would at times of low credit-demand have a capital reserve largely in excess of the requirement, the sur- plus of which could be invested. This would place in the hands of the banks the power to increase the money circulation and credit-accommodations at any time an increase in money or credit-funds was needed, and with entire safety to the community. By such an extension of the principle we would have attained for our funding system both elasticity and increased financial stability. The measure proposed by Mr. Pa)me is essentially an amendment of the Bank Act. If the amendment were so changed as to permit the issue of Treasury notes (whether they be in the form of bank-notes, greenbacks, currency certificates, or what not), as well as to deposit (loan) its revenue surplus against such collaterals, then the question of general Treas- 288 THE BANK AND THE TREASURY ury condition would be completely eliminated. Fur- ther, if interest were to be charged on such loans at the rate of, not one and one-half per cent, as pro- posed, but five or six per cent, the notes issued — whatever their form — would be promptly retired when they were not needed for circulation. The Payne measure (together with an extension of the same principle to include increased capitalization of banking needs, and a proper interest charge on emergency issues) would do for bank credit-funds and for the business of banking (selling commercial credit-accommodations at a profit) what the Cur- rency Law of 1900 has done for our credit- money. An adequate capitalization of bank credit-accounts would complete the evolution in the American fund- ing system, adapting it to the nation's fluctuating business needs. The bills introduced by Senators Aldrich, Kjiox, Culberson, and Hayburn are all measures directed toward this end, although they aU fall short of the mark. The significant measures at present before Congress are included in the appendix. APPENDIX OF DOCUMENTS "THE BALTIMORE PLAN" OF CURRENCY REFORM 1896 OUTLINES OF THE PLAN {Digest taken from "Sound Currency") Section i. The provision of the National Bank Act re- quiring the deposit of bonds to secure circulating notes here- after issued, shall be repealed. Sect. 2. Allow the banks to issue circulating notes to the amount of 50 per cent of their paid up, unimpaired capital, subject to a tax of one-half of i per cent per annum upon the average amount of circulation outstanding for the year; and an additional circulation of 25 per cent of their paid-up, unim- paired capital, subject both to the tax of one-half of i per cent per annum and to an additional heavy tax per annum upon the average amount of such circulation outstanding for the year; said additional 25 per cent to be known as "emer- gency circulation." Sect. 3. The tax of one-half of i per cent per annum upon the average amount of circulation outstanding shall be paid to the Treasurer of the United States as means of revenue, out of which the expense of the office of the Comptroller of the Currency, the printing of circulating notes, etc., shall be defrayed. The excess over one-half of i per cent of the tax imposed upon the "emergency circulation" shall be paid into the "guarantee fund," referred to in Sect. 6. Sect. 4. The banks issuing circulation shall deposit and maintain with the Treasurer of the United States a "redemp- [291] 292 APPENDIX tion fund" equal to s per cent of their average outstanding circulation, as provided for under the existing law. Sect. 5. The redemption of the notes of all banks, solvent or insolvent, to be made as provided for by the existing law. Sect. 6. Create a "guarantee fund" through the deposit by each bank of 2 per cent upon the amount of circulation received the first year. Thereafter impose a tax of one-half of I per cent upon the average amount of outstanding circu- lation, the same to be paid into this fund until it shall equal 5 per cent of the entire circulation outstanding, when the col- lection of such tax shall be suspended, to be resumed when- ever the Comptroller of the Currency shall deem it necessary. The notes of insolvent banks shall be redeemed by the Treasurer of the United States out of the "guarantee fund," if it shall be sufficient, and, if not sufScient, then out of any money in the Treasury, the same to be reimbursed to the Treasury out of the "guarantee fund," when replenished, either from the assets of the failed banks or from the tax afore- said. National banking associations, organized after this plan shall have gone into operation, may receive circulation from the Comptroller of the Currency upon paying into the "guar- antee fund" a sum bearing the ratio to the circulation apphed for and allowed that the "guarantee fund" bears to the total circulation outstanding, and to be subject to the tax of one- half of I per cent per annum, as called for by the Treasurer of the United States for the creation and maintenance of this fund. No association or individual shall have any claim upon any part of the money in said "guarantee fund," except for the redemption of the circulating notes of any insolvent national banking association. Any surplus or residue of said "guar- antee fund" which may be hereafter ascertained or deter- mined by law shall inure to the benefit of the United States. Sect. 7. The Government shall have a prior lien upon the assets of each failed bank and upon the liability of shareholders, and for the purpose of restoring the amount withdrawn from APPENDIX 293 the "guarantee fund" for the redemption of its circulation, not to exceed, however, the amount of the failed bank's out- standing circulation after deducting the sum to its credit in the "redemption fund" (Sect. 4) already in the hand of the Treasurer of the United States. Sect. 8. Circulation can be retired by a bank at any time upon depositing with the Treasurer of the United States law- ful money in amount equal to the sum desired to be with- drawn, and immediately upon such deposit the tax indicated in Sects. 2, 3 and 6 shall cease upon the circulation so retired. Sect. 9. In the event of the winding up of the business of a bank by reason of insolvency, or otherwise, the Treasurer of the United States, with the concurrence of the Comptroller of the Currency, may, on the application of the directors, or of the liquidator, receiver, assignee, or other proper official, and upon being satisfied that proper arrangements have been made for the payment of the notes of the bank and any tax due thereon, pay over to such directors, liquidator, receiver, assignee, or other proper official, the amount to the credit of the bank in the "redemption fund" indicated in Sect. 4. "THE CARLISLE PLAN" 1896 Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That so much of all acts and parts of acts as require or authorize the deposit of United States bonds to secure circu- lating notes issued by national banking associations, or as require such associations to deposit or keep on deposit United States bonds for any purpose except as security for public money, be, and the same are hereby, repealed as to associa- tions taking circulation under this Act; and notes issued under this Act shall not contain the statement that they are so secured. Sect. 2. That any national banking association .... may 294 APPENDIX take out circulating notes to an amount not exceeding 75 per centum of its paid-up and unimpaired capital upon deposit- ing with the Treasurer of the United States currency certifi- cates .... or United States legal-tender notes, including Treasury notes .... and other lawful money of the United States, at the discretion of the Secretary of the Treasury, as a guaranty fund equal to 30 per centum of the circulating notes applied for. The association making such deposit shall be entitled to receive from the Comptroller of the Currency circulating notes in blank, registered and countersigned as provided by law; and all such notes shall constitute, and are hereby declared to be, a first Hen upon all the assets of the association issuing the same. . . . Sect. 4. That each national banking association shall re- deem its notes at par on presentation at its own office and at such agencies as may be designated for that purpose by the Comptroller of the Currency; and whenever such association desires to retire the whole or any part of its circulation, the notes to be retired shall be forwarded to the Comptroller of the Currency for cancellation, and thereupon a sum equal to 30 per centum of such cancelled notes shall be returned to the association, in lawful money of the United States. . . . Sect. 5. That in order to provide a safety fund for the prompt redemption of the circulating notes of failed national banking associations each such association .... shall pay the Treasurer of the United States, .... a tax of one-fourth of I per centum for each half year upon the average amount of its circulating notes outstanding, .... until the said fund amounts to a sum equal to 5 per centum upon the total amount of such national bank notes outstanding, and thereupon the collection of said tax shall be suspended All circulat- ing notes of failed national banks taken out under this Act not redeemed on presentation to the Treasury of the United States, or an assistant treasurer of the United States, shall bear interest at the rate of 6 per centum per annum from the date of suspension of the bank until thirty days after public notice has been given that funds are on hand for their redemp- APPENDIX 295 tion, and such notes shall constitute a first lien upon all moneys thereafter received into the safety fund. Sect. 7. That every national banking association hereto- fore organized and having bonds on deposit to secure circu- lation may withdraw such bonds upon the deposit of lawful money of the United States, as now provided by law; and there- after such association may take out circulation under this Act and be entitled to all rights, privileges, and immunities herein conferred. Sect. 9. That the Secretary of the Treasury may, in his discretion, use from time to time any surplus revenue of the United States in the redemption and retirement of United States legal-tender notes, and notes issued under the Act of July 14, i8go, but the amount of such notes retired shall not in the aggregate exceed an amount equal to 70 per centum of the additional circulation taken out by national banks and State banks under the provisions of this Act Sect. 10. That the use of circulating notes of and above the denomination of ten dollars issued by a banking corpora- tion duly organized under the laws of any State, and which transacts no other than a banking business, shall be exempt from taxation under the laws of the United States when it is shown to the satisfaction of the Secretary of the Treasury and the Comptroller of the Currency: First — That such bank has at no time had outstanding its circulating notes in excess of 75 per centum of its paid-up and unimpaired capital; Second — • That its stockholders are individually liable for the redemption of its circulating notes to an amount equal to the par value of the stock owned by them ; . . . . Third — That the circulating notes constitute by law a first lien upon all the assets of the bank; Fourth — ■ That the bank has at all times kept on deposit with an ofl&cer of the State, authorized by law to receive and hold the same, a guaranty fund in currency certificates issued under Section 5193 of the Revised Statutes of the United States, or United States legal-tender notes, including Treasury 296 APPENDIX notes of 1890, equal to 30 per centum of its outstanding cir- culating notes ; and Fifth — That it has promptly redeemed its notes at par on demand at its principal office, or at one or more of its branch offices, if it has branches. Whenever the Secretary of the Treasury and the Comptroller of Currency shall be satisfied that any banking corporation duly organized under the laws of any State, and which trans- acts no other than a banking business as provided in this section, has been incorporated under the laws of the State in which it is located, and that such laws require First — That its stockholders shall be individually liable for the redemption of its circulating notes to an amount equal to the par value of the capital stock owned by them; Second — That the circulating notes thereof shall constitute a first lien upon all the assets of the bank; and, Third — That such bank shall keep on deposit at all times with an official of the State authorized by law to receive and hold the same, a guaranty fund as required in the fourth para- graph of this section. There shall thereupon issue to said bank a certificate to that effect. Said bank may then issue its notes .... FOWLER BILL OF MARCH 15, 1897 Be it enacted by the Senate and House 0} Representatives of the United States of America in Congress Assembled: That there shall be and there is hereby created and estab- lished a Department of Finance, which shall have entire and exclusive control and supervision of all national debts, their right to take out secured circulation and issue their notes. Sect. 2. That there shall be three ministers of finance, who shall take the place of the Comptroller of the Currency and constitute a board of finance; and said board of finance shall conduct the said Department of Finance Sect. 3. That any national bank now doing business, or APPENDIX 297 any other financial institution doing a similar business, .... may, in accordance with existing law, .... organize upon the following terms and conditions: If any corporation or association of persons described as aforesaid shall deposit with the United States Government any of the United States bonds now outstanding, or any that may be hereafter issued which, at their stated value as herein set forth, .... circulation known as United States Govern- ment bond notes shall be issued to said corporation .... (a) That the United States Government bonds now out- standing shall be received at the following prices, to wit: 2S, reg Q, Mar. 95^ 4S, 1907, reg Q, Jan. 109^ 4s, 1907, coup Q, Jan. iio^ 4S, 1925, reg Q, Feb. izoj 4s, 1925, coup Q, Feb. 120J Ss, 1904, reg Q, Feb. 113I 5s, 1904, coup Q, Feb. 113! 6s, cur'cy, '98, reg J- & J- i02f 6s, cur'cy, '99, reg J- & J- 105 4s, (Cher), 1897, reg March 102 4s, (Cher), 1898, reg March 102 4s, (Cher), 1899, reg March 102 and that from and after the passage of this Act said bonds shall be received upon the same income basis, respectively. (b) All banks organized under this Act shall take out for issue United States Government bond-notes in proportion to their respective capital .... and each bank shall pay into the United States Treasury one-fourth of i per centum per annum upon the notes so taken out for issue as a part of the fund to be created and known as "United States National- Bank Note Redemption Fund." Sect. 5. That at the same time that said corporation, if located in a reserve city, shall deposit United States Govern- ment bonds as aforesaid it shall also deposit with the United States Government United States legal-tender notes or gold APPENDIX certificates, or both, of such an amount that it, together with the gold said corporation has on hand, will equal 15 per centum of its deposits ; and the United States Government shall deliver to said corporation gold coin in lieu of said legal- tender notes and said gold certificates. Said corporation shall also deposit at the same time with the United States Govern- ment United States Treasury notes or United States silver certificates, at the option of said ministers, or both, which, with the silver coin then held by said corporation, shall amount to 10 per centum of its deposits, and the United States Govern- ment shall deliver to said corporation in lieu thereof silver coin of an equal amount; and said legal-tender notes, gold certifi- cates. Treasury notes, and silver certificates shall be thereupon cancelled. Said corporation shall thereafter keep as a reserve 25 per centum of its deposits in the following kinds of money: At least 60 per centum of said reserve shall be in gold coin, and the remaining 40 per centum of said reserve may be in silver coin or United States Government bonds notes: Pro- vided, however. That in lieu of one-half of such reserve cash on deposit, subject to check, may be held in reserve cities. Sect. 6. That at the same time the said corporation, if located outside a reserve city, shall deposit United States Government bonds as aforesaid, it shall also deposit with the United States Government United States legal-tender notes, or gold certificates, or both, of such an amount that it, together with the gold coin said corporation has on hand, will equal 9 per centum of its deposits; and the United States Govern- ment shall deUver to said corporation gold coin in lieu of said legal-tender notes and said gold certificates. Said corporation shall also deposit at the same time with the United States Government United States Treasury notes or United States silver certificates, at the option of said ministers, or both, which, with the silver coin then held by said corporation, shall amount to 6 per centum of its deposits, and the United States Government shall deliver to said corporation in lieu thereof silver coin of an equal amount; and said legal-tender notes, gold certificates, Treasury notes, and silver certificates shall APPENDIX 299 be thereupon cancelled. Said corporation shall thereafter keep as a reserve 1 5 per centum of its deposits in the follow- ing kinds of money: At least 60 per centum of said reserve shall be in gold coin, and the remaining 40 per centum of said reserve may be in silver coin, or United States Govern- ment bond notes: Provided, however, That in lieu of one- half of such reserve cash on deposit, subject to check, may be held in reserve cities. Sect. 7. That the United States shall not pay out or reissue any United States legal-tender notes or gold certificates from and after the ist day of January, eighteen hundred and ninety- eight, but the same when received shall be cancelled and destroyed; and further that the United States Government shall not pay out, issue or reissue any United States Treasury notes or silver certificates from and after the ist day of January, eighteen hundred and ninety-nine, but the same when re- ceived shall be cancelled and destroyed. Sect. 8. That any corporation organized under this Act may .... issue its own circulation, which shall be furnished by the United States Government, and be known as United States national-bank notes. Said United States national-bank notes shall be issued in denominations of ten dollars and mul- tiples thereof, and shall be a first lien upon the assets of the bank issuing the same, and also upon the liabiUty of the stock- holders, and may be issued only in the following manner and upon the following conditions: First — Every bank issuing United States national-bank notes shall at all times maintain against the amount of such notes outstanding a reserve corresponding to that required against its deposits. Second — Any bank that shall have complied with this law may, with the consent and under the supervision and control of the board of finance, issue an amount of United States national-bank notes equal to 20 per centum or one-fifth of its paid-up and unimpaired capital, and shall pay upon such an amount thereof as may be outstanding at any time a tax at the rate of i per centum per annum. 300 APPENDIX Third — Said bank may issue a second amount of such notes, equal to 20 per centum or one-fifth of its paid-up and unimpaired capital, and shall pay upon such an amount thereof as may be outstanding at any time a tax at the rate of 2 per centum per annum. Fourth — Said bank may issue a third amount of notes equal to 20 per centum or one-fifth of its paid-up and unim- paired capital, and shall pay upon such an amount thereof as may be outstanding at any time a tax at the rate of 4 per centum per annum. Fifth — Said bank may issue a fourth amount of notes equal to 20 per centum of its paid-up and unimpaired capital, and shall pay upon such an amount thereof as may be out- standing at any time a tax at the rate of 6 per centum per annum. Sixth — Said bank may issue a fifth amount of notes, equal to 20 per centum or one-fifth of its paid-up and unimpaired capital, and shall pay upon such an amount thereof as may be outstanding at any time a tax at the rate of 8 per centum per annum. Seventh — If the amount of United States national-bank notes issued by any bank shall exceed at any time the paid-up and unimpaired capital of said bank, a tax at the rate of 10 per centum per annum shall be paid by said bank on such excess. Eighth — That said ministers of finance are hereby author- ized and empowered to suspend one-half of said tax upon any one or all of the said several issues of United States national- bank notes at any time after nineteen hundred and ten, and at any time after nineteen hundred and twenty said ministers of finance are further authorized and empowered to suspend any portion of the tax then remaining except the 10 per centum tax referred to in paragraph seven. Sect. 9. That all taxes so paid to the Government upon said United States Government bond notes and said United States national bank notes shall constitute and be known as the "United States National-bank Note Redemption Fund," APPENDIX 301 and be held exclusively for the redemption, first, of the United States Government bond notes; second, for the United States national-bank notes in the event of the liquidation of any bank organized under this lavf. Provided, however, That when said "redemption fund" shall exceed 5 per centum of both the United States Government bond notes and the United States national-bank notes such excess shall belong to the United States Government, and may be used by it to defray its general expenses. Sect. 13 Second — That under such regulations and restrictions as shall be established by the said ministers of finance, national banks organized under this Act may establish branch banks by and with the consent of said min- isters, such branch banks to have the right to receive deposits, make loans, grant discounts and buy and sell exchange, but in no case to be permitted to issue circulating notes other than those of the parent bank. It shall in all respects be considered as a part of the parent bank and in each case where such branches are maintained the ministers of finance shall receive in the reports of the central bank a statement, properly sworn to and attested, of the condition of its branches. Sect. 14. First — That in the event of the liquidation of any national bank organized under this Act the United States Government shall redeem upon presentation, after notice given as herein provided, any of said United States Government bond notes or said United States national-bank notes, re- imbursing itself for the full amount thereof out of the assets of said bank, and distribute the remaining assets among the de- positors and all others having claims in the same manner as now provided by law. Second — That from the time of the suspension of said bank up to the date set by said ministers of finance for the redemp- tion of said United States national-bank notes, they shall bear interest at the rate of 5 per centum per annum. Such notice shall be given in some newspaper printed in the clearing-house city where said notes were cleared ; but nothing herein contained shall be construed to impose any hability upon the Govern- 302 APPENDIX ment of the United States, or any of its representatives, beyond the amount available from time to time out of said "United States National-bank Note Redemption Fund." Sect. 15. First — That any bank organized under this Act may at any time after nineteen hundred and five, with the consent of the ministers of finance, insure its depositors against loss by paying into the United States Treasury i per centum upon the average balance of deposits of the preceding fiscal year, and one-half of i per centum upon the average annual balances thereafter until the amount so paid into the United States Treasury by said bank shall amount to 5 per centum of the average balance of said bank for the last preceding year, and that said ministers of finance may then suspend said tax for the time being. If the deposits of said bank shall increase, or for any reason the amount of the insurance fund to the credit of said bank shall be less than 5 per centum of the deposits, said ministers may reimpose said tax of one-half of I per centum upon the deposits of said bank; and if said bank shall fail to pay such tax at any time after the payment of said I per centum the amount already paid by said bank shall be forfeited to the United States Government and the insurance of said depositors shall thereupon cease. Second — That the amounts of money so received shall constitute and be known as the "Depositors' Insurance Fund." Sect. 21. That it shall be unlawful for any national bank to engage in the promotion of any enterprise, or to loan the funds of the bank upon the bonds or securities of incomplete and partially developed projects of any kind, such as partially constructed railroads, street-car lines, electric-light, gas, water, mining, manufacturing, or irrigation plants. APPENDIX 303 INDIANAPOLIS MONETARY COMMISSION BILL January 6, 1898 Be it enacted, etc. : Sect. 4. That there is hereby created a division in the Treasury Department, to be known as the Division of Issue and Redemption, under the charge of an Assistant Treasurer of the United States, who shall be appointed by the President, by and with the advice and consent of the Senate. Sect. 5. That to the Division of Issue and Redemption shall be committed all functions of the Treasury Department per- taining to the issue and redemption of notes and certificates, and to the exchange of coins, and the said Division of Issue and Redemption shall have the custody of the Bank Note Guaranty Fund and of the Redemption Funds of the national banking associations, and shall conduct the operations of redeeming the circulating notes of national banking associations, as pre- scribed by law Sect. 6. That a reserve shall be established in the Division of Issue and Redemption aforesaid, by the transfer to it by the Treasurer of the United States from the general funds of the Treasury of an amount of gold, in coin and bullion, equal to 25 per centum of the amount of both United States notes and Treasury notes issued under the Act of July 14, 1890, outstanding, and a further sum in gold equal to 5 per centum of the aggregate amount of the coinage of silver dollars. . . . Sect. 7. That it shall be the duty of the Secretary of the Treasury to maintain the gold reserve in the Division of Issue and Redemption aforesaid at such sum as shall secure the certain and immediate redemption of all notes and exchange of all silver dollars presented, as hereinafter provided for, and the preservation of public confidence; and for this purpose he shall from time to time transfer to the Division of Issue and Redemption any funds in the Treasury not otherwise appro- priated, and in addition thereto he is hereby authorized to issue and sell, whenever it is in his judgment necessary to the ends aforesaid, bonds of the United States, bearing interest at 304 APPENDIX a rate not exceeding 3 per centum per annum payable in gold coin at the end of twenty years, but redeemable in gold coin at the option of the United States after one year; and the pro- ceeds of all such sales shall be paid into the Division of Issue and Redemption for the purposes aforesaid. Sect. 16. That, to provide for any temporary deficiency which may at any time exist in the Treasury of the United States, the Secretary of the Treasury be and he is hereby authorized, at his discretion, to issue certificates of indebted- ness of the United States Sect. 18. That any national banking association organized imder the laws of the United States shall, if its capital be wholly paid up and unimpaired, be entitled to receive from the Comptroller of the Currency circulating notes of denomi- nations hereinafter provided, in blank, registered and counter- signed as provided by law, to an amount not exceeding the amount of such paid-up and unimpaired capital, after deduct- ing therefrom its investment in real estate: Provided, That during the five years first succeeding the passage of this Act, any national banking association receiving from the Comp- troller of the Currency circulating notes in blank under the provisions of this Act, shall maintain on deposit with the Treasurer of the United States, bonds of the United States to an amount, at a valuation computed as hereinafter pre- scribed, equal to that of the circulating notes so received, when- ever such notes shall not exceed 25 per centum of the capital stock. And for each succeeding year after the expiration of five years from the passage of this Act, the amount of bonds required to be deposited before issuing notes in excess of such deposit shall be decreased by 20 per centum of the original 25 per centum of capital stock hereinbefore specified, and from and after the expiration of ten years from the passage of this Act no such bond deposit shall be required. And no further deposit of bonds shall be required than is herein pre- scribed; and any national banking association having at any time bonds of the United States deposited with the Treasurer in excess of the amount required by law to be at such time APPENDIX 305 deposited, may withdraw the whole or any part of such excess. But nothing herein contained shall be construed to authorize or permit the withdrawal of bonds required to be deposited under the provision of Section 5153 of the Revised Statutes of the United States, as security for the safe keeping and prompt payment of public moneys deposited with any national bank- ing association. Sect. 20. That every national banking association shall at all times keep and have on deposit with the Division of Issue and Redemption for the purpose hereinafter specified a sum in gold coin equal to 5 per centum of its outstanding circula- tion. The amounts so kept on deposit shall constitute a fund to be known as "The Bank Note Guaranty Fund," which fund shall be held for the following purpose, and for no other, namely : — • Whenever the Comptroller of the Currency shall have be- come satisfied .... that any association has refused to pay its circulating notes on demand in lawful money, he shall direct the redemption of such notes from the Bank Note Guaranty Fund aforesaid, and such notes shall thereupon be so redeemed. After the failure of any national banking asso- ciation to redeem its notes shall have been thus ascertained, the bonds deposited with the Treasurer of the United States shall be sold, as provided by law, and the proceeds of such sale shall be paid into the Bank Note Guaranty Fund. The Comptroller of the Currency shall forthwith collect, for the benefit of said fund from the assets of the bank and from the stockholders thereof, according to their liability, as declared by this Act, such sum as, with the bank's balance in the Bank Note Guranty Fund, shall equal the amount of its circulating notes outstanding. And for this purpose the United States shall, on behalf of the Bank Note Guaranty Fund, have a para- mount lien upon all the assets of the association; and such fund shall be made good out of such assets in preference to any and all other claims whatsoever, except the necessary costs and expenses of administering the same. Sect. 21. That whenever the Comptroller of the Currency 306 APPENDIX shall ascertain what deficiency, if any, exists between the aggregate collections for the benefit of the Bank Note Guaranty Fund in the case of any failed bank and the amount of its out- standing notes redeemed and to be redeemed from the said fund, he shall assess such deficiency upon all the national banks in proportion to their notes outstanding at the time of the failure of such bank. Sect. 25. That every national banking association shall pay, on or before the last day of every month, to the Division of Issue and Redemption, a duty imposed at the rate of 2 per centum per annum upon the average daily amount of its circulating notes outstanding in excess of 60 per centum of its capital stock, and not in excess of 80 per centum of such capi- tal stock, and a duty imposed at the rate of 6 per centum per annum upon the average daily amount of such notes out- standing in excess of 80 per centum of its capital stock. Sect. 30. That no national banking association shall count or report any of its own notes as a part of its cash or cash assets. McCLEARY BILL May II, 1898 Be it enacted, etc. : . . . . That there is hereby created a division in the Treasury De- partment to be known as the Division of Issue and Redemp- tion. There is hereby created a board consisting of three members, to be known as the Comptrollers of the Currency. The said board shall have the management of the Division of Issue and Redemption, and shall take the place of the Comptroller of the Currency Sect. 2. That to the Division of Issue and Redemption shall be committed all functions of the Treasury Department pertaining to the issue and redemption of notes and certifi- cates, and to the exchange of coins; and in the said Division of Issue and Redemption shall be held the guaranty fund and APPENDIX 307 the redemption fund of the national banking associations, and through it shall be conducted the operations of redeeming the circulating notes of national banking associations, as pre- scribed by law Sect. 3. That a reserve shall be established in the Division of Issue and Redemption aforesaid by the transfer to it by the Treasurer of the United States from the general funds of the Treasurer of an amount of gold, in coin and bullion, equal to 25 per cent of the amount, both of United States notes and Treasury notes issued under the Act of July 14, 1890, outstand- ing, and a further sum in gold equal to 5 per cent of the aggre- gate amount of the coinage of silver dollars Sect. 4. That it shall be the duty of the Secretary of the Treasury to maintain the gold reserve in the Division of Issue and Redemption aforesaid at such sum as shall secure the certain and immediate redemption of all notes and exchange of all silver dollars presented, as hereinafter provided for; and for this purpose he may, from time to time, transfer to the Division of Issue and Redemption any funds in the Treasury not otherwise appropriated, in excess of an actual cash balance of $50,000,000; and in addition thereto he is authorized to issue and sell, for gold, whenever it is in his judgment necessary to the ends aforesaid, and for no other purpose, certificates of indebtedness of the United States bearing interest at a rate not exceeding 3 per cent per annum, payable in gold coin at the end of five years, but redeemable in gold coin at the option of the United States after one year, and the proceeds of all such sales shall be paid into the Division of Issue and Redemption for the purpose aforesaid. Sect. 12. That the circulating notes provided for in this Act shall consist of three classes, namely, national reserve notes, national bank notes and national currency notes. The words "national reserve notes," when used in this Act, shall be understood to mean notes issued to a national bank- ing association in exchange for United States notes, and for whose current redemption in gold coin the banking association receiving the same shall be made immediately liable, and whose 308 APPENDIX ultimate payment shall be made by the Government of the United States. That the words "national bank notes," when used in this Act, shall mean circulating notes issued by national banking associations, and secured by deposits of United States bonds. That the words "national currency notes," when used in this Act, shall be understood to mean circulating notes issued by a national banking association, and constituting a direct and ultimate liability of the said banking association as pro- vided in this Act. Sect. 13. That any national banking association, on com- plying with the provisions of this Act, shall, if its capital be wholly paid up and unimpaired, be entitled to receive from the Comptrollers of the Currency national bank notes or national currency notes, or both, of the different denominations here- inafter specified (none, however, being less than $10) in blank, registered and countersigned as provided by law, to the amounts and in the manner following, and on the following terms and conditions, but in no case exceeding in the sum of their hank notes and currency notes * the amount of such paid-up and un- impaired capital. Subdivision A. That any national banking association may deposit with the Treasurer of the United States under such regulations as the Secretary of the Treasury may approve, United State notes to an amount not exceeding its paid-up and unimpaired capital, and shall then be entitled to receive in exchange therefor from the Comptrollers of the Currency an equal amount of National Reserve notes, of the kind and de- nominations described in Sections 12 and 15 of this Act. United States notes received into the Division of Issue and Redemption in exchange for national reserve notes shall be cancelled as received. Subdivision B. That upon the deposit by any national banking association of United States bonds, .... it shall be entitled to receive from the Comptrollers of the Currency *The insertion of the words in italics is recommended in the report. APPENDIX 309 national bank notes of different denominations in blank, as provided by this Act, equal in amount to the par value of the bonds so deposited Subdivision C. That any national banking association, having deposited with the Treasurer of the United States, United States notes and received in exchange therefor national reserve notes, shall be entitled to receive and issue, in addition thereto, an amount of national currency notes equal to the amount of national reserve notes received as aforesaid: Pro- vided, however, that the amount of national currency notes thus issued shall not exceed the amount of its national bank notes outstanding; And provided further. That the notes thus issued shall not exceed 40 per cent of the paid-up and unimpaired capital of the bank, but an additional amount of the national currency notes may be issued. Sect. 23. That every national banking association shall at all times keep and have on deposit with the Division of Issue and Redemption for the purpose hereinafter specified, a sum in gold coin equal to 5 per cent of the outstanding cir- culation of national currency notes. The amount so kept on deposit shall constitute a fund to be known as the "guaranty fund," which fund shall be held for the following purpose, and for no other, namely: Whenever the Comptrollers of the Currency shall have be- come satisfied that any association has refused to pay any of its circulating notes on demand, they shall direct the redemp- tion of its national currency notes from the guaranty fund aforesaid, and the redemption in gold coin of the United States from the reserve fund in the Division of Issue and Redemption of the national reserve notes issued to it. After the failure of any national banking association to redeem any of said notes shall have been thus ascertained the bonds deposited by it with the Treasurer of the United States shall be sold as provided by law, and the proceeds of such sale shall be applied first to the redemption of the notes for which they are held and the balance, if any, shall be paid into the guaranty fund, so far as 310 APPENDIX may be necessary to provide for the final redemption of any other outstanding notes of such bank. The Comptrollers of the Currency shall forthwith collect, for the benefit of said guaranty fund, from the assets of the bank and from the stockholders thereof, according to their liability as declared by this act, such sum as, with the bank balance in the guaranty fund as aforesaid, shall equal the amount of its national currency notes outstanding. And for this purpose the United States shall, on behalf of the guaranty fund, have a paramount lien upon all the assets of the asso- ciation; and such fund shall be made good out of such assets in preference to any and all other claims whatsoever, except the necessary cost and expenses of administering the same. Sect. 27. That the fund of 5 per cent of outstanding national bank notes required to be kept on deposit by every national banking association for the current redemption of the circu- lating notes of such association shall be required to be equal to S per cent of the national reserve notes issued to it and of its national bank notes outstanding, and shall be in gold coin of the United States; and the Comptroller of the Currency shall have authority to provide for the redemption of said national bank notes and national reserve notes at any or all of the sub- treasuries of the United States. Said note shall be paid in gold coin of the United States, and shall thereupon be returned to the banks to which they were originally issued. Sect. 30. That when the amount of the National Currency notes of any national banking association issued under this Act shall, together with its national banking notes outstanding, exceed 80 per cent of its capital, every such national banking association shall pay, on or before the last day of every month, to the Division of Issue and Redemption a tax imposed at the rate of one-half of i per cent per month upon the average daily amount of said National Currency notes in circulation in excess of 80 per cent of its capital stock, and which shall not have been returned to the comptrollers for cancellation or covered by an equal amount of gold coin deposited with the first comp- troller for the retirement of such notes. APPENDIX 311 Sect. 35. That it shall be lawful for any national banking association to establish branches under such rules and regu- lations as may be prescribed by the Comptrollers of the Cur- rency. ALDRICH BILL December 19, 1899 Be it enacted, etc. : That the dollar consisting of twenty-five and eight-tenths grains gold, nine-tenths fine, shall, as estabhshed by Section 3511 of the Revised Statutes of the United States, continue to be the standard unit of value, and all forms of money issued or coined by the United States shall be maintained at a parity of value with this standard; and United States notes, and Treasury notes issued under the Act of July 14, 1890, when presented to the Treasury for redemption shall be redeemed in gold coin of such standard. Sect. 2. That it shall be the duty of the Secretary of the Treasury, in order to secure the prompt and certain redemp- tion of United States and Treasury notes as hereinbefore pro- vided, to set apart in the Treasury a reserve fund of $150,000,- 000 in gold coin, which fund shall be used for such redemption purposes only, and whenever and as often as any of said notes shall be redeemed from said fund it shall be the duty of the Secretary of the Treasury to use said notes so redeemed to restore and maintain such reserve fund, in the manner follow- ing, to wit: First, by exchanging the notes so redeemed for any gold coin in the general fund of the Treasury; second, by accepting deposits of gold coin at the Treasury or at any sub- treasury in exchange for the United States notes so redeemed ; third, by procuring gold coin by the use of said notes, in ac- cordance with the provisions of section thirty-seven hundred of the Revised Statutes of the United States. If the Secretary of the Treasury is unable to restore and maintain the gold coin in the reserve fund by the foregoing methods, and the amount of such gold coin in said fund shall at any time fall 312 APPENDIX below $100,000,000, then it shall be his duty to restore and maintain the same by borrowing money on the credit of the United States. Sect. 7. That upon deposit with the Treasurer of the United States, by any national banking association, of any bonds of the United States in the manner provided by exist- ing law, such association shall be entitled to receive from the Comptroller of the Currency circulating notes in blank, registered and countersigned as provided by law, equal in amount to the par value of the bonds so deposited; and any national banking association now having bonds on deposit for the security of circulating notes, and upon which an amount of circulating notes has been issued less than the par value of the bonds, shall be entitled, upon due application to the Comptroller of the Currency, to receive additional circulating notes in blank to an amount which will increase the circulating notes held by such association to the par value of the bonds deposited, such additional notes to be held and treated in the same way as circulating notes of national banking associa- tions heretofore issued, and subject to all the provisions of existing law affecting such notes SECRETARY GAGE'S BILL Be it enacted, etc.: That there be established in the Treasury Department, as a part of the office of the Treasurer of the United States, a division to be designated and known as the Division of Issue and Redemption, to which shall be assigned, under such regulations as the Secretary of the Treasury may approve, all records and accounts relating to the issue, redemption and exchange as hereinafter provided of the several classes of United States paper money. There shall be transferred from the general fund in the Treasury of the United States and taken up on the books of said division as a redemption fund the sum of $125,000,000, in APPENDIX 313 United States gold coin and bullion, and such further sums of standard silver dollars and silver bullion, purchased under the Act of Congress approved July 14, 1890, as shall equal the silver certificates outside the Treasury and Treasury notes of 1890 outstanding on the date when this Act shall take effect; and thereafter the gold and silver coins and bullion hereby transferred from the general fund in the Treasury as herein provided shall be increased or diminished, as the case maybe, in accordance with the provisions of this Act, and in no other way. Sect. 2. That all United States notes. Treasury notes of i8go and silver certificates presented for redemption shall be redeemed from the redemption fund herein provided, in ac- cordance with the terms of existing law; but the notes and certificates so redeemed shall be held in and constitute a part of said fund, and shall not be withdrawn from said fund nor disbursed, except in exchange for an equivalent amount of the coin in which said notes or certificates were redeemed; but to enable the Secretary of the Treasury more thoroughly to carry out the provisions contained in this act, he is hereby authorized to exchange any of the funds in the Division of Issue and Redemption for any other funds which may be in the general fund of the Treasury Department. Sect. 5. That any national banking association whose deposit of bonds is less than the amount of its capital may deposit with the Treasurer of the United States, under such regulations as the Secretary of the Treasury may approve. United States notes, Treasury notes of 1890, and silver certifi- cates, and shall be entitled to receive from the Comptroller of the Currency and to issue an equal amount of its circulating notes; but the aggregate amount of bonds. United States notes, Treasury notes of i8go and silver certificates deposited by any national banking association shall not exceed the amount of its capital: Provided, That the total amount of United States notes. Treasury notes of 1890 and silver certificates deposited with the Treasurer of the United States under authority of this section shall not exceed the sum of $200,000,000. 314 APPENDIX Sect. 6. That the Secretary of the Treasury shall issue, from time to time, in his discretion, bonds of the same character and class as those described in the third section of this act, and shall substitute the same with the Treasurer of the United States for equal amounts of the United States notes. Treasury notes of 1890 and silver certificates deposited by national banking associations, and the bonds so issued and substituted shall be charged to the respective national banking associations, and be accounted for by them at such prices, not less than par, as shall represent the market value of such bonds; and the United States notes. Treasury notes of 1890 and silver cer- tificates released as herein provided shall become a part of the general redemption fund ; and the Secretary of the Treasury is hereby authorized to exchange any of said Treasury notes of 1890 and said silver certificates for a like amount of United States notes; Provided, That the amount of bonds issued under the author- ity of this section shall not exceed the sum of $200,000,000. Sect. 7. When any national bank now existing or here- after organized shall have deposited such United States bonds. United States notes, Treasury notes of 1890 or silver certifi- cates, to an amount of not less than 50 per centum of its capital, it shall be entitled to receive from the Comptroller of the Cur- rency, and to issue, national bank notes, in addition to the 50 per centum thus provided, to the amount of 25 per centum of such deposits; but the circulation issued by any national banking association shall never be in excess of its paid-up capital stock, and the additional notes so issued shall not be secured by said deposit, but shall constitute a first lien upon all the remaining assets of the association issuing such notes. Upon the failure of any association to redeem its circulating notes above provided, whether the same are issued against deposited security or against general assets, the same shall be promptly redeemed by the Treasurer of the United States. To secure the United States against any loss arising from its guarantee to pay and redeem such additional circulating notes, it shall be the duty of the Comptroller of the Currency to levy APPENDIX 315 upon and collect from every national banking association issuing such unsecured circulation a tax at the rate of 2 per centum per annum on such unsecured circulation; which said tax of 2 per centum per annum shall be paid to the Treasurer of the United States in equal semi-annual payments in January and July of each year, and when so collected it shall constitute a safety fund out of which the United States shall be reimbursed for any redemption of said unsecured circulation it may make as herein provided. The safety fund thus created shall be invested by the Secretary of the Treasury in such Govern- ment bonds as he may consider advisable. Said tax of 2 per centum per annum shall be in addition to the tax of one-half of I per centum per annum on circulating notes hereinafter authorized. Sect. 8. That each national banking association shall deposit and maintain in the Treasury of the United States a sum of lawful money equal to 10 per centum of its aggregate circulation, said sum to be in lieu of the 5 per centum redemp- tion fund now required by Sect. 3 of the Act approved June 20, 1874, to be maintained, and to be subject to all the pro- visions of existing law respecting said redemption fund not inconsistent with the provisions of this Act; and, in considera- tion of the deposits of bonds, United States notes. Treasury notes of 1890 and silver certificates, and the tax of 2 per cen- tum on the unsecured circulating notes of national banking associations, and of the deposit of lawful money provided in this section, the faith of the United States is hereby pledged to the redemption in lawful money of the United States of all the circulating notes of said national banking associations. 316 APPENDIX GOLD STANDARD ACT March 14, 1900 an act to define and fix the standard of value, to maintain the parity of all forms of money issued or coined by the united states, to refund the public debt, and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in Congress Assembled: That the dollar consisting of twenty-five and eight-tenths grains of gold, nine-tenths fine, as established by Section 3511 of the Revised Statutes of the United States, shall be the standard unit of value, and all forms of money issued or coined by the United States shall be maintained at a parity of value with the standard, and it shall be the duty of the Secretary of the Treasury to maintain such parity. Sect. 2. That United States notes, and Treasury notes issued under the Act of July 14, 1890, when presented to the Treasury for redemption, shall be redeemed in gold coin of the standard fixed in the first section of this Act, and in order to secure the prompt and certain redemption of such notes as herein provided it shall be the duty of the Secretary of the Treasury to set apart in the Treasury a reserve fund of $150,- 000,000 in gold coin and bullion, which fund shall be used for such redemption purposes only, and whenever and as often as any of said notes shall be redeemed from said fund it shall be the duty of the Secretary of the Treasury to use said notes so redeemed to restore and maintain such reserve fund in the manner following, to wit: First, by exchanging the notes so redeemed for any gold coin in the general fund of the Treasury; second, by accepting deposits of gold coin at the Treasury or at any sub-treasury in exchange for the United States notes so redeemed; third, by procuring gold coin by the use of said notes, in accordance with the provisions of Sect. 3700 of the Revised Statutes of the United States. If the Secretary is un- APPENDIX 317 able to restore and maintain the gold coin in the reserve fund by the foregoing methods, and the amount of such gold coin and bullion in said fund shall at any time fall below $100,000,- 000, then it shall be his duty to restore the same to the maximum sum of $150,000,000 by borrowing money on the credit of the United States .... and the gold coin received from the sale of said bonds shall first be covered into the general fund of the Treasury and then exchanged, in the manner hereinbefore provided, for an equal amount of the notes redeemed and held for exchange, and the Secretary of the Treasury may, in his discretion, use said notes in exchange for gold, or to purchase or redeem any bonds of the United States, or for any other lawful purpose the public interests may require, except that they shall not be used to meet deficiencies in the current revenues. That United States notes when redeemed, in ac- cordance with the provisions of this section, shall be reissued, but shall be held in the reserve fund until exchanged for gold as herein provided; and the gold coin and bullion in the reserve fund, together with the redeemed notes held for use as pro- vided in this section, shall at no time exceed the maximum sum of $150,000,000. Sect. 4. That there be established in the Treasury Depart- ment, as a part of the oflace of the Treasurer of the United States, divisions to be designated and known as the Division of Issue and the Division of Redemption, to which shall be assigned respectively, under such regulations as the Secretary of the Treasury may approve, all records and accounts re- lating to the issue and redemption of the United States notes, gold certificates, silver certificates, and currency certificates. There shall be transferred from the accounts of the general fund of the Treasury of the United States, and taken up on the books of said divisions respectively, accounts relating to the reserve fund for the redemption of the United States notes and Treasury notes, the gold coin held against outstanding gold certificates, the United States notes held against outstanding currency certificates, and the silver dollars held against out- standing silver certificates, and each of the funds represented 318 APPENDIX by these accounts shall be used for the redemption of the notes and certificates for which they are respectively pledged, and shall be used for no other purpose, the same being held as trust funds. Sect. io. That Sect. 5138 of the Revised Statutes is hereby amended so as to read as follows: "Sect. 5138. No association shall be organized with a less capital than $100,000 except that banks with a capital of not less than $50,000 may, with the approval of the Secretary of the Treasury, be organized in any place the population of which does not exceed 6,000 inhabitants, and except that banks with a capital of not less than $25,000 may, with the sanction of the Secretary of the Treasury, be organized in any place the population of which does not exceed 3,000 inhabitants. No associa- tion shall be organized in a city the population of which exceeds 50,000 persons with a capital of less than $200,000." Sect. ii. That the Secretary of the Treasury is hereby authorized to receive at the Treasury any of the outstanding bonds of the United States .... and to issue in exchange therefor an equal amount of coupon or registered bonds of the United States in such form as he may prescribe, in de- nominations of $50 or any multiple thereof, bearing interest at the rate of 2 per cent per annum, payable quarterly Sect. 12. That upon the deposit with the Treasurer of the United States by any national banking association, of any bonds of the United States in the manner provided by existing law, such association shall be entitled to receive from the Comptroller of the Currency circulating notes in blank, registered and countersigned as provided by law, equal in amount to the par value of bonds so deposited; .... pro- vided, That the total amount of such notes issued to any such association may equal at any time but shall not exceed the amount at such time of its capital stock actually paid in APPENDIX 319 FOWLER BILL April 4, 1902 Be it enacted, etc. : . . . . That there shall be, and is hereby, created and established in the Treasury Department a Division of Banking and Cur- rency, which shall be in charge of a board consisting of three members Sect. 2. That if any national bank shall assume the cur- rent redemption, as hereinafter described, of an amount of United States notes equal to 20 per centum of its paid-up capital, it shall have the right, without depositing United States bonds as now provided by law — First — To immediately take out for issue and circulate an amount of bank notes equal to 10 per centum of its paid-up capital, by paying a tax, on the first days of January and July of each year, of one-eighth of i per centum upon the average amount of such notes in actual circulation during the pre- ceding six months. Second — To take out for issue and circulate an amount of bank notes equal to 10 per centum of its paid up-capital at any time after the expiration of one year from the date of the assumption aforesaid; and it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of one-eighth of i per centum upon the average amount of such notes in actual circulation during the preceding six months Third — To take out for issue and circulate an amount of bank notes equal to 10 per centum of its paid-up capital at any time after the expiration of two years from the date of the assumption aforesaid; and it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of five-eighths of i per centum upon the average, amount of such notes in actual circulation during the pre- ceding six months. Fourth — To take out for issue and circulate an amount of 820 APPENDIX bank notes equal to lo per centum of its paid-up capital at any time after the expiration of three years from the date of the assumption aforesaid ; and it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of five-eighths of i per centum upon the average amount of such notes in actual circulation during the pre- ceding six months. Fifth — To take out for issue and circulate an amount of bank notes equal to lo per centum of its paid-up capital at any time after the expiration of four years from the date of the assumption aforesaid; and it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of five-eighths of i per centum upon the average amount of such notes in actual circulation during the pre- ceding six months. Sixth — To take out for issue and circulate an amount of bank notes equal to lo per centum of its paid-up capital at any time after the expiration of five years from the date of the assumption aforesaid; and it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of five-eighths of i per centum upon the average amount of such notes in actual circulation during the preceding six months. Seventh — With the approval of the Board of Control, to take out for issue and circulate an amount of notes equal to 20 per centum of its paid-up capital at any time after the expiration of six years from the date of the assumption afore- said; but it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of one and one-half per centum upon the average amount of such notes in actual circulation during the preceding six months. Eighth — With the approval of the Board of Control, to take out for issue and circulate an amount of notes equal to 20 per centum of its paid-up capital at any time after the expiration of seven years from the date of the assumption aforesaid; but it shall pay into the Treasury of the United States, on the first days of January and July of each year, a tax of two and one- APPENDIX S21 half per centum upon the average amount of such notes in actual circulation during the preceding six months. The manner and form of the assumption of the current re- demption of the United States notes, as aforesaid, shall be as follows: Each note shall bear the endorsement: "For value received, the national bank of (city), (State), v^rill currently redeem this note in gold coin until the same has been paid and canceled in accordance with the pro- visions of law." .... Whenever a national bank shall present any United States notes at the United States Treasury for indorsement, as afore- said, it shall at the same time surrender to the United States Treasury an additional amount of United States notes equal to one-half of the United States notes presented for such in- dorsement and receive in exchange therefor gold coin; and the United States notes so redeemed shall not be reissued, but shall be canceled and destroyed. Sect. 3. That when the national banks of the United States shall have assumed the current redemption of United States notes amounting in the aggregate to $130,000,000, and the United States has redeemed and canceled United States notes amounting to $65,000,000, no national bank shall thereafter pay out any United States notes the current redemption of which has not been assumed by some national bank, but shall return the same to the United States Treasury for redemption, and the Secretary of the Treasury shall redeem the United States notes so returned out of the gold coin in the issue and redemption of the Treasury, and they shall not be reissued, but shall be canceled and destroyed. But it shall be the duty of the Secretary of the Treasury to maintain the reserve fund at an amount not less than thirty-three and one-third per cen- tum of the United States notes at any time outstanding. From and after the first presentation for redemption and cancellation of any United States notes in accordance with the provisions of this section, the Secretary of the Treasury shall not pay out or issue any gold certificates. Sect. 4. That after the national banks shall have assumed 322 APPENDIX the current redemption of $120,000,000 of United States notes, and the United States shall have redeemed, canceled, and destroyed $65,000,000 of United States notes, in accordance with Section 2 of this Act, any national bank which has not assumed the current redemption of any United States notes as hereinbefore provided may then take out an amount of cir- culation equal to 10 per centum of its capital, and from year to year thereafter additional amounts of circulation in accord- ance with the provisions of Section 2 of this Act; but upon the first 20 per centum of the total circulation to which it is entitled under this Act it shall pay into the Treasury of the United States, on the first days of January and July of each year, five-eighths of i per centum upon the average amount of such notes in actual circulation during the preceding six months, and upon all such notes taken out for issue in excess of said 20 per centum the taxes prescribed in Section 2 of this Act Sect. 6. That all the bank notes taken out for issue in accordance with the provisions of this Act shall be furnished by the United States at the expense of the respective banks issuing them, and shall be in denominations of ten dollars and multiples thereof. Sect. 7. That such notes shall be a first lien upon the assets of the respective banks issuing them, and shall be received upon deposit and for all purposes of debt or liability by every national bank at par and without any charge of whatsoever kind, and such notes shall be receivable for all public dues except duties on imports, and when so received may be paid out again. Sect. 8. That the total amount of circulating notes of all kinds of any national bank may equal, but shall not at any time exceed, the amount of its paid-up capital Sect. 10. That the Secretary of the Treasury is hereby authorized, in his discretion, to deposit all the money of the United States in excess of $50,000,000, except that in the Issue and Redemption Division of the Treasury, in national banks, upon the condition that said banks shall first deposit in the United States Treasury United States bonds equal in APPENDIX 323 amount at par to the sum to be so deposited; and such banks shall, on the first days of January and July of each year, pay interest thereon to the United States at the rate of i per centum per annum upon the average balances of the preceding six months, but such banks shall not be required to hold any reserve against such deposits "Any national banking association may amend its articles of association with reference to the places vsrhere its banking operations are to be carried on upon the unanimous vote of its board of directors by and vyith the approval of the Board of Control of Banking and Currency: Provided, however, That authority to establish branches in the possessions of the United States and in foreign countries shall be given only to banks having a paid-up capital of not less than $5,000,000." PAYNE BILL February 26, 1903 Be it enacted by the Senate and House of Representatives of the United Slates of America in Congress assembled: "Sect. 5153. All national banking associations, designated for that purpose by the Secretary of the Treasury, shall be depositories of public money, under such regulations as may be prescribed by the Secretary, and they may also be em- ployed as financial agents of the Government; and they shall perform all such reasonable duties as depositories of public moneys and financial agents of the Government as may be required of them. The Secretary of the Treasury may de- posit in such designated depositories public money received from all sources, and shall require such depositories to give satisfactory security, as hereinafter authorized, for the safe- keeping and prompt payment of the public money so de- posited with them and for the faithful performance of their duties as financial agents of the Government. The Secretary of the Treasury may accept as security for the safe-keeping of public money deposited with national banking associations, 324 APPENDIX as herein authorized, the deposit of bonds of the United States, bonds or other interest-bearing obligations of any State of the United States, or any legally authorized bonds issued for municipal purposes by any city in the United States which has been in existence as a city for a period of twenty-five years, and which for a period of ten years previous to such deposit has not defaulted in the payment of any part of either principal or interest of any debt authorized to be contracted by it, and which has at such date more than fifty thousand inhabitants as established by the last national census, and whose net indebted- ness does not exceed lo per centum of the valuation of the taxable property therein, to be ascertained by the last pre- ceding valuation of property for the assessment of taxes; or the first-mortgage bonds, not including street railway bonds, of any railroad company which has paid dividends of not less than 4 per centum per annum regularly and continuously on its entire capital stock for a period of not less than ten years previous to the deposit of the bonds. The Secretary of the Treasury may accept the securities herein enumerated in such proportions as he may from time to time determine, and he may at any time require the deposit of additional securities, or require any depository to change the character of the securi- ties already on deposit. National banking associations having on deposit public money shall pay to the United States for the use thereof interest at the rate of not less than one and one- half per centum per annum, such rate to be fixed from time to time by the Secretary of the Treasury ; and all public moneys in any depository shall be payable on demand upon the draft of the Treasurer of the United States. The United States shall have a lien on the current assets of banks in which public moneys are deposited for the repayment of the same on de- mand of the Treasurer of the United States as aforesaid; but the securities deposited with the Secretary of the Treasury for the safe-keeping of such moneys shall be sold before the said lien is enforced and the proceeds applied to the discharge of said lien to the extent of the proceeds of sale : Provided, That no reserve shall be required on account of such deposits." APPENDIX 325 FOWLER BILL February 26, 1903 Be it enacted, etc. : . . . . That any national bank may, with the approval of the Comptroller of the Currency, take out for issue and circulation an amount of national-bank notes not exceeding 25 per centum of its paid-up and unimpaired capital without depositing United States bonds with the United States Treasury in the manner provided by existing law. Sect. 2. That said national-bank notes shall be furnished by the United States at the expense of the respective banks issuing them, and shall be in the denominations of ten dollars and multiples thereof. Sect. 3. That before any national bank shall receive any of the bank notes referred to in this Act it shall first deposit in the Treasury of the United States as a guaranty of the pay- ment thereof an amount of United States bonds or gold coin, or United States notes, or in all equal to 5 per centum of the amount of the notes so taken out Sect. 4. That every national bank taking out such notes for issue and circulation shall, on the first days of January and July of each year, pay into the Treasury of the United States, in gold coin, a tax of one-quarter of i per centum upon the average amount of such notes in actual circulation during the preceding six months, and the tax so paid into the Treasury shall, with the 5 per centum deposited as a guaranty for the payment of the notes, constitute a guaranty fund. Sect. 5. That such notes shall be a paramount lien upon the assets of the respective banks issuing them Sect. 6. That any national bank having notes outstand- ing in excess of 75 per centum of its paid-up capital, to secure the payment of which United States bonds have been deposited, may, upon the deposit of lawful money for the redemption of such excess, take out for circulation the notes provided for in this Act, without reference tp the limitation of $3,ooo,ocx3 each 326 APPENDIX month prescribed in Section 9 of the Act approved July twelfth, eighteen hundred and eighty-two. Sect. 7. That the provisions of the law contained in Section 9 of the Act approved July twelfth, eighteen hundred and eighty-two, limiting the amount of notes that may be retired to $3,000,000 in any calendar month, shall not apply to the notes taken out in accordance with the provisions of this Act. Sect. 8. That every national bank taking out such notes for issue shall maintain at all times the same reserve against such notes when in actual circulation as is now prescribed by law for deposits Sect. 12. That upon the failure of a national bank any national-bank notes that have been taken out by it in accord- ance with the provisions of this Act shall, upon presentation to the United States Treasury, be paid in gold coin out of the guaranty fund; but the United States Treasury shall recover from the assets of the failed bank an amount equal to its out- standing notes, and the same shaU be paid into the guaranty fund Sect. 15. That in addition to the provisions of Section 5153 of the Revised Statutes, concerning the designation of public depositaries and the deposit of pubKc moneys therein, the Secretary of the Treasury may also deposit in such designated depositaries any public money received from whatever source, including receipts from customs, without requiring security by the deposit of United States bonds and otherwise, as pro- vided in said section, but no such deposit shall in any case exceed 75 per centum of the paid-up and unimpaired capital of any such depositary. National banking associations hav- ing on deposit public money in accordance with the provisions of this Act shall pay to the United States for the use thereof interest at the rate of two per centum per annum, payable semi-annually on the first days of January and July of each year. The United States shall have a paramount lien on the assets of banks in which pubUc moneys are deposited in ac- cordance with the provisions of this Act for the repayment of the same on demand of the Treasurer of the United States. . . . APPENDIX 327 S. 3027 IN THE SENATE OF THE UNITED STATES January 7, 1908 Mr. Culberson introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO REQUIRE NATIONAL BANKS TO HAVE AND KEEP ON HAND IN THEIR VAULTS THE RESERVE REQUIRED BY LAW, AND POR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That from and after the passage of this Act every national bank shall have and keep on hand in its vaults the reserve of lawful money provided for by law. All laws and parts of laws which authorize national banks to have and keep part of their reserve with other national banks, and all laws and parts of laws otherwise in conflict herewith, are hereby re- pealed. S. 3044 IN THE SENATE OF THE UNITED STATES January 7, 1908 Mr. Heyburn introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO amend sections fifty-one hundred and NINETY-ONE AND FIFTY-ONE HUNDRED AND NINETY-TWO OF THE REVISED STATUTES OF THE UNITED STATES AND ALL ACTS AMENDATORY THEREOF, AND FOR OTHER PUR- POSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That from and after the first day of June, nineteen hundred and eight, every national banking association organized under the Act of June third, eighteen hundred and sixty-four, and 328 APPENDIX any Act supplemental or amendatory thereof, shall at all times have on hand in lawful money of the United States an amount equal to at least twenty per centum of the aggregate amount of its deposits, and whenever the lawful money of any such association shall be below the amount of twenty per centum of its deposits such association shall not increase its liabiUty by making any new loans otherwise than by discounting or purchasing bills of exchange payable at sight. Nor shall such banking association make or pay any dividend of its profits until the required proportion of the aggregate amoimt of its deposits and its lawful money of the United States so intended to be held in reserve shall have been fully restored, and the Comptroller of the Currency shall notify any such association whose lawful money reserves are below the amoimt above required to be kept on hand to make good such reserves, and if such association shall fail for thirty days thereafter to make good its reserves of lawful money the Comptroller of the Currency shall, with the concurrence of the Secretary of the Treasury, proceed to wind up the business of such asso- ciation, as provided in section fifty-two hundred and thirty- four of the Revised Statutes of the United States. No part of the lawful money reserves which such national banking association is hereby required to have on hand in lawful money of the United States shall consist of anything but lawful money of the United States actually in the posses- sion and custody of such national banking association. All Acts and parts of Acts inconsistent with any of the fore- going provisions of this Act are hereby repealed. All Acts and parts of Acts providing for the establishment or creation of central reserve banks, reserve banks, or addi- tional reserve banks are hereby repealed, and any such central reserve banks, reserve banks, or additional reserve banks as may have been heretofore created and be now existing shall, on or before the thirtieth day of June, nineteen hundred and eight, pay and return to the respective banks to which such moneys may belong all the moneys which such reserve banks APPENDIX 329 may hold or have in their possession or under their control to the credit of any other national banking association as a part of the lawful reserves of such other national banking association. No national banking association shall, after the passage of this Act, deposit any part of its lawful money reserve herein provided to be maintained and kept with any other bank, or banking association, or elsewhere than in the vaults of the national banking association to which such reserve may belong. All Acts and parts of Acts in conflict with the provisions of this Act are hereby repealed. S. 2954 IN THE SENATE OF THE UNITED STATES December 21, 1907 Mr. Rayner (for Mr. Owen) introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL PROVIDING security to the depositors of united STATES national BANKS; FOR THE PREVENTION OF THE HOARDING OF CURRENCY, AND FOR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That from and after the passage of this Act the Comptroller of the Currency shall require the national banking associations of the United States to pay into the Treasury of the United States a tax upon their deposits, as fixed by the of&ce of the Comptroller of the Currency, in a sum amply sufficient to provide a fund for the immediate payment of the depositors in full of any insolvent bank. Such fund shall be called the "liquidation fund," and from such fund, whenever a national bank is declared insolvent by the Comptroller of the Currency, the depositors of such bank shall be paid in full immediately 330 APPENDIX from such "liquidation fund," and such liquidating bank be charged therewith. The net liquidated assets of such bank shall be deposited to the credit of the "hquidation fund" to the extent required to reimburse such fimd the money advanced therefrom. Sect. 2. That the Secretary of the Treasury is hereby directed to prepare and keep on hand not less than one hun- dred million dollars of Treasury notes of the United States, to be kept in a special fund known as the "special circulation fund." Such notes may be advanced to any person or cor- poration upon proper security of bonds acceptable to the Secretary of the Treasury: Provided, That such advances shall not be in excess of ninety per centum of the market value of such bonds. Such advances made from the "special circulation fund" shall be charged for at a rate of six per centum per annum for the first four months and thereafter at the rate of eight per centum per annum, not exceeding a total period of one year. In the event of the depredation of the market value of such bonds, further security shall be required to preserve the margin of the per centum under penalty of sale of such securities on the open market. The advances made from such fund shall be repaid within twelve months, and in default thereof, the bonds shall be sold, and after the repayment of the principal and interest of such advances and the cost of sale, the balance shall be returned to the owner of such bonds. The amount of the special circulation notes in the Treasury shall at no time be allowed to diminish to a point of exhaustion. The interest accruing on the loan of such special circulation notes shall go into the "liquidation fund" hereinabove provided. APPENDIX 331 S. 3187 IN THE SENATE OF THE UNITED STATES January 7, 1908 Mr. Brown introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL PROVIDING FOR THE CREATION OF A SPECIAL FUND WITH THE TREASURER OF THE UNITED STATES TO INSURE THE PAYMENT OF DEPOSITS IN NATIONAL BANKS THAT MAY HEREAFTER BECOME INSOLVENT. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That every national bank organized under the laws of the United States, or which shall hereafter be organized, shall, on or before the first day of January of each year after the passage of this Act, deposit with the Treasurer of the United States a sum equal to one-tenth of one per centum of its aver- age deposits for the six months preceding said first day of January, which sum shall be placed in a special fund to be maintained perpetually for the payment of depositors in na- tional banks hereafter declared to be insolvent by the Comp- troller of the Currency. In case any national bank shall refuse or neglect to make such deposit, special notice shall be served upon its officers by said Treasurer of the United States, and neglect or refusal to comply with the provisions of this Act within thirty days after said special notice shall have been served, shall work a forfeiture of the charter of said bank, and the Comptroller of the Currency shall immediately take pos- session as provided by law in cases of mismanagement or in- solvency: Provided, That whenever the total amount paid into the Treasury by any bank shall be equal to or greater than two per centum of its average deposits for the preceding six months, said banks shall be exempt from making the deposit. Sect. 2. That said special fund created by this Act shall 332 APPENDIX be invested by the Treasurer of the United States as he may deem expedient, in bonds of the United States or bonds of the several States, and said Treasurer is authorized to dispose of any portion of such bonds whenever he deems it necessary for the purpose of paying depositors in insolvent national banks as hereafter provided in this Act. Sect. 3. That whenever a national bank shall be declared insolvent and a receiver is appointed, said receiver shall, within thirty days, report to the Secretary of the Treasury a certified Mst of the amounts due bona fide depositors, and, upon receipt of this list, the Secretary of the Treasury shall imme- diately pay out of the special fund created by this Act to the receiver of said insolvent bank the total amount due said de- positors, as shown by said certified list, which simi shall be forthwith distributed by said receiver to said depositors: Pro- vided, That for the purposes of this Act no one shall be deemed a depositor who has received and accepted collateral security for his deposit. Sect. 4. That the receiver shall settle up the affairs of said insolvent bank, as provided by law, paying into the special fund provided for in this Act all the dvidends due depositors, said dividends to become a part of said special fund. S. 3028 IN THE SENATE OF THE UNITED STATES January 7, 1908 Mr. CtTLBERSON introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO FURTHER PROTECT DEPOSITS IN NATIONAL BANKS, FOR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That in every case where any national bank which accepts the provisions of this Act becomes insolvent, or is unable to APPENDIX 333 pay its deposits, in whole or in part, all national banks which shall accept the provisions of this Act shall pay whatever may be due the depositors of such bank which it is unable immediately to pay, and the amount to be paid by each of said banks shall be in proportion to the combined capital and surplus of each, as shown by the statement of the condition of the banks made to the Comptroller of the Currency next preceding the insolvency or failure to pay deposits. By deposits, as herein used, is meant individual deposits subject to check and which bear no interest: Provided, however, That such deposits shall bear interest at the rate of six per centum per annum from and after such insolvency or failure to pay deposits until paid. Sect. 2. That whenever any national bank which accepts the provisions of this Act shall become insolvent or is unable to pay its deposits, in whole or in part, it shall be the duty of the Comptroller of the Currency, in addition to the duties now devolved upon him by law with reference to insolvent or failed banks, as speedily as practicable to assess all national banks which have accepted the provisions of this Act their pro rata of the indebtedness due depositors by such bank, as pro- vided in the foregoing section, and to collect and pay the same to the depositors entitled thereto. The necessary expenses in- cident to the enforcement of this Act shall be paid as in other cases of insolvent or failed banks: Provided, That the de- positors shall be paid in full : Provided further. That after ex- hausting all the resources of such insolvent or failed bank and the liabilities of the stockholders therein, and paying all neces- sary expenses incident to the settlement of the affairs of such bank, the Comptroller of the Currency shall refund to the re- spective banks which contributed their pro rata to the payment of the deposits in such insolvent or failed bank the balance, if any, in proportion to the contributions of such banks. Sect. 3. That immediately after the passage of this Act the Comptroller of the Currency shall address a communica- tion to each national bank then in operation, enclosing a copy 334 APPENDIX of this Act, inquiring if the bank will accept the provisions thereof. All communications of the banks in reply to such inquiry shall be filed and preserved by the Comptroller of the Currency as part of the archives of his office. The banks which accept the provisions of this Act shall be held and bound thereby and the liability may be enforced by the Comptroller of the Currency. In case any bank shall decline to accept the provisions of this Act, or shall fail to reply to the com- munication of the Comptroller of the Currency on the subject within twenty days, such bank and the depositors therein shall be denied all benefits arising under this Act: Provided, That as additional national banks are organized they shall have ten days from the date of their charters to avail them- selves of the provisions of this Act, and upon failure to file their acceptance thereof within that time such bank and their depositors shall be denied all benefits arising thereunder. Sect. 4. That as acceptances of the provisions of this Act are received by the Comptroller of the Currency, it shall be his duty to issue to each bank which accepts the same a cer- tificate under his hand and seal stating substantially the fact of acceptance, and said certificate shall expressly state that the deposits of the bank are further protected by this Act, which certificate may be published by the bank. It shall also be the duty of the Comptroller of the Currency to transmit to the Congress, at the beginning of each session, the name and location of each national bank which has accepted the pro- visions of this Act, and the name and location of each national bank which has dechned or failed to accept the same. Sect. 5. That no public money shall be deposited or re- main in any national bank which decUnes or fails to accept the provisions of this Act. Sect. 6. That nothing in this Act shall be taken, held, or construed as implying or fixing any liability upon the United States to guarantee deposits in any national bank, and it is hereby declared that the extent of the obligation of the United States is to enforce this Act. APPENDIX 335 S- 3539 IN THE SENATE OF THE UNITED STATES January 13, 1898 Mr. Gore introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL AUTHORIZING NATIONAL BANKING ASSOCIATIONS TO CONFORM TO STATE LAWS LEVYING A TAX OR ASSESSMENT TO SECURE DEPOSITORS. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That whenever any State enacts a law levying a tax or an assessment on State banks for the purpose of raising a fund to be used to protect the depositors in such banks from loss, all national banks in such State may be permitted to enjoy the benefits of such law by paying out of their earned surplus their pro rata share of such assessment upon such terms and condi- tions as the Secretary of the Treasury may prescribe, and it shall be the duty of the Secretary of the Treasury to promul- gate such rules as may be necessary to carry the provisions of this Act into effect. S. 3804 IN THE SENATE OF THE UNITED STATES January 14, 1908 Mr. Scott introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL to tax CERTAIN DEPOSITS WITH NATIONAL BANK- ING ASSOCIATIONS, AND FOR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That whenever any national banking association shall re- ceive from the Secretary of the Treasury, under the author- ity vested in him by section fifty-one himdred and fifty-three 336 APPENDIX of the Revised Statutes, as amended by section three of the Act approved March fourth, nineteen hundred and seven, entitled, "An Act to amend the national banking Act, and for other purposes,'' or by any other provision of law now- existing or hereafter enacted, any deposits of public money, such banking association shall be, and is hereby, made sub- ject to a tax of one twenty-fourth of one per centum per month upon the average amount of such deposits so received and held by it as hereinafter provided, the tax hereby levied being in addition to any and all other taxes imposed by law upon national banking associations. Sect. 2. That it shall be the duty of each national bank- ing association with whom the Secretary of the Treasury shall make deposits of public moneys as aforesaid to render a re- turn in duplicate, under the oath of the president or cashier of said banking association, in such form and manner as may be prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, one copy of which return shall be deposited with the collector of in- ternal revenue of the internal-revenue collection district in which such banking association is located and one copy trans- mitted to the Commissioner of Internal Revenue. Such return shall be made semi-annually on the first day of Decem- ber and the first day of June of each year, and shall set out the average monthly amount of the deposits aforesaid so received and held by such banking association. The copy of said return which is to be deposited with the collector of internal revenue as aforesaid shall be accompanied by the amount of the tax shown to be due by said return. Sect. 3. That in default of the return herein provided for the Commissioner of Internal Revenue shall estimate the amount of the deposits received and held by any such bank- ing association upon the best information he can obtain, in- cluding information of such deposits secured from the Secretary of the Treasury; and the tax found due upon such estimate shall be assessed and collected as in other cases of default APPENDIX 337 under the internal-revenue laws. And for refusal or neglect to make the return or payment herein provided for the bank- ing association shall pay a penalty of two hundred dollars for every such default, to be collected by distraint. Sect. 4. That the amounts collected as tax under the pro- visions of this Act shall constitute a special fund in the Treas- ury of the United States to be denominated the depositors' surety fund, which fund shall be held to the order of the Sec- retary of the Treasury, to be used by him under such regu- lations as he may promulgate, to reimburse depositors in national banks, either in full or in such pro rata part as the condition of the said fund may allow, for loss occasioned by the failure of any national banking association, and for no other purpose except such as may be specifically authorized by law. Sect. 5. That all existing provisions of law for the assess- ment and collection of internal-revenue taxes, so far as ap- plicable, are hereby made a part of this Act. S. 3807 IN THE SENATE OF THE UNITED STATES January 14, 1908 Mr. Curtis introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL AUTHORIZING NATIONAL BANKING INSTITUTIONS TO TAKE ADVANTAGE OF GUARANTEE BANK-DEPOSIT LAWS IN CERTAIN STATES, AND FOR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That the Comptroller of the Ciu-rency be, and he is hereby, authorized and directed to issue a permit to any national banking institution doing business in States which have a guarantee bank-deposit law to take advantage of such law, provided said national banking institution is authorized to do 338 APPENDIX so by a vote of the majority of the stock of said institution at a meeting of the stockholders called for that piirpose. S. 1239 IN THE SENATE OF THE UNITED STATES December 5, 1907 Mr. Knox (by request) introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO PROVIDE AN ELASTIC CURRENCY BY MAKING IT LAWFUL FOR ANY OR ALL HOLDERS OF GOLD COIN OF THE UNITED STATES OR OF BONDS OF THE UNITED STATES, OR OF BONDS OF ANY STATE, COUNTY, OR MUNICIPALITY WITHIN THE UNITED STATES WHICH MAY BE APPROVED BY THE SECRETARY OF THE TREASURY, TO DEPOSIT, THROUGH ANY NATIONAL BANKING ASSOCIATION, SAID COIN OR BONDS WITH THE TREASURER OF THE UNITED STATES, OR ANY ASSISTANT TREASURER, AND TO SECURE THEREFOR A NEW FORM OF LEGAL-TENDER GOVERNMENT NOTES CALLED "united STATES CURRENCY NOTES"; PROVIDING FOR A TAX ON SAID DEPOSITORS OF BONDS WHILE SAID BONDS REMAIN ON deposit; AUTHORIZING NATIONAL BANKING ASSOCIATIONS, AT THE DISCRETION OF THE SECRETARY OF THE TREASURY, TO HOLD UNITED STATES BONDS, OR ANY STATE, COUNTY, OR MUNICIPAL BONDS WHICH MAY BE APPROVED BY HIM, AND WHICH ARE HEREBY MADE CONVERTIBLE, IN LIEU OF MONEY, FOR HALF OF THEIR LEGALLY REQUIRED RESERVES; AND AUTHORIZING NA- TIONAL BANKING ASSOCIATIONS TO CHARGE A COMMISSION FOR SERVICES HEREIN PROVIDED FOR. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That the Secretary of the Treasury is hereby authorized and required, as rapidly as practicable, to cause to be provided and kept in readiness for issuing, upon such demand or de- APPENDIX 33d mands as may be made, according to the provisions of this Act, a supply of circulating notes to be known as United States currency notes. Said notes, in the payment of all debts, either pubUc or private, shall be legal tender for a dollar of twenty-five and eight-tenths grains of gold, nine-tenths fine, for each dollar they represent, and when presented to the United States Treasury they shall be redeemed in gold coin of the United States; and when so redeemed they may be re- issued in the manner provided in this Act for their first issue. Said notes shall be provided in sufl&cient quantites to insure there being stored in the Treasury and subtreasuries at all times ready for issue an amoimt of them equivalent to five hundred miUions of dollars, and they shall be issued only when secured by deposits of bonds, as provided in section three of this Act, or in exchange for gold coin of the United States. United States currency notes when held by any na- tional banking association may be coimted as a part of its lawful reserve. Sect. 2. That in order to furnish suitable notes for circu- lation, the Secretary of the Treasury shall cause plates and dies to be engraved in the best manner to guard against coun- terfeiting and fraudulent alterations, and shall have printed therefrom and numbered such quantity of circulating notes of the denominations of five dollars, ten dollars, twenty dol- lars, fifty dollars, one hundred dollars, five hundred dollars, one thousand dollars, five thousand dollars, and ten thou- sand dollars as may be required to supply the demands of those entitled to receive the same. Such notes shall express upon their face or back: — First. That they are secured by gold coin, or by bonds deposited with the Treasurer of the United States. Second. That in payment of all debts, either pubUc or private, they are legal tender for a dollar of twenty-five and eight-tenths grains of gold, nine-tenths fine, for each dollar they represent. Third. That United States currency notes, if presented 340 APPENDIX to the Treasurer of the United States, shall be payable in gold coin of the United States. Fourth. The engraved signatures of the Treasurer and Register and the imprint of the seal of the Treasury. Fifth. Such devices and such other statements, not in- consistent with the provisions of this Act, as the Secretary of the Treasury shall, by regulation, direct. Sect. 3. That any and all national banking associations, saving institutions. State banks, trust companies, or other corporations, or firms, or individuals, so desiring may deposit with the Treasmrer of the United States, or any assistant treasurer, bonds of the United States, or of any State, county, or mimicipality in the United States which may be approved by the Secretary of the Treasury, and such depositors shall receive in exchange for the bonds deposited United States currency notes, such as are provided for by sections one and two of this Act, in amounts equal to ninety-five per centum in the case of United States bonds, and to seventy-five per centum in the case of State, county, and municipal bonds, of the par value of the bonds deposited: Provided, however, That should the market value of such bonds, in the judgment of the Secretary of the Treasury, be or become depreciated below their par value, the Treasurer of the United States is hereby directed to require the depositor to deposit in addi- tion lawful money of the United States equal to the depreci- ation of the market value of said bonds below their par value; and should the depositor fail to promptly make the said ad- ditional deposits of lawful money, or should he fail for three months to pay the tax hereinafter provided for, the Treasurer of the United States is hereby required to sell said bonds at pubhc sale. Each depositor of bonds under the provisions of this Act shall pay quarterly, on the first days of March, June, September, and December, to the Treasurer of the United States, a tax equal to five per centum per annum, if United States bonds are deposited, and to seven per centum per annum if other bonds are deposited, on the amount of said APPENDIX 341 notes received by him during the time said bonds remain on deposit, and each depositor shall receive all interest on said bonds the same as though they were in his own possession. All money received by the Treasury Department in payment of the tax herein provided for shall be used for the pur- chase of gold coin, and said gold coin shall be added to the separate fund for the redemption of United States currency notes. Sect. 4. That any depositor of bonds under this Act, or his lawful representative, successors, or assigns, may at any time demand and receive the bonds deposited, or the proceeds of their sale, as provided by this Act, together with any and all deposits of lawful money which the depositor may have been required to make, upon the return to the Treasurer of the United States of an amount of United States currency notes or of gold coin of the United States equal to the face value of the notes received by the said depositor and the un- paid tax, as herein provided. Any gold coin received by the Treasury Department under the operations of sections one, four and six of this Act shall be placed into a separate fund and used only for the redemption of the United States cur- rency notes herein provided for. So much of the redemption fund provided for by the Act of March fourteen, nineteen hun- dred, as shall be necessary for the redemption of any of these notes shall be temporarily transferred to this separate fund, and replaced as soon as possible. Sect. 5. That on and after the passage of this Act national banking associations, in emergencies and with the approval of the Secretary of the Treasury, may hold and count as fifty per centum of their legally required cash reserves, an amount of United States bonds or of any State, county, or municipal bonds which may be approved by the Secretary of the Treas- ury for the purposes enumerated in section three of this Act and by this Act made convertible, which in the case of United States bonds at ninety-five per centum of their par value, and in the case of State, county, and municipal bonds at seventy- 342 APPENDIX five per centum of their par value, will be equivalent in amount of fifty per centum of said legally required reserves. (Note. — The whole of section five could be discarded without interfering with the principal purpose of the biU.) Sect. 6. That in order to extend the privileges of this Act to any and all holders of bonds herein mentioned, and to facilitate its operations, national banking associations, at the request of any savings institution. State bank, trust com- pany, corporation, firm, or individual, shall from them receive deposits of any bonds, notes or coin, mentioned in this Act, and shall for and in the name of such depositor forward said bonds, notes, or coin to the United States Treasury or to the nearest subtreasury, and shall receive from the Treasury or subtreasury and deliver to the said depositor the bonds, notes, or coin in exchange; and for this service national banking associations may charge said depositors a commission of not more than one-fifth of one per centum over and above all actual and necessary expenses, said commission to be calcu- lated upon the par value of the bonds, notes, and coin handled. (Note. — The whole of section six could be discarded without interfering with the principal purpose of the bill.) Sect. 7. That all Acts or parts of Acts inconsistent here- with are hereby repealed. S. 3023 IN THE SENATE OF THE UNITED STATES January 7, 1908 Mr. Aldrich introduced the following biU; which was read twice and referred to the Committee on Finance. A BILL TO AMEND THE NATIONAL BANKING LAWS. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That any national banking association which has circulat- ing notes outstanding, secured by the deposit of United States bonds to an amount of not less than fifty per centum of its APPENDIX 343 capital stock, and which has a surplus of not less than twenty per centum, may make application to the Comptroller of the Currency for authority to issue additional circulating notes to be secured by the deposit of bonds other than bonds of the United States. The Comptroller of the Currency, if in his judgment business conditions demand such additional cir- culation and the condition of the association making the ap- pHcation warrants the issue, may approve such application and shall determine the time of issue and shall fix the amount, within the limitations hereinafter imposed, of such additional circulating notes to be issued. Whenever after receiving no- tice of such approval any such association shall deposit with the Treasurer or any assistant treasurer of the United States such of the bonds described in section two of this act as shall be approved in character and amount by the Treasurer of the United States and the Secretary of the Treasury, it shall be entitled to receive, upon the order the Comptroller of the Currency, circulating notes in blank, registered and counter- signed as provided by law, equal in amount to seventy-five per centum of the market value, as fixed by the Treasurer of the United States, of the bonds so deposited, such addi- tional circulating notes to be used, held, and treated in the same way as circulating notes of national banking associa- tions heretofore issued and secured by a deposit of United States bonds, and shall be subject to all the provisions of law affecting such notes: Provided, That the amount of such additional circulating notes dehvered at any time to any asso- ciation shall not in any case exceed the limit fixed for such issue by the Comptroller of the Currency: And provided fur- ther, That the total amount of circulating notes outstanding of any national banking association, secured by United States bonds or otherwise, shall not at any time exceed the amount of its unimpaired capital and surplus: And provided further, That there shall not be outstanding at any time circulating notes issued under the provisions of this Act to an amount of more than two hundred and fifty million dollars: And 344 APPENDIX provided further, That all acts and orders of the Comptroller of the Currency and the Treasurer of the United States author- ized by this section shall have the approval of the Secretary of the Treasury. Sect. 2. That the Treasurer of the United States, with the approval of the Secretary of the Treasury, may accept as security for the additional circulating notes provided for in the preceding section, bonds or other interest-bearing ob- ligations of any State of the United States, or any legally authorized bonds issued for municipal purposes by any city or county in the United States which has been in existence as a city or county for a period of fifteen years, and which for a period of ten years previous to such deposit has not defaulted in the payment of any part of either principal or interest of any funded debt authorized to be contracted by it, and which has at such date more than twenty thousand inhab- itants as established by the last national census, and whose net indebtedness does not exceed ten per centum of the valu- ation of the taxable property therein, to be ascertained by the last preceding valuation of property for the assessment of taxes: or the first-mortgage bonds of any railroad com- pany, not including street-railway bonds, which has paid dividends of not less than four per centum per annum reg- ularly and continuously on its entire capital stock for a period of not less than five years previous to the deposit of the bonds. The Treasurer of the United States, with the approval of the Secretary of the Treasury, may accept, for the purposes of this Act, securities herein enumerated in such proportions as he may from time to time determine, and he may at any time require the deposit of additional securities, or require any association to change the character of the securities already on deposit. Sect. 3. That all bonds deposited to secure circulating notes issued in accordance with the terms of this Act shall be transferred to the Treasurer of the United States in trust for the association depositing them, with a memorandum to that APPENDIX 345 efifect attached to or written or printed on each bond, and signed by the cashier or some other officer of the association making the deposit. A receipt shall be given to the associa- tion by the Comptroller of the Currency, or by a clerk ap- pointed by him for that purpose, stating that such bond is held in trust for the association on whose behalf the transfer is made, and as security for the redemption and payment of any circulating notes that have been or may be delivered to such association. No assignment or transfer of any such bond by the Treasurer shaU be deemed valid unless countersigned by the Comptroller of the Currency. The provisions of sec- tions fifty-one hundred and sixty-three, fifty-one hundred and sixty-four, fifty-one hundred and sixty-five, fifty-one hun- dred and sixty-six, fifty-one hundred and sixty-seven of the Revised Statutes respecting United States bonds deposited to secure circulating notes shall, except as herein modified, be appHcable to all bonds deposited under the terms of this Act. Sect. 4. That section fifty-two hundred and fourteen of the Revised Statutes, as amended, be further amended to read as follows: "Sect. 5214. National banking associations having on deposit bonds of the United States, bearing interest at the rate of two per centum per annum, including the bonds issued for the construction of the Panama Canal, imder the provi- sions of section eight of 'An Act to provide for the construc- tion of a canal connecting the waters of the Atlantic and Pacific oceans,' approved June twenty-eighth, nineteen hun- dred and two, to secure its circulating notes, shall pay to the Treasurer of the United States, in the months of January and July, a tax of one-fourth of one per centum each half year upon the average amount of such of its notes in circula- tion as are based upon the deposit of such bonds; and such associations having on deposit bonds bearing interest at a rate higher than two per centum per annum shall pay a tax of one-half per centum each half year upon the average amount of such of its notes in circulation as are based upon the 346 APPENDIX deposit of such bonds. National banking associations having on deposit bonds to secvire their circulating notes other than bonds of the United States shall pay a monthly tax of one-half of one per centum upon the average amount of such of their notes in circulation as are based upon the deposit of such bonds. Every national banking association having outstand- ing circulating notes secured by a deposit of bonds other than bonds of the United States shall make monthly returns, imder oath of its president or cashier, to the Treasurer of the United States, in such form as the Treasurer may prescribe, of the average monthly amount of its notes so secured in cir- culation. The taxes received on circulating notes secured by bonds other than bonds of the United States shall be paid into the Division of Redemption of the Treasury and credited to the reserve fund held for the redemption of the United States and other notes." Sect. 5. That section nine of the Act approved July tvsrelfth, eighteen hundred and eighty-two, as amended by the Act approved March fourth, nineteen hundred and seven, be fur- ther amended to read as follows: "Sect. g. That any national banking association desiring to withdraw its circulating notes, secured by deposit of United States bonds in the manner provided in section four of the Act approved June twentieth, eighteen hundred and seventy- four, is hereby authorized for that purpose to deposit lawful money with the Treasurer of the United States and, with the consent of the Comptroller of the Currency and the approval of the Secretary of the Treasury, to withdraw a proportional amount of bonds held as security for its circulating notes in the order of such deposits; and in .like manner and effect any such association desiring to withdraw any of its circulat- ing notes, secured by the deposit of bonds other than bonds of the United States, may make such withdrawal at any time by the deposit of lawful money or national bank notes with the Treasurer of the United States, and upon such deposit a proportionate share of the bonds so deposited may be with- APPENDIX 347 drawn: Provided, That the provisions of this section shall not apply to United States bonds called for redemption by the Secretary of the Treasury, not to withdrawal of circulating notes in consequence thereof." Sect. 6. That section fifty-one hundred and seventy-two of the Revised Statutes be, and the same is hereby, amended to read as follows: "Sect. 5172. In order to furnish suitable notes for cir- culation, the Comptroller of the Currency shall, under the direction of the Secretary of the Treasury, cause plates and dies to be engraved, in the best manner to guard against counterfeiting and fraudulent alterations, and shall have printed therefrom, and numbered, such quantity of circula- ting notes, in blank, of the denominations of five dollars, ten dollars, twenty dollars, fifty dollars, one hundred dollars, five hundred dollars, one thousand dollars, and ten thousand dol- lars, as may be required to supply the associations entitled to receive the same. Such notes shall state upon their face that they will be redeemed by the United States in lawful money upon presentation at the Treasury. This pledge shall be certified by the written or engraved signatures of the Treasurer and Register, and by the imprint of the seal of the Treasury. They shall also express upon their face the promise of the association receiving the same to pay on demand, attested by the signature of the president or vice- president and cashier. Upon request of any national bank- ing association the Comptroller of the Currency, under the direction of the Secretary of the Treasury, shall cause to be prepared circulating notes in blank, registered and counter- signed, as provided by law, to an amount equal to fifty per centum of the capital stock of such association; such notes to be deposited in the Treasury or the subtreasury of the United States nearest the place of business of the association making the request, and to be held for such association, subject to the order of the Comptroller of the Currency, for their deliv- ery as provided by law." 348 APPENDIX Sect. 7. That circulating notes of national banking as- sociations, when presented to the Treasury for redemption, as provided in section three of the Act approved June twen- tieth, eighteen hxmdred and seventy-four, shall be redeemed in lawful money of the United States. Sect. 8. That national banking associations located out- side of reserve or central reserve cities, which are now re- quired by law to keep a reserve equal to fifteen per centum of their deposit liabilities, shall hereafter hold at all times at least two-thirds of such reserve in lawful money. The pro- visions of section fifty-one hundred and ninety-one of the Re- vised Statutes, with reference to the reserves of national banking associations, shall not apply to deposits of public moneys by the United States in designated depositaries. S. 3026 IN THE SENATE OF THE UNITED STATES January 7, igo8 Mr. Culberson introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO amend section three of the act entitled "an act to amend the national banking act, and FOR other purposes," APPROVED MARCH FOURTH, NINE- TEEN HUNDRED AND SEVEN, AND FOR OTHER PURPOSES. Be it enacted by the Senate and the House of Representatives of the United States of America in Congress assembled: That section three of the Act entitled "An Act to amend the national banking Act, and for other purposes," approved March fourth, nineteen hundred and seven, be amended so as to read as follows: "Sect. 3. That section fifty-one hundred and fifty-three of the Revised Statutes be amended to read as follows: Sect. 5153. All national banking associations, designated APPENDIX 349 for that purpose by the Secretary of the Treasury, shall be depositaries of public money, under such regulations as may be prescribed by the Secretary; and they may also be employed as financial agents of the Government; and they shall perform all such reasonable duties, as depositaries of public money and financial agents of the Government, as may be required of them. The Secretary of the Treasury shall re- quire the associations thus designated to give satisfactory security, by the deposit of United States bonds and otherwise, for the safe-keeping and prompt payment of the public money deposited with them, and for the faithful performance of their duties as financial agents of the Government: Provided, That the Secretary shall, on or before the first of January of each year, make a public statement of the securities required dur- ing that year for such deposits. And every association so designated as receiver or depositary of the public money shall take and receive at par all of the national currency bills, by whatever association issued, which have been paid into the Government for internal revenue, or for loans or stocks: Provided, That the Secretary of the Treasury shall distribute the deposits herein provided for, as far as practicable, equi- tably between the different States and sections: Provided further, That whenever pubUc money is deposited in national banks under authority of this section, said banks shall pay to the United States interest on such deposits, to be collected by the Secretary of the Treasury, as follows: For the months of August, September, October, and November of each year at the rate of two per centum per annum; for the months of December, January, February, and March of each year at the rate of four per centum per annum; and for the months of April, May, June and July of each year at the rate of six per centum per annum." 350 APPENDIX s. 3472 IN THE SENATE OF THE UNITED STATES January 9, 1908 Mr. BuLKELEY introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO PROVIDE FOR EMERGENCY CIRCULATION OF NA- TIONAL BANKING ASSOCIATIONS. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That whenever, in the discretion of the Secretary of the Treasury, a necessity or emergency exists therefor, he may authorize any national banking association to receive from the Comptroller of the Currency, in such form and under such regulations as he may prescribe, circulating notes in blank, registered and countersigned as provided by law, equal in amount to the par value of bonds to be deposited with the Treasurer of the United States in the manner provided by existing law; such bonds to be deposited, in addition to United States bonds and Panama Canal bonds now authorized by law, may be the bonds of any State or county or of any city, town, or municipal corporation of not less than fifty thousand population, on which bonds the rate of interest is not less than three and one-half per centum per annum, and on which bonds there has never been default in the payment of either the principal or interest: Provided, That no bonds of any State or county or of any city, town, or municipal corporation shall be received for deposit that have defaulted in the pay- ment of either the principal or interest on any bonds previ- ously issued by them, the amount of such bonds so deposited not to exceed the capital stock paid in of any such banking institution: Provided further, That the aggregate amount of circulation of any banking association making such deposit shall not exceed the amount of its unimpaired capital: Pro- vided further, That the circulating notes furnished to national APPENDIX 351 banking associations under the provisions of this Act shall be of denominations prescribed by law, or of such other de- nominations or proportions as the Secretary of the Treasury, in his discretion, may prescribe, and subject, otherwise than herein prescribed, to existing laws governing such issue and circulation of the notes of national banking associations: Provided further, That any national banking association issu- ing any such circulating notes, which notes may be outstand- ing one year from the date of issue, shall pay a tax of ten per centum on such circulating notes outstanding, such tax to commence from the date of issue, and an additional tax of five per centum for every period of six months in excess of the one year such circulating notes may remain outstanding: Provided further, That any persons, firms, associations, cor- porations. State banks or State banking associations, and also every national banking association other than the bank of issue, shall pay a like tax of ten per centum on the amount of such notes so held, to commence from the date of issue, and a hke additional tax of five per centum for every period of six months in excess of the one year such circulating notes may have remained outstanding : Provided further. That the amount of such circulating notes and the tax due thereon shall be returned and the tax paid at the same time and in the same manner and with the like penalties as provided by law for the return and payment of taxes on deposits, capital, and circulation imposed by the existing conditions of internal- revenue law. 352 APPENDIX S. R. 25 IN THE SENATE OF THE UNITED STATES January 9, 1908 Mr. Clay introduced the following joint resolution; which was read twice and referred to the Committee on Finance. JOINT RESOLUTION for the issue of three hundred AND FIFTY MILLIONS OF TREASURY NOTES. Resolved by the Senate and House of Representatives of the United States of America in Congress assembled: That the Secretary of the Treasury be, and he is hereby, au- thorized and directed to issue on the credit of the United States the sum of three hundred and fifty millions of dollars of United States notes in addition to the United States notes now in circulation and authorized by law in such form as he may deem expedient, not bearing interest, payable to the bearer on demand, and of such denominations not less than one dollar, as he may prescribe, and such notes so issued shall be lawful money and a legal tender in the payment of all debts, public and private, within the United States. And said notes shall be deposited in depositories designated under existing law by the Secretary of the Treasury. The Secre- tary of the Treasury shall require the banking associations designated as depositories for said notes to give satisfactory security by the deposit of United States bonds, State, county, or municipal bonds for the safe keeping and prompt payment of the public money thus deposited and for the faithful per- formance of their duties as financial agents of the Govern- ment. And said depositories receiving any part of said sum shall pay to the Government of the United States interest on the amount so deposited of not less than five per centum. And the Secretary of the Treasury shall distribute the deposits herein provided for, as far as practicable, equitably between the different States and sections in proportion to population. APPENDIX S53 S. 3988 IN THE SENATE OF THE UNITED STATES January 15, 1908 Mr. Owen introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL PROVIDING A MEANS FOR THE INSURANCE OF THEIR DEPOSITS BY THE NATIONAL BANKING ASSOCIATIONS OF THE UNITED STATES AND THE EXPANSION OF A BOND- SECURED CURRENCY UNDER AN INTEREST CHARGE COM- PELLING THE CONTRACTION OF THE EXPANSION SO PROVIDED. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That from and after the passage of this Act the Comptroller of the Currency shall require the national banking associa- tions of the United States to pay into the Treasury of the United States a tax upon their deposits, as fixed by the ofiice of the Comptroller of the Currency, in a sum amply sufficient to provide a fund for the immediate payment of the depos- itors in full of any insolvent bank. Such fund shall be called the "liquidation fund," and from such fund, whenever a national bank is declared insolvent by the Comptroller of the Currency, the depositors of such bank shall be paid in full immediately from such "liquidation fund," and such liqui- dating bank be charged therewith. The net liquidated assets of such bank shall be deposited to the credit of the "liquida- tion fund" to the extent required to reimburse such fund the money advanced therefrom: Provided, That no deposit under contract to bear interest in excess of four per centum per annum on time or two per centum per annum on current account shall be included in the insurance provided by this Act, and such deposit shall not be paid out of the "liquida- tion fund" herein provided for. 354 APPENDIX Sect. 2. That the Secretary of the Treasury is hereby directed to prepare and keep on hand not less than one hun- dred miUion dollars of Treasury notes of the United States, to be kept in a special fund known as the " special circulation fund." Such notes may be advanced to any person or cor- poration upon proper seciurity of bonds belonging to the classes of bonds as fixed by law, and which are acceptable to the Comptroller of the Currency, and approved by the Secretary of the Treasury: Provided, That such advances shall not be in excess of eighty-five per centum of the market value of such bonds. That the Comptroller of the Currency, with the approval of the Secretary of the Treasury, may accept, as seciu-ity for the Treasury notes herein provided for, the bonds or other interest-bearing obligations of the United States or of any state of the United States, or any legally authorized bonds issued for municipal purposes by any city or county in the United States which has been in existence as a city or county for a period of fifteen years and which has never within that time defaulted in the payment of any part of the principal or interest of any such indebtedness authorized to be con- tracted by it and which has at such date more than twenty thousand inhabitants as established by the last national cen- sus and whose net indebtedness does not exceed ten per centum of valuation of the taxable property therein, to be ascertained by the last preceding valuation of property for the assessment of taxes. Such advances made from the "special circulation fund" shall be charged for at a rate of six per centum per annum for the first four months and thereafter at the rate of eight per centum per annum, not exceeding a total period of one year. In the event of the depreciation of the market value of such bonds, further security shall be required to preserve the margin of ten per centum, under penalty of sale of such securities on the open market. The advances made from such fund shall be repaid within twelve months, and in de- fault thereof the bonds shall be sold, and after the repayment APPENDIX 355 of the principal and interest of such advances and the cost of sale the balance shall be returned to the owner of such bonds. The amount of the special circulation notes in the Treasury shall at no time be allowed to diminish to a point of exhaustion. The interest accruing on the loan of such special circulation notes shall go into the "liquidation fund" hereinabove provided. S. io8 IN THE SENATE OF THE UNITED STATES December 4, 1907 Mr. Platt introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL TO PROTECT AND SUPPORT COMMERCIAL CREDIT, TO EQUALIZE RATES OF INTEREST, TO PROVIDE FOR THE IN- CORPORATION OF CLEARING HOUSES, TO REGULATE AND DEFINE THEIR OPERATIONS, TO PROVIDE A CLEARING- HOUSE CURRENCY SECURED BY PLEDGE OF COMMERCIAL ASSETS AND THE RESPONSIBILITY OF THE ASSOCIATED BANKS, AND TO PROVIDE FOR THE CIRCULATION AND RE- DEMPTION THEREOF. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: LOCAL NATIONAL CLEARING-HOUSE ASSOCIATIONS That associations to be known as national clearing houses, for the settlement of money transactions by efifecting clearances between banks and for doing other business for and between banks not inconsistent with the provisions of this Act, may be formed by any number of banks not less than five, duly in- corporated, either under the national-bank Act, or under the laws of any State of which a majority shall be organized under the national-bank Act, in any city or town of not less than six thousand inhabitants, who shall enter into articles of as- sociation for the regulation of the business of the association 356 APPENDIX and the conduct of its affairs, which said articles shall be approved by the stockholders of each bank uniting to form the association at a meeting called for the purpose, and shall be signed by the officers of each bank by authority conferred upon them to do so by vote of the stockholders, and a copy of them forwarded to the Comptroller of the Ciurency to be filed and preserved in his office. Sect. 2. That the banks uniting to form such an associa- tion shall, by their proper officers, make an organization cer- tificate, which shall specify — First. The name assumed by such association, which name shall be "The National Clearing House of " (giving the name of the city or town where locate and where its business of effecting clearances shall be carried on). Second. The names, the amounts of capital stock, and the number of shares into which it is divided of the banks composing the association. Third. A declaration that said certificate is made to enable such banks to avail themselves of the advantages of this Act. The said certificate shall be acknowledged before a judge of some court of record or a notary public, and such cer- tificate, with the acknowledgment thereof authenticated by the seal of such court or notary public, shall be transmitted to the Comptroller of the Currency, who shaU record and care- fully preserve the same in his office. Copies of such cer- tificate, duly certified by the Comptroller and authenticated by his seal of office, shall be legal and sufficient evidence in all courts and places within the United States or the juris- diction of the Government thereof of the existence of such association and of every other matter or thing which could be proved by the production of the original certificate. Sect. 3. That any banking association organized under the national-bank Act shall be entitled to membership in the clearing house of its locality organized under this Act on pre- senting to the said clearing house a certificate from the Comp- troller of the Currency that such an association has complied APPENDIX 357 with all the provisions to be complied with before commencing the business of banking, and that such association is author- ized to commence such business; and any banking associa- tion organized under the laws of any state shall be entitled to membership in the clearing house of its locality on pre- senting a Certificate from the superintendent of banking of said State that such association has complied with aE the pro- visions of the State law required to be complied with before commencing the business of banking, and that such associa- tion is authorized to commence such business; and any national or State bank in a locality in which there is no clearing association organized under this Act may be assigned to membership in the nearest or most convenient clearing-house association by the clearing house of issue of its State or Dis- trict hereinafter provided for in section nine of this Act: Pro- vided, That such State or Territorial banking associations shall maintain reserves as provided in sections ninety-four to one one hundred and five inclusive, of chapter five of the national- bank Act, as amended, or in any other part thereof. Sect. 4. That every association formed pursuant to the provisions of this Act shall, from the date of the execution of its organization certificate, be a body corporate, but shall transact no business except such as may be incidental to its organization, and necessarily preliminary, until authorized by the Comptroller of the Currency to commence the business of effecting clearances. Such association shall have power to adopt a corporate seal, and shall have succession by the name designated in its organization certificate for a period of twenty years from its organization, unless sooner dissolved according to the provisions of its articles of association or by the act of the banks owning two-thirds of the capital stock represented in the association, or unless the franchise shall be forfeited by a violation of this Act. By such name it may make contracts, sue and be sued, complain and defend in any court of law or equity as fully as natural persons. It may elect or appoint directors, and by its board of directors 358 APPENDIX appoint a president, vice-president, treasurer, and other of- ficers, define their duties, require bonds of them, and fix the penalty thereof; dismiss said ofi&cers, or any of them, at pleas- ure, appoint others to fill their places, and exercise under this Act all such incidental powers as shall be necessary to carry on the business of a clearing house for the settlement of money transactions by the mutual set-ofi of debits and credits, com- monly called making clearances for banks, and act for the members of the association in their united capacity when authorized to do so by a majority vote of said members; and its board of directors shall have power to define and regulate by by-laws not inconsistent with the provisions of this Act the manner in which its directors shall be elected or appointed, its oflScers appointed, its property transferred, its general business conducted, and all the privileges granted by this Act to associations organized under it shall be exercised and en- joyed; and its usual business shall be transacted at an office or banking house located in the place specified in its organ- ization certificate. • NATIONAL CLEARING HOUSES OF ISSUE Sect. 9. That the national clearing-house association organized under this Act, in the chief commercial city in each State, or in the city most central and convenient for business in each State, or any clearing house so organized effecting bank clearings of over five hundred and twenty million dol- lars annually, to be designated and approved by the Secre- tary of the Treasury, shall be made a clearing house of issue. And if there shall be more than one national clearing house of issue in a State, then the Secretary of the Treasury shall divide the State into a like number of clearing-house districts which shall be convenient for the business tributary to each clearing house of issue. The Secretary of the Treasury shall authorize the organization of a national clearing house of issue in any State or Territory in which there may not be a APPENDIX 359 city or town having five banks duly incorporated under either the national-bank Act or under the laws of said State, and shall fix the location of same: Provided, That said national clearing house of issue shall be composed of not less than ten banks, none of whom shall have a capital less than the min- imum amount authorized by the national-bank Act and a majority of whom shall be organized imder said national- bank Act. Banks in each State or District shall transact the business described in section ten of this Act only with the national clearing houses of issue in their State or District. At the annual meeting of the national clearing houses of issues there shall be elected a loan committee, whose duties shall be as described in sections ten and eleven of this Act. The loan committee shall be composed of six members, who shall be directors in banks which are members of any of the local national clearing-house associations or of the national clearing house of issue of the State or District. They shall be elected by a majority vote of the bank members of the na- tional clearing houses in the State or District present or rep- resented by proxy at the annual meeting. Each bank member shall be entitled to one vote for each one thousand dollars of its capital stock, which votes may be cast by a duly cer- tified oflacer of the bank in person or by proxy, duly attested by the bank. Members of this committee shall not be eli- gible for reelection until one year after their terms of office shall have expired. They shall be divided into three classes at their first election; one-third shall serve one year, one- third two years, and one-third three years, and at every elec- tion thereafter they shall be elected for a term of three years. Sect. io. That every clearing house of issue organized under this Act shall be authorized and empowered to obtain from the Comptroller of the Currency and issue to banks composing the national clearing-house associations within its State or District notes to be circulated as money in accord- ance with the provisions of this Act, and to act as trustees by receiving from bank members, and holding in trust in 360 APPENDIX accordance with the provisions of this Act, securities pledged by said bank members as collateral to the circulating notes issued to them. The collateral securities which a national clearing house of issue may receive from its bank members, or from any bank member of a clearing house within its State or District, shall consist of commercial assets, promissory notes, bills of exchange, convertible bonds and stocks, and other securities and evidences of debt. On the approval of the loan and appraisement of the value of said commercial assets by its loan committee, the said clearing house of issue may deliver to said bank member seventy-five per centum of said value in its said circulating notes as an advance upon said pledged property, and shall require from said bank mem- ber its promissory note of equal amount, which note shall be in form as approved by said clearing house of issue. The bank member taking said circulating notes shall en- gage to redeem them in lawful money of the United States at all times upon demand of payment duly made during the usual hours of business at the office of such bank mem- ber, and also when called upon to do so by the clearing house issuing the notes, and to maintain with its clearing house of issue a five per centum reserve fund, as provided in section thirteen of this Act, and to give any additional collateral needed to restore any depreciation in the value of the assets pledged, on demand. On failure to comply with such de- mands before the close of business hours of the day when made, said bank member shall be adjudged in default, and shall be thereupon closed pending an examination by a com- mittee from the association which issued the notes. On recommendation by the examining committee the loan com- mittee shall proceed to liquidate the loan by turning the securities into cash, in accordance with the method provided in section eleven. The bank member taking said notes may release its secur- ities from pledge by depositing with the said clearing house of issue clearing-house currency, United States legal-tender APPENDIX 361 notes, coin, or coin certificates, with any charges made by said clearing house of issue, whereupon it shall be entitled to and shall receive all its securities so pledged. The charges shall be regulated by each national clearing house of issue. Upon the receipt of such deposit the national clearing house of issue shall immediately give notice in a newspaper pub- lished in the city, town, or county in which the association is located, which notice shall be published at least once a week for six months successively, that the notes of such bank member will be redeemed at par and that the circulating notes of such bank member must be so presented for redemp- tion within six years from the date of such notice; and all notes which shall not be thus presented for redemption and payment within the time specified in such notice shall cease to be a charge upon the funds in the hands of the national clearing house of issue for that purpose. At the expiration of such notice it shall be lawful for the national clearing house of issue to surrender and such bank member or its legal rep- resentative shall be entitled to receive all the money remain- ing after such redemption, except so much thereof as may be necessary to pay the reasonable expenses chargeable against the said accounts, including the payment for the publication of the above-mentioned notices. All circulating notes which shall be thus redeemed either by the national clearing house of issue or by the bank mem- ber shall be burned to ashes in the presence of three persons, one to be appointed by the Comptroller of the Currency, one by the national clearing house of issue, and one by the bank member on whose account they were issued; and a cer- tificate of such burning shall be made on the books of the national clearing house of issue and duplicates forwarded to the Comptroller of the Currency and to the bank member whose notes are thus cremated. Sect. ii. That each bank member taking such circulating notes shall guarantee the national clearing house of issue from loss resulting from such issue to them, and in case of a default 362 APPENDIX in the payment of a loan when demanded by the national clearing house of issue or of a default arising in any other manner, then it shall be the duty of said clearing house of issue to levy upon all the national clearing houses in said State or District, in proportion to the capital of their bank members, a suflScient sum to provide for the payment of said loan, which sum shall be held for the payment and redemp- tion of the circulating notes so issued. And if enough money cannot be obtained by such assessments, then it shall be the duty of said national clearing house of issue to report to the Comptroller of the Currency the fact of said default, and it shall be his duty to levy a further assessment upon all the clearing houses organized under this Act in all the States until such sum is secured, in which case the funds so raised by the Comptroller shall be paid by him to the Treasurer of the United States as a special fund to pay the circulating notes of the defaulting bank member: and he shall appoint a receiver for the collateral securities to the loan or loans in default, who shall take possession thereof and turn them into cash and distribute the proceeds to the banks which have contrib- uted to the assessment, and any surplus after reimbursing them their advances shall be handed over to the bank mem- ber in default or its legal representative. But if the assessment by the clearing house of issue on the banks of its State or District is sufficient to provide the needed funds, then the collaterals shall be administered upon and turned into cash by the loan committee or by a liquidating committee of said clearing house of issue, and the cash pro- ceeds shall be appropriated as above provided. At no time shall the total amount of such notes issued to any bank mem- ber exceed the amount at such time actually paid in of the capital stock of the bank member so applying. And said loan committee are charged with the duty of supervising said loans so as to maintain the margin of the value of the collat- eral security, and shall demand additional securities to make good any depreciation in their value, and they may allow APPENDIX 363 withdrawals and substitutions of securities which shall not diminish the said value. Sect. 12. That a national clearing house of issue shall be authorized and empowered to receive from its bank members gold coin of the United States of full weight and may deliver to said bank member its circulating notes of the par value of the gold coin so deposited, which notes shall indicate on their face that they are gold notes, and the said bank mem- ber shall engage to redeem said circulating notes at all times when called upon to do so by the association issuing them or on demand by the holder thereof at its office during the usual hours of business. Such gold notes may be issued to any bank member in exchange for gold coin without regard to the amount of the capital stock of the bank depositing the gold coin. Such notes issued against the deposit of gold coin may be held by any bank as a part of its lawful reserve. The clearing house of issue shall make report of gold notes so issued to the Comptroller of the Currency, and shall make no charges except for storage for the issue of its notes against the deposit of gold. Sect. 13. That every bank member of every association organized or to be organized under this Act shall at all times keep and have on deposit with its clearing house of issue as a reserve fund a sum in lawful money of the United States equal to five per centum of its circulating notes issued under this Act, excepting that no reserve fund shall be required against gold notes. Such five per centum reserve fund shall be held and used by the clearing house of issue for the redemption of the circulation issued to such bank member and the sum thereof shall be counted as part of its lawful reserve, and when the circulating notes of any such bank member shall be pre- sented to its clearing house of issue for redemption, the same shall be redeemed in lawful money of the United States. All notes so redeemed shall be charged to the bank member for whose account they were issued, and upon receipt of notice of such redemptions such bank member so notified shall 364 APPENDIX forthwith deposit with its clearing house of issue a sum in lawful money of the United States equal to the amount of its circulating notes so redeemed. If any such notes are worn, mutilated, defaced, or rendered otherwise unfit for use, they shall be destroyed and replaced by new, as provided in section fifteen of this Act. And when such redemptions have been so reimbursed, the circulating notes so redeemed and the new notes issued in place of those destroyed shall be forwarded to the respective bank members on whose account they were issued. S. 547 IN THE SENATE OF THE UNITED STATES December 4, 1907 M. Hansbrough introduced the following bill; which was read twice and referred to the Committee on Finance. A BILL PROVIDING FOR THE ESTABLISHMENT OE THE CEN- TRAL NATIONAL BANK OF THE UNITED STATES, AND FOR OTHER PURPOSES. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That there shall be established in the city of Chicago, State of Illinois, the Central National Bank of the United States, with a capital stock of ten per centum of the aggregate capital of all national banks. The said Central National Bank of the United States shall commence business on the first day of July, nineteen hundred and eight, and cease to exist on the thirtieth day of June, nineteen hundred and fifty-eight. Congress may extend the life of the bank beyond the date last named. The stock of said bank shall be non-negotiable and non- assignable, and shall be resold to the United States at par in case of the failure or hquidation of any bank owning the same. Any stock so repurchased by the United States shall APPENDIX 365 be held in the Treasury as an asset to be resold to any national bank afterwards organized under existing law. The Secretary of the Treasury, the Comptroller of the Currency, the Treasurer of the United States, and the Director of the Mint are hereby directed to organize the Central Na- tional Bank of the United States in accordance with the pro- visions of this Act. Sect. 2. That any national bank may subscribe to the capital stock of the Central National Bank of the United States in the amount of ten per centum of the capital stock of the subscribing bank, and the stock so subscribed may, in the discretion of the Secretary of the Treasury, be counted as a part of the reserve fund of said bank. Sect. 3. That of that portion of the lawful reserves of na- tional banks which is authorized by existing law to be depos- ited in national banks of reserve and central reserve cities one-half may be deposited in the Central National Bank of the United States: Provided, That the said Central National Bank of the United States is hereby prohibited from paying interest on deposits except on deposits of the United States. Sect. 5. That the general council by a vote of fifteen of its members at any regular or special meeting may issue the demand notes of the Central National Bank of the United States in the form of currency, secured by the bills receivable or bonds owned by said bank, to an amount not exceeding three hundred million dollars, to be paid out from time to time as circumstances require. All notes issued by the said general council shall be redeemable on demand at the prin- cipal office of said bank or at any of its branches in gold coin. United States notes, gold certificates, or silver certificates, and when so redeemed and paid shall be canceled and de- stroyed. The general council may, in cases of unusual emergency, authorize the issue of notes in excess of the three hundred million dollars herein provided for, and all such excess issues shall be secured in full by gold deposited with the Treasmrer APPENDIX of the United States. A tax at the rate of one-eighth of one per centum per annum shall be paid by the bank to the United States Government upon its circulating notes during the time the said notes are in use. All notes issued shall be printed by the Bureau of Engraving and Printing at the expense of the bank and delivered to the Comptroller of the Currency, who shall in turn deliver them to the officers of the bank and take their receipt therefor. Sect. 6. That the Central National Bank of the United States may buy and sell foreign and domestic exchange; deal in gold and silver bullion, or advance cash upon the same. It may loan upon municipal, county. State, and such other high-grade bonds as have not defaulted in interest payments, during the preceding five years, but no loan upon this class of security shall exceed forty per centum of the market value of the same. It may advance money to solvent borrowers, secured upon grain or cotton in elevators or warehouses at terminal railroad points, when the said elevators or ware- houses are under State supervision, at sixty per centum of their market value. The said bank may advance money to the Government of the United States at such rate of interest as may be agreed upon between the members of the general council of said bank and the Secretary of the Treasury. It may rediscount for solvent national or State banks and make loans to the same upon satisfactory securities. It may also buy or sell United States bonds and such other high-class bonds and securities as may be acceptable to the general coun- cil or to any committee thereof specially designated by the general council to pass upon the same. It shall not loan upon real estate, mortgages on real estate, or the capital stock of national or State banks or trust companies, nor shall it pur- chase or discount bills of exchange on foreign countries, unless the same be secured by grain, cotton, or other convert- ible property, or by at least three reputable and solvent signers in good standing, or by a solvent incorporated bank. No loans APfENDiX S67 or discounts shall be made by said bank which have longer than one hundred and twenty days to run after date of pur- chase or discount by said bank. It shall at all times keep on hand in United States gold coin or any gold or silver certificates or in United States notes a sum equal to forty per centum of its demand deposits. Sect. 7. That from the net earnings or profits of the Cen- tral National Bank of the United States in any one year a dividend of four per centum may be paid to the stockholders. Any excess profits equal to two per centum of the capital stock of the bank shall be set aside for a surplus fund of the bank, and any further excess, amounting to not less than two per centum of the capital, shall be divided equally between the Treasury of the United States and the shareholders of the Central National Bank of the United States. Sect. 8. That the Comptroller of the Currency shall appoint four inspectors skilled in accounting and credits, who shall make examination of the said bank and its branches as often as in the judgment of the Comptroller it may be necessary, the said inspectors to report to the Comptroller the condition of the bank and its various branches, showing the amount of loans, their character, reserve on hand, and its general con- dition, and the reports of the said inspectors shall be published at least once each week in at least two daily newspapers in the city of Chicago. Sect. 9. That the general council shall have authority, with the approval of the Secretary of the Treasury, to estab- hsh branches of the Central National Bank in any reserve or central reserve city, and at such other points as may be deemed advisable in the judgment of the general council, with the approval of the Secretary of the Treasury. Sect. 10. That the by-laws of the Central National Bank of the United States shall be prepared by the governor of the bank, to be approved by the general council and the Secre- tary of the Treasury. S68 APPENDIX H. R. 13845 IN THE HOUSE OF REPRESENTATIVES January 15, 1908 Mr. FoRNES introduced the following bill; which was referred to the Committee on Banking and Currency and ordered to be printed. A BILL PROVIDING FOR THE ESTABLISHMENT OF THE UNITED STATES NATIONAL BANK OF AMERICA, IN THE CITY OF WASHINGTON, DISTRICT OF COLUMBIA. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled: That there shall be established in the city of Washington, District of Columbia, the United States National Bank of America, with a capital of one hundred million dollars, consisting of one hundred thousand shares of stock at one thousand dollars a share, to be disposed of in the following manner: The United States Treasury to purchase, at par, three-fifths of said stock, the funds for said purchase and ownership to be derived from the sale of sixty million dollars of United States gold bonds, payable in fifty years, and bear- ing an interest at the rate of three per centum per annum, and to be designated "United States currency bonds"; the remaining two-fifths of the said shares of stock may be offered at not less than par to the national banks, each in pro- portion to the total of its combined capital and surplus at the time of the purchase of said shares of stock, and to be paid for in gold coin: Provided, That if said shares of stock are sold at a premium, said premium shall be credited to the sur- plus account of the United States National Bank of America. Sect. 2. That the said United States National Bank of America shall commence business on the first day of Sep- tember in the year nineteen hundred and eight, and shall cease to exist on the first day of September in the year nineteen hundred and fifty-eight: Provided, That Congress may at any APPENDIX 369 time extend the life of the said United States National Bank of America beyond the day and date last named in this Act. Sect. 3. That a branch of the said United States National Bank of America shall be established and maintained in each of the hereinafter named cities, which are hereby designated "Central reserve cities": The city of New York, in the State of New York; the city of Chicago, in the State of Illinois; the city of New Orleans, in the State of Louisiana; the city of Boston, in the State of Massachusetts; the city of Denver, in the State of Colorado; the city of Saint Louis, in the State of Missouri; the city of Atlanta, in the State of Georgia; the city of San Francisco, in the State of California; the city of Cincinnati, in the State of Ohio the city of Portland, in the State of Oregon. Sect. 10. That the United States National Bank of Amer- ica, or any of its branches, shall not participate in any syn- dicate or underwritings, and no member of the board, officer or employee of the United States^^Jatioaah'Bank of America, or any of its branches, shalljse^ermitted, either as individuals, or members of a firm, or members of a corporation, to borrow the funds from the said United States National Bank of Amer- ica, or any of its branche*^ Any violation of this provision shall be punishable by i^,pJfeonment for not less than ten years, and a fine of not less than five thousand dollars for each offense. Sect. ii. That upon the organization of the United States National Bank of America, as provided for in this Act, it shaU issue one hundred million of dollars demand notes in the form of currency as printed according to law, and they shall be redeemable on demand, in gold coin, at the United States National Bank of America, or any of its branches. The capital of the United States National Bank of America, as provided for in this Act, shall be used for the redemption of said demand notes. That any commercial bank, char- tered or incorporated according to the Federal or State laws 370 APPENDIX with an unimpaired capital and a surplus of not less than twenty-five per centum of its capital, shall have the privilege to obtain for legitimate business of such bank such an amount of the notes of the United States National Bank of America as the board of directors may approve upon the payment of one-eighth of one per centum tax on the amount, and thereafter interest at the rate of fom- per centum per annum for the time such notes are retained, not to exceed one year at any one time, and upon depositing with the United States National Bank of America a sufficient amount of security on the basis of ninety per centum of their par value, such securities to be of not less than par value, when offered, and of the class which are a legal investment for the savings banks of the State of New York, or the State of Massachusetts, or either of these States: Provided, however, That no real estate secmty, or securities, shall be accepted. The security, or securities, shall be re- turned to said depository bank when the amount of the bank notes are returned to the United States National Bank of America, or any of its branches, and the interest thereon paid for the period of the retention of them. Sect. 12. That the board of directors may, by a vote of twenty of its members, issue additional notes of the United States National Bank of America in any amount not exceed- ing four hundred millions of dollars. Said notes to be avail- able for the business of the banks named in section ten of this Act upon the same class of securities and percentage basis thereof, but the amount so granted shall not exceed fifty per centum of the capital of the bank entitled to such notes, and the terms for such demands shall be the tax, as designated in section ten of this Act, and interest at the rate of six per centum per annum for the first amount of ten per centum of the capital of the bank so granted, seven per centum per annum on the second amount of ten per centum of the cap- ital of the bank so granted, eight per centum per annum on the third amount of ten per centum of the capital of the bank so granted, nine per centum per annum on the fourth amount APPENDIX 371 of ten per centum of the capital of the bank so granted, and ten per centum per annum on the fifth amount of ten per centum of the capital of the bank so granted. The re- turn of the securities and payment of the interest shall be as described in section ten of this Act. It may rediscount, for banks named in section ten of this Act, for a period not ex- ceeding three months, and when said bank indorses such paper and gives satisfactory security. It may advance money to and receive deposits from the Government of the United States at such rate of interest as may be established by the board of directors with the Government. Sect. 13. That the Comptroller of the Currency, with the approval of the board of directors, shall appoint a sufii- cient number of fully qualified inspectors whose duty it shall be to carefully inspect and report to the board of directors the solvency and legahty of the business methods of any bank having or desiring to have business relation of whatever nature with the United States National Bank of America or any of its branches. Such inspections to be made at least twice in each and every year during such business relation, or whenever the Comptroller of the Currency may direct, or at the request of the board of directors. That the salary and allowances of such inspector shall be fixed by the board of directors.